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Friday, July 10, 2009

Living La Vida OpEx or CapEx

In business, one of the fundamental concerns when it comes to spending money is should the money be spent as an Operating Expense (OpEx) or Capital Expenditure (CapEx). The difference between the 2 is that an OpEx is a pay as you go model while a CapEx is a pay up front model. Looking at these 2 ways of spending money can help you in your personal life make better financial decisions. Consider a common wasteful spend that occurs every January, home exercise equipment.

When you are considering buying home exercise equipment, you are trying to fulfill your goal of staying healthy. Buying home exercise equipment with money you have in the bank is an example of CapEx. You are spending your money up front for the long term capacity to exercise. You laid out cash for the capability to exercise as much as you want. Another approach would be to join a gym and pay as you go. This would be an example of OpEx. As long as you are exercising, you will pay. If you stop exercising, you will stop paying.

Which is better? Let’s say you spend $350 on gym equipment to enable you to fulfill your goal. In gym membership time, that is about 15 months of usage of all their equipment. They maintain it, and the variety of offerings is more than your $350 of equipment. Further, let’s say you decide after 2 months you are not really into exercising then it is a matter of canceling the gym membership (whose cancellation fee may be the equivalent of 1 months usage). Financially, for most people, when considering exercising, the outlay of money is less with the OpEx model.

When would you use CapEx? When you have nearly zero doubt that the upfront investment of your money out weights a pay as you go model. Why? Let’s consider the exercise equipment model again. The first month of gym membership is $25, which you take out of the $350 you set aside. That leaves $325 to earn interest that month! The next month, you take the $325 + interest earned and subtract the next $25. And so on it goes. You make money with all the unspent money, plus if your lifestyle changes, your costs can adapt more easily. Let’s consider our spend on the boat. The cost of renting a boat like the one we bought is around $1,000 per week. Plus, the rental boats are not allowed to venture where we want to nor are we allowed to make the modifications we want to. Within 2 years of our voyage, we will have recouped the cost of the boat, taken it to places not allowed by rental companies, and modified it to suit our needs. In this case, we decided that a CapEx was the better way to go. Cars are similarly in this category.

We’ve tuned our life to be as much OpEx as possible. This not only allows us to spend more nimbly, but we have more in reserves if something unexpected were to happen. Our advice is to always start in the OpEx model and always challenge the need to go CapEx. If, after going OpEx, you find you are better off in CapEx mode for something, then simply switch. For the few times you pick wrong, you will more than have moved ahead with all the other places that going OpEx was the better choice.

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