CAPEX Part 1

Quick reference

• 00:04 I really need to stop putting up the titles for
• 00:06 each of these sessions because it's giving the game away of what's coming next.
• 00:11 Can you guess?
• 00:13 Just for change, I thought I'd put this unfamiliar slide up.
• 00:17 So a model is best thought of broken down into its constituent parts.
• 00:21 Deep breath.
• 00:23 It's the arrow again.
• 00:24 We're going from A to B in the straightest way we possibly can.
• 00:29 So we've built an efficient model, we'll put in our checks first of all.
• 00:32 We'll build the operational section, the revenue, opex, cogs,
• 00:36 and capex which we've done three quarters of that now.
• 00:38 We have already completed the working capital adjustments.
• 00:42 Hm, clue. We might be looking at assets this time
• 00:45 and out.
• 00:46 We could've considered the financing and tax, put it all into the financial
• 00:51 statements, and then we port on any other key outputs, as we see fit.
• 00:55 So where are we, exactly?
• 00:57 Well, you may recall, we actually explained before there are three financial
• 01:01 statements, and we agreed that the smallest of these three financial
• 01:05 statements conceptually is the income statement.
• 01:07 And we should work our way down that,
• 01:08 which is consistent with the way we think naturally about building a model.
• 01:12 So we've already modeled Revenue.
• 01:13 We've split COGS in two.
• 01:15 We looked at non-inventory and inventory, or we modeled both of those.
• 01:18 And we've also looked at Operating Expenditure.
• 01:20 This brings us down to halfway through depreciation.
• 01:25 So depreciation is the penal allocation of a large amount of expenditure that's
• 01:30 gone to the cashflow statement which is for a big ticket item, which is for
• 01:35 sometimes held for continuing use in the business to generate profits.
• 01:40 It might be a building, it might be a fleet of cars.
• 01:42 It might be property plant equipment.
• 01:44 It may be tangible.
• 01:46 It may be intangible like copyright, patents, things like this.
• 01:51 And we split it out.
• 01:52 So we need to calculate the capital expenditure, and
• 01:54 then allocate it using either depreciation or amortization.
• 01:58 Depreciation is method for
• 01:59 tangible assets, and amortization is for intangible ones.
• 02:04 So let's get going.
• 02:06 We are in the asset section of our modelling.
• 02:10 So what is an asset?
• 02:12 Well, time to get out the dictionary, assets can be defined as the future
• 02:16 economic benefits controlled by the entity as a result of past transactions or
• 02:20 other past events.
• 02:21 It's all about the past.
• 02:24 Three key characteristics.
• 02:26 It's expected to provide future economic benefits to an entity.
• 02:30 If it doesn't generate a profit in the future,
• 02:32 you just write it up as a big hit now, say and big expense over the growth rate.
• 02:37 It needs to be controlled by an entity, but it does not need to be owned.
• 02:42 So list assets if you have main, list some rewards associated with them.
• 02:46 Can't be shown as an asset.
• 02:49 And the transaction or event leading to the creation of the asset must have
• 02:52 occurred already as at the balance sheet date.
• 02:58 In particular, I want to look at non-current assets.
• 03:01 There's current and there's non-current.
• 03:02 Current is for usually, for ongoing use in the business for making a profit.
• 03:09 Whereas non-current assets are for are ongoing to use in the business.
• 03:12 But not for making a profit, but just for being there.
• 03:15 That for greater than one year by definition, they need to
• 03:18 generate a future economic benefit, otherwise you should just write them off.
• 03:22 Not intended to reach out to customers, but they can be.
• 03:24 And there's usually a de minimis limit that it's gotta be over a certain amount,
• 03:29 say $1,000.
• 03:29 Otherwise, can you imagine?
• 03:31 Well, I've bought this box of pencils here.
• 03:33 And I'm gonna last five years and it costs me $1.50 so it's depreciated.
• 03:39 Nonsense.
• 03:44 So depreciation is an idea that if capital expenditure is expected to create future
• 03:47 economic benefits, then the amount should be spread over more than one period.
• 03:52 We should put it over the economic life.
• 03:53 How long do we think this asset will last for, and still generate profits?
• 03:59 The remaining amount, or the estimated trade-in, is known as the residual value.
• 04:03 Now, for that last 10 years, pretty much all financial models have just
• 04:07 assumed residual value is now zero and soon to be prudent.
• 04:10 And there's different methods of depreciation.
• 04:14 The one we're gonna look at at this stage is straight line depreciation.
• 04:19 That's when we allocate it linearly.
• 04:21 So if I've got $100 of capex in five years, that's $20 in each period the end.
• 04:25 And that's what this is showing.
• 04:27 Upon opening that book value, that is what it's worth at the start of the period.
• 04:31 We've got our additions.
• 04:33 We have our depreciation expense.
• 04:35 So this one is going over 550.
• 04:38 You can see it's ten years.
• 04:39 It gives you your closing net book value.
• 04:41 It's the same each period.
• 04:43 Another common method,
• 04:46 and we'll come back to this more later, is the declining balance depreciation method,
• 04:50 where the amount of depreciation decreases each period.
• 04:54 And it's a rate that's fixed.
• 04:55 And it's usually based on a percentage of the opening balance.
• 04:59 So in the example here, you can see it's half of the opening balance each time.
• 05:04 This is a method that is sometimes employed.
• 05:06 And you can see, if you compare the two,
• 05:09 it tends to actually generate much faster allowances.
• 05:14 You've got what's called Accelerated Capital Allowances because what happens
• 05:18 is, with greater depreciation, means you got less profit,
• 05:22 means you got less tax to pay.
• 05:23 And that's good because it's not gonna affect shareholders and
• 05:26 that doesn't have the same amount of cash.
• 05:29 But we don't have to pay so much tax.
• 05:31 So, we need to stop modeling this and we'll do that next time out.

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