Definition
Capital expenditure, often shortened to capex, is money spent on assets expected to last more than a year: machinery, vehicles, computer equipment, premises improvements and, in some cases, software development. It is recorded on the balance sheet rather than charged as an expense straight away, and reaches profit gradually through depreciation. Maintenance capex keeps the existing business running. Growth capex adds capacity, such as a second production line.
Depreciation and amortisation spread the cost of long-lived assets over the years they are used. They reduce profit without any cash leaving the business in that year.
Worked example
Gullwing Removals is a fictional UK business with a fleet of ten vans. Each van costs £40,000 and lasts about five years.
- To keep the fleet steady, the business needs to replace two vans a year, a maintenance capex of £80,000 a year.
- The seller has not replaced a van in three years.
- EBITDA of £300,000 looks healthy, but about £240,000 of catch-up spending is now due.
EBITDA is earnings before interest, tax, depreciation and amortisation. It helps compare operating profit across businesses, but it is not the same as cash.
Why buyers care
EBITDA and SDE leave capital expenditure out, so two businesses with the same earnings can produce very different amounts of cash. A lender will look at what is left after necessary spending on assets, and so should you.
Ask for the fixed asset register, capital spending for the last three to five years, and the age and condition of the main assets. Ask what the seller expects to replace in the next few years. Where replacements have been held back ahead of a sale, reflect the overdue spending in the price you offer or build it into your financing plan from the start.
Seller's discretionary earnings (SDE)
Seller's discretionary earnings is the yearly financial benefit a business gives one full-time working owner, before financing costs, non-cash charges and one-off spending.