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Capex vs Opex - Two ways to show your investment in digital.
When it comes to business expenditure it's very much the good, the bad and ugly depending on which side of the fence you sit and what day it is. If you run a small business or work in accounts, then you can quit reading now as I’m not planning on teaching you all how to suck eggs. However, if you work for a brand, in the marketing or technology teams, this basic advice can help you reframe your budgets, justify greater investment for projects you want to drive forward and even recalculate your ROI models.
As people progress through their careers some financial data stands out as being useful for the journey ahead. Knowing enough to navigate everything from the P&L to the EBITDA will come in handy as you become more commercially minded but when it comes to planning and investing in digital and the most common websites and apps, one pair of terms stand out.
Capital Expenditure (CapEx) vs Operational Expenditure (OpEx)
Clearly both mean money out of the door and you could argue that whether you choose one or the other (hence the vs), either way, it is going to cost you. But if you think very carefully and plan ahead, the choice you make could not only cost less but be the difference between seizing an opportunity or missing it. There are pros and cons with both so proceed carefully and pump some strategic thought into how you treat the systems and services you’re buying.
Let’s keep it super simple and useful starting with some definitions.
Capex is incurred by a business when it purchases a new asset (let’s say a piece of software/hardware) or through an upgrade, thereby increasing the value of the existing asset, and thereby adds to the overall value of the Company. In both cases, the asset will have a value and continue to be worth something after a year or more; at the end of its expected lifespan with your business. The initial cost of this asset will be shown on your Balance Sheet as will its depreciation, usually monthly, as it reduces in value over time.
Opex is a different beast and covers any expenditure incurred in the day to day operation of a business. Unlike Capex, it has an immediate effect on the balance of your Profit and Loss. You can always treat the purchase of an asset as if it were an operational expense, but slow down and think about this as it's not going to be cost-effective.
Here some clear examples:
If I want to buy property for my business this is Capex. Clearly, it’s an asset to the business and therefore adds to the overall value of the business. Consequently, this should be treated differently to its equivalent in monthly rent or lease costs because these are Opex - they affect the profit in the year but do not add to the value of the business.
Same applies for tech. Buying a new laptop would be Capex. The laptop has residual value and a lifespan of more than a year. Alternatively, I can lease the same equipment but it’ll never be mine so it is classed as Opex.
Be warned though, it can get blurry! Sometimes, it’s not quite as clear cut as the examples above because you need to make a judgement call on thresholds for your type of business. For example, on equipment, a £50 keyboard would usually be considered as Opex. It is tangible and likely to last more than a year but the second-hand value will be minimal and so it would be misleading to make it a CapEx purchase and claim that it adds value to the business.
The cost of developing your own software programs, even if not obviously physical, would likely be a Capex, as it shows clear value to the business and can be used in the future. Like the property example above though, if it's someone else’s software i.e. a SaaS subscription-like Slack or Gmail, then your subscription is OpEx - it’s just a cost and doesn’t add value to the business.
To put it simply: Capex will add to the value of a business in the future. Opex is today.
Expenditure and tax liability
As you can imagine by the examples I’ve shared, Capex and Opex are treated differently in respect of Tax.
By taking advantage of something called the AIA (Annual Investment Allowance) you can claim the full cost of buying assets, against your profits thereby reducing your tax bill significantly.
Assets include buying software and apps. Even if you recharge the cost to your client, as long as you retain ownership it is considered an asset to your business. Not Monthly software subscriptions though, because you do not own it, therefore subscriptions fall under Opex.
You can also allow for and spread the price of the assets you buy, including vehicles or websites/ecommerce sites that you have built for you, over a number of years.
The timespan obviously depends on the nature of the asset but this is particularly useful if:
a) your asset value is more than the AIA annual allowance; currently £1m.
b) you want to spread your tax allowance, and reduce your tax bill over a number of years.
c) your annual profit is lower than the tax you are reclaiming.
Using either of these schemes does mean that if you decide to sell on the asset during a year where you’ve claimed tax allowance, you’ll have to repay what was claimed on a pro-rata basis in line with its value and length of ownership.
Basically, if the cost of your asset expenditure in a year is more than your profit, then it would be more cost-effective to spread and offset the expenditure over a longer period. This would also reduce your Company’s Tax obligations over a longer period. If you ‘write off’ its whole cost in a single year then remember you’ll only get tax advantage in that first year and only against the profit you make.
It’s always worth taking the AIA and tax allowances into consideration. As with all Government legislation, the rules are complicated, so double check before making decisions.
Now we know as an agency that within brands you’ll actively have a finance team hopefully helping you make your budgets go further. However, when it comes to digital you’d be surprised at the options available and the techniques which can come into play when creating assets and developing innovations both in technology and process.
Remember your website and associated apps are all assets and therefore should be treated like one both in their development and roadmap but also on the brand's balance sheet. On top of this If you have experts working on your digital assets, then you can include them in your annual R&D claim, but that’s another layer of detail that can wait.
If you want to talk about buying world class digital support cost-effectively then drop us a line.