CapEx vs Depreciation: What’s the Difference?

Understanding the relationship between CapEx and depreciation is fundamental to financial analysis and company valuation. While both relate to long-term assets, they work in opposite directions on financial statements, and confusing them is one of the most common mistakes analysts make.

Capital expenditure (CapEx) represents actual cash spent to acquire or improve assets. Depreciation is a non-cash accounting entry that spreads the cost over time. Mastering this distinction is essential for accurate free cash flow calculations, valuation models, and financial statement analysis.

This guide explains exactly how CapEx and depreciation differ, how to calculate each, and why the relationship between them matters for investment decisions.

What is Capital Expenditure (CapEx)?

Capital Expenditure (CapEx) is money invested in a business to acquire, upgrade, or maintain assets such as buildings, machinery, land, vehicles, and equipment. CapEx creates long-term value for the business and incurs expenses that may be spread over several years. By investing in capital expenditures, businesses can generate returns over the expected life of the asset.

CapEx appears on the cash flow statement as an outflow in the “Investing Activities” section. Unlike operating expenses that hit the income statement immediately, capital expenditures are capitalized, meaning they’re recorded as assets on the balance sheet and expensed gradually over time through depreciation.

Types of Capital Expenditure:

Growth CapEx – Spending on new assets that expand the company’s productive capacity. Examples include building a new factory, acquiring additional equipment to increase production, or purchasing another company’s assets. Growth CapEx signals management’s confidence in future demand. Learn more about the distinction in our guide to growth CapEx vs maintenance CapEx.

Maintenance CapEx – Spending required to maintain current operations at existing levels. This includes replacing worn-out equipment, upgrading aging facilities, and routine capital replacements. Maintenance CapEx is necessary just to sustain current revenue; without it, productive capacity would decline.

Why the Distinction Matters?

For valuation purposes, growth CapEx and maintenance CapEx have different implications:

• Growth CapEx is discretionary and tied to expansion plans
• Maintenance CapEx is essentially mandatory and should approximate depreciation over time

When building DCF models, analysts often assume maintenance CapEx equals depreciation in the terminal year, while growth CapEx drops to zero once the company reaches steady state.

What is Depreciation?

Depreciation is a non-cash expense that recognizes the cost of an asset over its useful life. Depreciation spreads the cost of an asset by allocating it over several years based on its expected lifespan. In other words, depreciation reflects the gradual reduction in the value of an asset as it gets older, wears out, and becomes obsolete. This process allows businesses to reduce taxable income and defer income taxes until the asset is sold or retired from service.

Unlike CapEx, depreciation doesn’t involve any actual cash movement. It’s purely an accounting mechanism that matches the cost of an asset to the revenue it helps generate over time, following the accounting matching principle.

Depreciation appears in two places on financial statements:

1. Income Statement: As an operating expense, reducing reported earnings
2. Balance Sheet: As accumulated depreciation, reducing the net book value of fixed assets

Why Depreciation Matters for Valuation?

Because depreciation is a non-cash expense, it must be added back when calculating operating cash flow. This is why EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is such a popular metric; it removes the impact of depreciation to show the underlying cash-generating ability.

However, treating depreciation as “not real” is dangerous. Depreciation represents the economic reality that assets wear out and must eventually be replaced. Companies that consistently report CapEx below depreciation are effectively shrinking their asset base.

How Do CapEx and Depreciation Differ?

While depreciation and CapEx both concern expenses related to the purchase of assets, they are two distinct concepts. CapEx is a shorthand term for capital expenditures, which refers to money spent on acquiring or maintaining physical assets such as equipment, buildings, or technology. Depreciation is an accounting technique used to spread out the cost of an asset over its useful life. CapEx involves actual cash outlay for purchasing an asset, whereas depreciation does not involve any cash flow.

Here’s a comprehensive comparison of CapEx vs depreciation:

Aspect	CapEx	Depreciation
Cash Impact	Real cash outflow	Non-cash expense
Timing	Occurs at purchase	Spread over useful life
Financial Statement	Cash flow statement (investing)	Income statement (expense)
Balance Sheet Effect	Increases fixed assets	Reduces fixed asset value
Tax Treatment	Not immediately deductible	Tax-deductible expense
Discretion	Management can choose the timing	Fixed by accounting policy
FCF Calculation	Subtracted from cash flow	Added back to net income

The Capex-Depreciation Relationship:

Over the long term, CapEx and depreciation should converge for a mature company:

• If CapEx consistently exceeds depreciation, the company is growing its asset base
• If depreciation exceeds CapEx, the company is shrinking (or has very old, fully depreciated assets)
• At steady state, maintenance CapEx should approximately equal depreciation

This relationship is critical for capital budgeting decisions and terminal value calculations in DCF analysis.

How to Calculate Depreciation

Depreciation may be calculated in several different ways. One of the most common is straight-line depreciation, which divides the original cost of an asset by its estimated useful life to arrive at a base depreciation amount. The asset’s salvage value is then deducted from the total cost to determine the final amount of the depreciable cost. Other methods, such as accelerated or double declining balance depreciation, may also be used in certain circumstances.

Straight-Line Depreciation Formula:

Annual Depreciation = (Asset Cost – Salvage Value) / Useful Life

Example:

• Equipment cost: $100,000
• Salvage value: $10,000
• Useful life: 10 years

Annual Depreciation = ($100,000 – $10,000) / 10 = $9,000/year

Other Depreciation Methods:

Declining Balance Method – Accelerates depreciation in early years. Common rates are 150% or 200% (double-declining) of the straight-line rate.

Depreciation = Book Value × (2 / Useful Life)

Year 1: $100,000 × 20% = $20,000 Year 2: $80,000 × 20% = $16,000 Year 3: $64,000 × 20% = $12,800

Units of Production Method – Ties depreciation to actual usage rather than time.

Depreciation = (Cost – Salvage) × (Units Produced / Total Expected Units)

Which Method to Use for Analysis?

For valuation and analysis purposes, straight-line depreciation is most common because it’s predictable and easy to forecast. However, always check the company’s accounting policies in the notes to financial statements; the method used affects reported earnings and EBIT margins.

Factors Affecting CapEx and Depreciation

Both CapEx and depreciation can be affected by inflation, exchange rates, legal restrictions, and market conditions. For example, increasing prices due to inflation can make a fixed asset more expensive over time and require a higher level of CapEx or more aggressive depreciation to reduce the associated costs. Additionally, changes in legal regulations or market conditions can have an impact on both CapEx and depreciation decisions.

Factors Affecting CapEx Decisions:

1. Interest Rates: Higher rates increase the cost of financing capital investments, often reducing CapEx
2. Economic Outlook: Companies invest more during expansions, less during recessions
3. Industry Lifecycle: Growth industries require more CapEx; mature industries focus on maintenance
4. Competitive Pressure: Need to match competitors’ investments in technology or capacity
5. Tax Incentives: Accelerated depreciation or investment tax credits can stimulate CapEx

Factors Affecting Depreciation:

1. Asset Useful Life Estimates: Longer lives mean lower annual depreciation
2. Salvage Value Assumptions: Higher salvage values reduce the depreciable base
3. Depreciation Method Choice: Accelerated methods front-load expenses
4. Accounting Standards: IFRS vs. GAAP can produce different results
5. Asset Impairments: Write-downs accelerate depreciation recognition

Industry Variations:

Different industries have dramatically different CapEx and depreciation profiles:

Industry	CapEx Intensity	Typical CapEx / Revenue
Utilities	Very High	15–25%
Telecommunications	High	12–18%
Manufacturing	Moderate–High	5–10%
Retail	Moderate	3–6%
Software / Tech	Low	1–3%

Understanding these benchmarks helps identify whether a company’s spending is appropriate for its industry. The asset turnover ratio can help assess how efficiently a company uses its capital investments.

CapEx vs Depreciation: A Worked Example

Let’s trace how CapEx and depreciation flow through the financial statements with a concrete example.

Scenario: TechManufacturing Inc. purchases new production equipment for $500,000 on January 1. The equipment has a 10-year useful life and $50,000 salvage value. The company uses straight-line depreciation.

Step 1: Record the CapEx (Day 1)

Statement	Impact
Cash Flow Statement	−$500,000 (Investing Activities)
Balance Sheet	+$500,000 (Property, Plant & Equipment)
Income Statement	No impact

Step 2: Record Depreciation (Year 1)

Annual depreciation = ($500,000 – $50,000) / 10 = $45,000

Statement	Impact
Income Statement	−$45,000 (Depreciation Expense)
Balance Sheet	−$45,000 (Accumulated Depreciation)
Cash Flow Statement	+$45,000 (Added back in Operating Activities)

Step 3: Calculate Free Cash Flow Impact

Net Income Impact: -$45,000 (depreciation expense)

Add back Depreciation: +$45,000

Subtract CapEx: -$500,000

Net FCF Impact Year 1: -$500,000

Key Insight: The full cash impact hits in Year 1, but the earnings impact is spread over 10 years. This is why analysts focus on free cash flow rather than net income for valuation; it captures the true cash economics.

Common Mistakes When Analyzing CapEx and Depreciation

Even experienced analysts make these errors. Avoid them in your analysis.

1. Ignoring Maintenance CapEx in Valuations

Some analysts add back all depreciation without subtracting any CapEx, effectively assuming assets last forever. This overstates free cash flow and inflates valuations. At a minimum, maintenance CapEx (often estimated as depreciation) must be subtracted.

2. Treating All CapEx as Growth Spending

Not all CapEx grows the business. A company spending $100M on CapEx while reporting $80M in depreciation isn’t necessarily growing; it might be catching up on deferred maintenance. Always separate growth CapEx from maintenance CapEx.

3. Assuming Depreciation Equals Economic Reality

Accounting depreciation rarely matches actual asset deterioration. A building depreciated over 40 years might last 100 years with proper maintenance, while technology equipment might become obsolete before it’s fully depreciated. Adjust your analysis accordingly.

4. Missing the CapEx-to-Depreciation Ratio Signal

The CapEx/depreciation ratio reveals management’s investment strategy:

• Ratio > 1.5: Heavy investment, likely growing
• Ratio ≈ 1.0: Maintaining current capacity
• Ratio < 0.8: Under-investing, potential future problems

A persistently low ratio is a red flag; the company may be sacrificing long-term health for short-term cash flow.

5. Ignoring Working Capital With CapEx

Major capital projects often require additional working capital (inventory, receivables). Analyzing CapEx without considering associated working capital needs understates the true investment required. Check the receivables collection period and inventory conversion for related impacts.

Frequently Asked Questions About CapEx and Depreciation

Q: Is depreciation a capital expenditure?

A: No, depreciation is not a capital expenditure; they’re essentially opposites. CapEx is actual cash spent to acquire assets, while depreciation is a non-cash accounting expense that allocates that cost over the asset’s useful life. CapEx appears on the cash flow statement; depreciation appears on the income statement. However, they’re related: depreciation exists because CapEx occurred.

Q: What is the relationship between CapEx and depreciation?

A: CapEx and depreciation are two sides of the same coin. When a company makes a capital expenditure, it records an asset on the balance sheet. Depreciation then gradually expensifies that asset over time on the income statement. For mature companies at steady state, annual CapEx should approximately equal annual depreciation, enough to maintain productive capacity without growing or shrinking.

Q: How do you calculate CapEx from depreciation?

A: You can estimate CapEx using the balance sheet equation: CapEx = Ending PP&E – Beginning PP&E + Depreciation. This works because PP&E increases with CapEx and decreases with depreciation. For forecasting, many analysts assume maintenance CapEx equals depreciation, then add growth CapEx separately based on expansion plans.

Q: Should CapEx be higher than depreciation?

A: It depends on the company’s situation. Growing companies typically have CapEx exceeding depreciation as they expand capacity. Mature companies maintaining operations should have CapEx roughly equal to depreciation. If CapEx consistently falls below depreciation, the company may be under-investing and shrinking its asset base, a potential warning sign.

Q: Why is depreciation added back in cash flow calculations?

A: Depreciation reduces net income, but isn’t an actual cash outflow; no check is written for depreciation. Since we start with net income (which already subtracts depreciation), we must add it back to calculate true cash flow from operations. The actual cash impact occurred earlier when the CapEx was made, which is captured in investing activities.

Q: Where can I learn more about CapEx and depreciation analysis?

A: Valuation Master Class offers practical training programs where you’ll analyze real companies’ CapEx and depreciation patterns. Choose your track: Starters for those beginning their finance career, Advancers for mid-career professionals, or Switchers for career changers entering finance.