What is the relationship between depreciation and capital expenditure?

Depreciation and capital expenditure are both related to a company's long-term assets, but they represent different financial activities.

Depreciation is the process of allocating the cost of a tangible asset over its useful life. It is a way for businesses to account for the wear and tear of assets over time. This is an expense that is recorded on the income statement and reduces the value of the asset on the balance sheet. It's important to note that depreciation doesn't involve an actual cash outflow; rather, it's an accounting method used to measure the gradual consumption of an asset.

On the other hand, capital expenditure (CapEx) refers to the funds used by a company to acquire, upgrade, and maintain physical assets such as property, buildings, technology, or equipment. This is an investment made with the expectation that the asset will generate profits in the future. Unlike depreciation, capital expenditure involves an actual cash outflow and is recorded as an increase in the asset value on the balance sheet.

In essence, while depreciation represents the decrease in value of an asset over time, capital expenditure represents the investment made to acquire or improve the asset. The relationship between the two can be seen in the way they affect a company's financial statements. Depreciation reduces the value of assets on the balance sheet and is recorded as an expense on the income statement, reducing net income. Meanwhile, capital expenditure increases the value of assets on the balance sheet and, while it reduces cash flow, it does not impact the income statement until the asset begins to depreciate.

Therefore, understanding the relationship between depreciation and capital expenditure is crucial for assessing a company's investment in its assets, its cash flow situation, and its profitability over time.