The best way to calculate capex is by gaining full access to a company’s financial accounts, its financial staff and its executives. With this combination, you’ll be able to paint a good picture of the capex necessary to keep the business running at its current levels of cash flow. However, often we must value companies prior to conducting formal due diligence and in these cases, we typically only have access to standard financial statements. This post discusses calculating capex with access only to these statements.

A few basics first:

• Capex is important because it can significantly influence the value of a business
• We can classify capex as either growth or maintenance, but we’re mostly interested in maintenance capex
• Maintenance capex refers to the capex required to keep a business running at current cash flow levels
• Growth capex refers to capex required to grow the business beyond typical cash flows (e.g. acquisitions)
• Financial statements do not have a line item titled maintenance capex
• And, no formula exists to calculate maintenance capex from the financial statements
• Therefore, maintenance capex calculations are mostly estimates

The first place you may think of looking for data to calculate capex is the cash flow statement (within the investment section). There may be a line item for Investments in Equipment (or similar), which defines cash flow related to investments in assets. While this essentially refers to capex, it will likely include capex related to acquisitions and other growth campaigns. The reason we only want maintenance capex is because we’re valuing the business based on its current state and current cash flows.

The second place you may look for evidence is the depreciation line on the P&L statement. Many people use this as a proxy for capex and cite its smoothing effect as an additional advantage (I wrote about this in a recent post on EBITDA vs. EBIT). However, this smoothing, which accounts for many years, may reflect the business as a different beast because it is backward looking. Additionally, depreciation doesn’t account for asset price inflation, which is significant for certain businesses.

So what else can we refer to? Short answer… nothing. In my opinion, the ideal method for calculating capex from the financial statements is to analyse investing cash flows and depreciation over various years to find trends and arrive at an informed estimate. [EDIT] Also check the supplemental notes for more granular information on cash flows and depreciation (thanks, Scott). Here are a few steps I normally follow:

1. Look at the Investment in Equipment line on the cash flow statement, remove acquisition capex, but make sure to add back an amount that will maintain the newly acquired assets. Look at previous years too; you may find a year without growth and with a similar level of profit, hence, evidence of maintenance capex levels.
2. Look at the Depreciation section of the P&L, increase the amount for inflation, and adjust for structural changes such as acquisitions or major growth into other areas. Again, compare with previous years to find (and understand) abnormalities.
3. Compare the above figures over various years to establish a trend and to help make inferences about what capex should be in future years. Avoid suggestions from management that maintenance capex is some fraction of what you’ve calculated; often managers underestimate capex (edit: managers always underestimate capex).
4. Compare your capex to revenue (and earnings) ratios of listed businesses in the same industry. One would expect similar businesses to spend similar amounts on capex to maintain assets and uphold regular levels of service.
5. Test your calculated figures with management and ask them for specific forecasts on large items. You may find cyclical items that run on a cycle not apparent from only 3-5 years of historic financials. Again, overestimate and make sure the investment is viable on those figures because your overestimation will likely become an underestimation.

Calculating maintenance capex can be time consuming and frustrating, but it is imperative that you understand it in detail in valuing a business. I’ve seen many investments fall short of expectations because private equiteers took management capex forecasts as gospel.