WHAT IS THE INVESTMENT PLAN OF A COMPANY=CAPEX
It is defined as the cash flow allocated for the investment plan, known as “CAPEX” (Capital Expenditures). The assets of a company can be categorized as current assets (less than 1 year) and non-current assets (more than 1 year).
The cash flow that the company invest in non-current assets is the CAPEX, and by definition, the non-current assets are those assets that will be held more than a year in the company (usually the operating cycle in accounting is defined as short-term, less than a year). Non-current assets are considered the fixed infrastructure of the company, and without them, it would not be possible to manufacture and sell the products or services of the company. The CAPEX is very important as somehow establishes the foundations for building manufacturing capacity for the future, that will allow to increase sales.
The non-current assets «NCA» can be classified as: (I) Tangible (land, vehicles, furniture, buildings, computers, machinery, etc); (II) Intangible (trademarks, goodwill, patents, software developed by a company); (III) Long-term financial assets (financial products owned by the company, with the idea to remain these assets in the company for the long run, such as shares of another company).
Imagine that company “A” has an investment plan, CAPEX, of €50 millions to build a hotel resort in Aruba or an IT company that invest $200 millions in the 4G internet infrastructure.
There are different types of CAPEX, mainly:
- Replacement CAPEX: Cash invested in NCA to maintain the current production level.
- Growth CAPEX: Cash invested in NCA to expand the current production level.
- Efficiency CAPEX: Cash invested in NCA to increase the efficiency of the current NCA.
- Socially Responsible CAPEX: Cash invested in the environment (i.e. reduce the environmental impact of a mining facility).
The non-current assets loss value every year, and this loss of value is accounted by the Depreciation and Amortization, quoted as «D&A». There are different types of D&A, but the most common one is the linear D&A, where the NCA loss value at the same pace every year. It is key to understand that CAPEX means there is a cash-outlay (money goes out of the company to purchase the non-current assets) but the D&A does not mean a cash-outlay. The D&A is an accounting item from the Profit and Loss Account (P&L) that accounts for an expense and decreases the Earning Before Taxes (EBT), decreasing the tax bill of a company.
The D&A is calculated as follows: [Gross Book Value – Residual Value of the Asset at the end of the life span] / Expected lifespan. The NCAs usually have a Residual Value of zero at the end of the lifespan.
When discussing about non-current assets, we must define:
- Gross Book Value («GBV»): It includes all the cost items from purchasing of the asset to have it fully operational. For example, imagine Apple is purchasing a automatic insertion robot for $10 millions in Japan, the transportation costs to Europe are $10,000, import duties $1 million and installation cost of the robot in the factory $990,000. The gross book value of the non-current asset would be $12 millions and the CAPEX amount $12 millions too.
- If the expected life of the robot is 10 years with a residual value of zero at the end of the lifespan, the yearly D&A would be $12 millions/10 years= $1.2 millions per year.
Once we know de GBV and the D&A, we must build the amortization table of the non-current assets that have the following items:
- Gross Book Value, GBV.
- Yearly Depreciation and Amortization, D&A. It is the value that is accounted in the Profit and Loss Account of the company.
- Accumulated D&A. It is the accumulated life of the non-current asset. Please note that this amount is not saved as cash-flow anywhere in the company.
- Net Book Value, NBV. It is defined as the accounting value of the non-current asset that is recorded in the balance sheet of the company.
Let’s build the amortization table for the example explained above:
AMORTIZATION TABLE OF THE NON-CURRENT ASSET: AUTOMATIC INSERTION A/I ROBOT
The % remaining life of the NCA is a key metric, as it is not the same to buy a company where its NCAs are fairly new (value close to 80-90%) or quite old (% remaining life 10%). Imagine a company that is bought by an investor group that pays $1,000 millions and assets with a 100% remaining life (lifespan 10 years) and GBV of $200 millions, or the same transaction, where the company pays $1,000 millions but with a 10% remaining life. This would mean that the buyer should invest another extra cash of $180 millions to renew the non-current assets of the company.
Please note that all the non-current assets have a expected lifespan and D&A, except the «land», that has a D&A value of zero, and therefore the GBV=NBV.
The expected lifespan of the non-current assets can be calculated using the Tax Authorities Tables of each country or the expected life defined by the Accounting standards.
If we define the Tax Authorities Tables, the lifespan of the assets must meet the following 2 criteria:
- The total number of years chosen as lifespan should not be higher than the lifespan defined in the table.
- The yearly D&A expressed as %, cannot be greater that the value defined in the table.
- If the selected lifespan meet both criteria 1+2, the expected lifespan can be chosen.
USEFUL LIFESPAN OF NON-CURRENT ASSETS ACCORDING TO THE SPANISH TAX AUTHORITIES
Let’s imagine we are developing a patent (intangible non-current asset) and we decide to use a 5 years lifespan for this NCA. If the lifespan is 5 years, the D&A would be 100%/5=20%. This D&A value of 20% is not allowed by the table, as the maximum value must not be greater than 10%. The 5 years lifespan is allowed, as it is less than 20 years. However, as both criteria must be met, the 5 years expected life cannot be selected.
If we try with 10 years as expected lifespan, this value provides a 10 years lifespan (less than 20 years) and a yearly D&A of 100%/10=10%, that is at the maximum allowed value. In this case, a 10 years lifespan for the NCA can be used as we meet both criteria.