Capital expenditure, also called CapEx, is the money used by a company to maintain its current assets and pay for expenses that may happen at inconsistent intervals. Think of it as an emergency fund for an entire business. It may have to replace something as small as a computer mouse for an employee or as large as an entire new warehouse to store products. That employee may have had that mouse for four years, but it suddenly broke and needed replacing. The company does not need a new warehouse every year, but the rapid increase of sales of a particular product demanded more storage space that prompted a quick expansion of space. CapEx funds make paying for all these expenses possible because a company knows that while specific expenses are unpredictable, there will always be a range of unpredictable expenses that require funding. Having funds set aside facilitates planning for the unknown.
On a smaller level, real estate investors also rely on CapEx methodology to set aside a certain amount of money each month to prepare for potential property damage and repairs. A real estate investor is responsible for funding the new roof when it is damaged, the new washer and dryer when the old appliances break, and the mortgage payment when a property is vacant for four months. CapEx funds are set aside in good times to prepare for the inevitable month (or longer) of greater outlay.
While the CapEx model is generally used by companies or investors running small business ventures, the same methodology can improve your individual finances. At its core, CapEx is a risk management protection. Having funds to pay for the unpredictable emergency or strange occurrence that happens randomly prevents you from frantically wondering how you will pay for a new refrigerator. Some weird expense is going to come up for you this year. You have no way to predict what it is right now, but it will surprise you. CapEx acknowledges that something weird is going to happen and cost money. By acknowledging that we do not know what weird expense we will have, we can better prepare ourselves to address any unpredictable expense.
How it Works
Yes, there is math involved in figuring out how much money you should save for completely unpredictable expenses. To figure out how much money you save to plan for the unknown, you need to know (a) how much something costs and (b) the average lifespan or timeframe for that cost. That sounds confusing, but it is much easier to consider when you think about it from a real estate investor (or homeowner) perspective:
Say you own a home and want to make sure you can afford any repairs that may be required. This includes small costs like replacing light bulbs, medium costs like replacing a dryer, and large costs like replacing a roof. To figure how much you should be saving each month to be able to eventually pay for your new dryer or roof while still regularly replacing light bulbs, you can use the CapEx methodology. You just need to know the cost of each item and its average lifespan to determine how much you should save on a monthly basis to eventually pay for that item.
Expense | Expected Cost | Expected Frequency | CapEx Funds (Monthly Cost) |
Light bulbs (20 throughout home) | $60 for 20 | 1 year | $5 |
Dryer | $1,000 | 12 years | $6.94 |
Roof | $8,000 | 20 years | $33.33 |
(For reference, these are slightly conservative estimates, meaning I chose either shorter timelines or higher prices than you absolutely have to for these items.)
In other words, if you will need a new roof in about 20 years, you should start saving $33.33 each month to eventually cover that expense. You are not actually paying $33.33 in roof repair each month. This is just the amount to allocate each month so you are prepared to pay for a new roof, whenever that happens.
In reality, you may not need a new roof for 40 years. You also may need a new roof in five years. So how does CapEx help? The longer the list of expenses for which you prepare, the more likely you can cover your expenses. If you need a new roof in five years instead of 20 and are only preparing for a roof expense in 20 years, it will be difficult to cover the expense. However, say that roof collapses but for the past five years you were saving for eventually replacing a washer, dryer, refrigerator, dishwasher, TV, computer, and lawnmower as well as multiple doors, windows, sinks, toilets, light bulbs, and air filters. Chances are, you have enough money to replace the roof.
Our expenses are unpredictable. But if we save a little bit for all of them, we have the money to address whichever expense requires our CapEx funds the soonest. Chances are, some of your expenses will outlive their predicted lifespan while others crash unexpectedly. Instead of panicking every time, just replace the roof early and be thankful when your washer and dryer last 20 years.
CapEx the Unpredictable
While home repair is a pretty traditional extrapolation thanks to the use of CapEx by most real estate investors, you can use CapEx for anything! I previously provided an example about how I use CapEx to pay for my rugby hobby. Any ongoing hobby that may have expenses like gear or travel is a great use of following the CapEx model of saving funds monthly so you do not feel financial pressure when your team makes the national championship or you need to buy a new tent before your big camping trip.
In addition to hobbies, you can use CapEx for other categories of life that are important to you. For example, maybe a Technology CapEx Fund is a good idea for you. Over my lifetime, the amount of technology that has become essential has grown significantly. Even if we cannot predict the next piece of ubiquitous technology, we can still prepare to replace our current technology. While this is not perfect, it prepares us better than the alternative. While I could not have predicted buying a phone for more than the cost of my computer back in 2004, I also no longer need to replace my iPod because that $1,000 phone can be both a phone and a music player.
By combining and saving for all technology costs together, we can better account for the rapidly changing environment of technology as a whole because some items will become obsolete, others will become more expensive, and new pieces of technology will be invented. If someone only saved for a new flip phone in 2004, good luck buying an iPhone. But if they also saved for a new iPod, headphones, and computer, their Technology CapEx Fund could probably handle their 2009 iPhone purchase.
Right now, a Technology CapEx Fund might include funds to replace your TV, phone, tablet, computer, headphones, key software, mouse, extra screen, and wireless keyboard. In ten years, something on this list will cost much more, something will cost much less, something will no longer exist in its current capacity, and there will be a new piece of technology we all need. But saving for all of it each month makes us better prepared for whatever future purchases we deem necessary.
CapEx the Inconsistent
In addition to bundling unpredictable expenses, you can also use the CapEx methodology for inconsistent or atypical spending goals that are a bit more predictable. Think of your one-month 20th anniversary European vacation, your parent’s 75th birthday celebration at an all-inclusive resort, or your sister’s bachelorette trip. These expenses are a bit more predictable, but if they are particularly costly, you may not have as much time to prepare for them as you would like. To account for events like this, I love to over-fund some high-yield savings accounts (HYSA) like my travel fund in order to allow me to more easily say yes to memorable events.
It is also why my “Baseball Fund” HYSA has more than $3,000 in it at the moment. The Red Sox, Dodgers, Nationals, and Orioles may not have been ready to go to the World Series, but I sure was ready to go if any of them made it! (Yes, it hurts more when you expand to include two local teams, and they still all fall short.) Anyways, my baseball fund is well funded at the moment because I plan for a World Series game any year so that when the Red Sox and Dodgers played each other in the World Series in 2018, we were ready.
CapEx Anything and Everything
CapEx is not limited to large businesses. Or real estate investors. Or even home repair, technology funds, hobby funds, and vacation funds. You can CapEx anything!
Any area of spending in which you have numerous potential expenses that could hit at unpredictable times and/or are large expenses is a good area for CapEx. (Notice how that is an “and/or” meaning things could just be unpredictable or expensive. Either quality is certainly sufficient to prompt a CapEx fund in an area.) Pretty much everything I buy fits into one of my specific spending categories, and I have a small “Miscellaneous” HYSA for moments like when I realized that 80% of my tank tops had holes in them last November and needed to buy new ones before they fell apart.
If you are interested in using CapEx to start saving in some HYSAs to better prepare yourself for future unpredictable expenses, we have a CapEx Calculator to help! (It is free for our subscribers for now, but if you all like it, we will probably add it to our paid resources, so make a copy of it today!) To use the sheet for your own expenses, select “File,” then “Make a copy” to save the CapEx Calculator to your own Google Drive.
The CapEx Calculator calculates your monthly expenses and also shows what other rates of contribution would amount to in case you would like to contribute a little bit from each paycheck. The sheet comes with directions to help you through the CapEx process. Make copies, set up HYSAs to house the money you save, and have fun using CapEx for many different expenses!
Comments