Capital Outlay Meaning Example Two Types Of Capital Outlay

Capital Outlay Meaning

Capital Outlay, also known as the capital expenditure, refers to the sum of money spent by the company to invest in the purchase of the capital assets such as plants, machinery, property, equipment or for extending the life of its existing assets with the motive of increasing the production capacity of the company.

Types of Capital Outlay

There are two types which include:

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#1 – Purchase of New Assets

When the company spends the money to purchase the new assets that appear in the balance sheet of the companyBalance Sheet Of The CompanyA balance sheet is one of the financial statements of a company that presents the shareholders’ equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner’s capital equals the total assets of the company.read more, such as machinery, plant, land, buildings, equipment, etc., it will be treated as the company’s capital outlay. Therefore, the company spends the money on purchasing the new assets as it would increase the company’s future growth

#2 – Extending the Life of Its Existing Assets

When a company invests money in the existing assets of its business, it leads to an increase in the life of the assets and production capacity. Therefore, such expenses are counted under the capital outlay of the company.

Example of Capital Outlay

Company A Ltd manufactures and sells automobile parts in the market. As per the analysis, it is found by the management of the company that the demand for the products of the company is increasing, and to fulfill further demand, it needs new machinery. Along with the purchase of the new machinery, there is some existing machinery of the company which, if repaired, will increase the company’s production capacity. So the company purchased new machinery worth $ 500,000 and invested $100,000 to extend the life of its existing assets. Whether the expenditures will be considered as capital outlay or not?

It refers to the sum of money spent by the company to invest in purchasing capital assets such as plants, machinery, property, and equipment or for extending the life of its existing assets to increase the company’s production capacity.

In the above case, both the capexCapexCapex or Capital Expenditure is the expense of the company’s total purchases of assets during a given period determined by adding the net increase in factory, property, equipment, and depreciation expense during a fiscal year.read more, i.e., expenditure on the purchase of new machinery worth $ 500,000 and the expenditure on the existing assets worth $100,000 for extending their life, will be considered the cash outlay as both help increase the production capacity of the company.

Advantages of Capital Outlay

It helps in the capacity building of an organization, giving it a strategic advantage over its competitors, in the long run, working for the company.It can help achieve economies of scale and reduce the cost of production by producing more and commanding better prices in the market, hence increasing overall profitability.Capital expenditure helps the company attract good talent that can work in the organization, making it more robust and dynamic, furthering the process of providing better products and services.It enables us to open up new avenues for products, people, and places, expanding its overall reach further into the markets and the economy.

Limitations

If it is not planned carefully, it can be a disaster. Therefore, every aspect should be understood and considered before making such decisions.Sometimes outsourcing can be a much more viable option instead of investing the own money, i.e., rather than producing itself, such function and responsibility can be given to someone else so that the burden is shared from management’s standpoint. So, this should also be considered an option before making any such decisions.An increase in capital outlay may create complex bureaucratic structures in an organization that may make it rigid and inflexible in communication and work culture.Sometimes market conditions or overall climate may adversely impact the expansion plans, so proper research and care are a must before taking any decision as it may prove fatal.

Important Points

They are not considered and treated as the immediate expenses of the company. Rather, it will be expensed gradually over the useful life of the assets in which the capital expenditure is made, i.e., every year, assets will be depreciated in the company’s books of accounts.Generally, the capital outlays are planned by the companies using the capital budgeting processesCapital Budgeting ProcessesThe capital budgeting process is planning to evaluate the potential investments or expenditures whose amount is significant. It helps determine the company’s investment in the long term fixed assets such as investment in the addition or replacement of the plant & machinery, new equipment, Research & development.read more as with the help of capital budgetingCapital BudgetingCapital budgeting is the planning process for the long-term investment that determines whether the projects are fruitful for the business and will provide the required returns in the future years or not. It is essential because capital expenditure requires a considerable amount of funds.read more; the company would look at all the potential investments available, and then out of all the available options, it will choose the one which will give the maximum benefit to it. Also, in the case of the single investment option, the company would get to know whether it is beneficial for the company to invest the amount.There are ways in which the company can make capital outlay, including purchasing new assets and extending the life of existing assets.

Conclusion

Capital Outlay is the outlay of the company’s cash either to purchase the company’s new assets or to extend the life of the existing assets to increase the company’s production capacity. It helps in the capacity building of an organization, giving it a strategic advantage over its competitors in the long run and opening up new avenues in terms of products, people, and places, expanding its overall reach further into the markets and the economy. However, if the capital outlay is not planned carefully, it can be a disaster. Therefore, every aspect should be understood and considered before making such decisions.