What's the difference between capital and operating cost?

From the The Money Files Blog
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A blog that looks at all aspects of project and program finances from budgets, estimating and accounting to getting a pay rise and managing contracts. Written by Elizabeth Harrin from GirlsGuideToPM.com.

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For those of you who prefer reading or can't see the video, here is the transcript:

Today, I want to talk about capital expenditure which you might know as capex and operating expenditure which you might know as opex. And I want to explain the differences between these two different types of money, the way that the money is categorized which will hopefully give you an idea of what you need to be looking for when you’re preparing project budgets.

So, capital expenditure or capex is money that is allocated for buying things, physical things. So in an IT environment, that could be PCs. It could be servers. It could be the engineering time required to bring an asset into service. So really, capital is about assets, things that company can actually tangibly own and will keep.

Operating expenditure on the other hand is more about labor costs. It’s transient expense that is used to keep the operation running. Hence, its name. So operating expenditure on a project might be things like travel expenses or a training budget or hiring a room for a meeting, or providing sandwiches and a working lunch for your team.

So the way that finance departments categorize money tends to be either as capital or as opex. And you may find that as a project, you end up with two different budgets. So while at the end of the day, it’s all money that leaves our bank accounts or our company’s bank accounts, the way that finance departments need to account for it is different because if you’re buying an asset, assets depreciate in value. So if you’re buying a car for example at home, you might buy a car today for a particular cost and if you sell it again in 3 years, it will actually be worth less. It’s still worth something but it’s worth less than what you paid for it today. And that’s depreciation. So the cost of the asset devalues over time. And accounting departments need to take that into account when they’re looking at what assets a project has purchased.

With operating expenditure though, it’s gone. You hire a room. You eat some sandwiches. You pay for a training course. And at the end of the day, you may have something left in terms of knowledge transfer or a successful outcome but you actually don’t have a tangible asset that adds value to the organization.

So at the end of the day as I say, it’s the same cash that leaves the company but you need to talk to your finance department about how they determine the categorization. Because some companies may decide that certain costs can be capitalized and others may decide that actually that isn’t within their regulations and they want to count that particular expense as an opex charge.

So talk to your finance department when you start working out your budget for your project and see how they determine within finite detail the difference between opex and capex. You’ll then be able to look at your two budgets and you may just find that you end up with two capital budgets and opex is handled somewhere else, perhaps in the running of the department or perhaps in the running of the department that you are delivering a project to.

Once you understand the differences, once you understand what money has been allocated to you as a project manager to manage, you’ll be better placed to start asking intelligent questions around whether a particular piece of equipment you want to buy or a particular thing that you want to do is counted as capital and opex and you’ll know who to ask in order to be able to process those charges effectively.

Posted on: May 05, 2011 02:13 PM | Permalink

Comments (4)

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Good video and transcript, Elizabeth. A PM needs to distinguish clearly between CAPEX and OPEX. In some organizations, PMs regularly track the operating costs and do not have a clear view into Capital costs and their depreciation. Software acquistion as part of an IT project often becomes as asset for the project, department and organization. Like you had said, the Finance/Accounting department will be able to guide you in properly allocating capital cost for your project in such cases.

It's difficult to give prescriptive rules because different companies have different approaches to splitting costs. I have actually found that capital costs are tracked more regularly than opex costs, which tend to be managed as part of the 'overhead' for running the business. So it is interesting to hear your view, which is the opposite! It just shows that different country and company rules create different situations for us all, and that the only way to know what the best thing is to do, is to ask.

As rightly stated the best people to advise about this is always the Finance department. One good example is cost of pre-feasibility study for a capital project - my view is it should be a capital cost. Would be interesting to hear others.

I'd agree that feasibility should be capitalised if it's for a capital project, but I know accounting rules around the world prioritise slightly different things so I would always turn to the Finance department for the final decision.

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