CapEx Vs. OpEx In The Cloud: 10 Key Differences

As many companies shift from traditional IT infrastructure to cloud computing, they are also rethinking how they handle cloud costs — from accounting to tax reporting.

Computing costs are predictable and relatively fixed in traditional IT environments. An organization purchases computing capacity upfront and uses it over time. The total cost of ownership is fairly easier to calculate with this setup.

By contrast, cloud computing operates on a pay-as-you-go basis, with no upfront payments. Resources and services are available on-demand, and IT spend fluctuates based on consumption.

The traditional approach prioritizes capital expenditure (CapEx), whereas cloud economics favors operating expenses (OpEx).

So, what’s the difference between CapEx and OpEx? Which approach is the most cost-effective? And what are some examples of each?

Table Of Contents

What Is CapEx In Cloud Computing?

CapEx is short for capital expenditure. Capital expenditure is the cost a business incurs to acquire assets that will provide benefits beyond the current year. CapEx is also referred to as PP&E, which stands for Property, Plant, and Equipment.

When a company invests money, uses collateral, or incurs debt in order to acquire new assets or increase their value over time, they incur capital expenditures. So, capital expenditures are usually long-term investments in the business.

Also, CapEx IT spending is often a one-time purchase of a specific high-dollar fixed asset during a single tax year, with little ongoing costs during that period.

Examples of CapEx expenditure in the cloud:

So, how do you identify capital expenditure?

What are the characteristics of CapEx expenditure?

The key to determining capital expenditure is to observe distinct concepts, such as where they should be accounted for and how they should be taxed. Here’s how.

Say, you construct a new building for a data center at a modest cost of $800,000. You’ll only be able to deduct this expense over 39 years, which is the amount of time a nonresidential real property must be depreciated at the time of writing this (always consult your tax consultant). So, the maximum deductible amount in your tax return will be (800,000/39) = $20,512.82 per year.

CapEx challenges to know

IT capital expenditures are not without challenges, such as:

So, how are operating expenses different from capital expenditure in IT spending?

What Is OpEx In Cloud Computing?

OpEx is short for operating expenses, also known as operational expenses, and operating costs. Operating expenses refer to the money a company spends to run day-to-day operations.

Most of these expenses are used up within a year of purchasing them.

Also, operational expenses are pay-as-you-go, which means you deduct them as and when you need them. For this reason, firms often need to reduce OpEx spending without hurting their ability to produce, innovate, compete, and offer stellar customer experiences.

Note: Although “expenses” and “expenditures” are often used interchangeably, they are not the same thing. Accountants define expenditures as long-term payments based on long-term spending plans. But expenses usually refer to short-term spend.

Examples of OpEx expenses in the cloud

Now, here’s how to determine operating costs in your company.

What are the characteristics of OpEx expenses?

The following characteristics make OpEx spending easier to notice, account for, and budget for.

Suppose you pay $20,000 in rent in one year. By claiming that $20,000 on your tax return, you will reduce your taxable profit by $20,000 — reducing your tax burden in that year.

But, like CapEx expenditure, the OpEx spending model is not flawless.

OpEx challenges to know

Operational expenses can pose difficulties in several ways. especially for companies that have a lot of their operations running in the cloud.

If you want to solve these challenges, you need to have full visibility into your operating costs as a bare minimum.

Why You Need To Understand OpEx Vs. CapEx

Understanding the difference between operating expenses and capital expenditures will help you decide when to go either way. The alternative may put you out of business. For example, SaaS companies that overreport COGS weaken their margins, which deters investors and hinders growth funding.

Yet deciding what expenses to record under OpEx vs. CapEx can be tricky in practice.

Example one

You can purchase new data storage systems if you require more storage space to host your data. Whether you pay cash or borrow to finance it, it will be a capital expenditure. In contrast, leasing additional virtual storage is an operational expense because it is ongoing.

Example two

Purchasing servers, computers, and networking equipment from a vendor and installing them in a data center constitutes CapEx expenditure. However, renting virtual machines, compute capacity, and supporting infrastructure through a cloud provider like AWS factors towards operating expenses.

Example three

General maintenance and repairs to existing fixed assets, such as buildings and equipment, are also considered operating expenses. However, expenses become capital expenditures if the improvements extend the asset’s useful life.

In the next section, we’ll summarize the two spending models.

10 Differences Between CapEx And OpEx In The Cloud

For a quick assessment, here’s a side-by-side comparison of OpEx vs. CapEx spending.

	CAPEX	OPEX
Stands for	Capital expenditure	Operating expenses
Meaning	Costs of long-term investments — benefits expected to last longer than one year.	Costs of day-to-day operations — benefits used up within the same year they are purchased/incurred.
Paid for	Upfront, whether through cash from savings or retained profits or taking on debt.	Pay-as-you-go pricing, ongoing costs that are covered by income as they occur.
Amount paid	Huge investments that often tie up cash in long-term investments.	Relatively small, ongoing payments (monthly, quarterly, annually)
Opportunity cost	Often involves overbuying now to meet future capacity requirements then.	Frees up cash flow to invest in other areas because there is no large, upfront payment.
Ownership and responsibility	Buying transfers ownership to the buyer, including full responsibility and control, including access and building updates for both owned hardware and software.	A vendor, such as a cloud provider, is responsible for system updates, upgrades, and replacements for hardware and software.
Accounting treatment	Recorded in the balance sheet as assets, only appearing in income statements as deductions.	Recorded in profit and loss statements as expenses.
Taxation treatment	Deductible over the lifetime of a tangible asset. Amortized over the life of an intangible asset.	Deducted in full within the same year they are incurred.
Returns on Investment	Gradual over the life cycle of the asset.	Earned in shorter billing cycles.
Financing	Capital or borrowed cash from financial institutions.	Retained profits, savings, soft loans, bank overdraft.
Examples	Land, building, IT equipment, patents, etc.	Subscriptions, wages/salaries, marketing, etc.

How To Understand And Control CapEx Expenditure

Tracking capex costs for SaaS companies is relatively straightforward compared with OpEx. In most cases, the challenge is dealing with the long approval processes and bureaucracy involved in making a final decision.

Once that’s done, you can purchase a perpetual license, which you don’t need to renew each year. Or, you can purchase another asset outright and track its maintenance costs periodically, which isn’t nearly as complex as tracking OpEx in the cloud daily — even hourly.

Here’s why.

How To Understand And Control OpEx Cost In The Cloud

Compared to locally installed environments, cloud computing can be particularly challenging because it’s inherently complex and dynamic. To succeed, you must collect, analyze, and understand all operating expenses centrally.

For SaaS companies, a large portion of expenses comes from cost of goods sold. COGS can be challenging to visualize, track in real-time, and optimize without hindering your ability to innovate continuously.

Yet, overreporting COGS has a direct negative impact on your margins, depressing investor confidence. The result is that your business may be undervalued, diminishing your ability to raise enough cash to finance growth.

Instead, you can use CloudZero’s cloud cost intelligence to:

With CloudZero, you can accurately allocate and predict your cloud costs without tagging. Don’t just take our word for it. to see CloudZero in action!

Frequently Asked Questions About Capex And Opex In Cloud Computing

We’ve answered a few of your FAQs below.

Do you expense or capitalize software costs in SaaS?

SaaS companies follow different GAAPs (ASC 350-40 and 720-45) for capitalizing development costs. In accordance with these rules, preliminary project costs are expensed, but should be capitalized once the project plan completes and app development begins.

What are examples of CapEx in SaaS businesses?

Capital expenditures can include the costs of housing a physical data center, buying software licenses, upgrading hardware or physical infrastructure components, and maintaining servers locally.

Is headcount a Capex or Opex expense?

Their compensation is Capex if they deploy, manage, and maintain your physical infrastructure. You need people to care for that hardware, whereas a separate company handles that for you under OpEx.

What are the drawbacks of using OpEx in SaaS?

Aside from unpredictability, difficulties deciding what to expense as OpEx, and allocation challenges, OpEx expenses hold value only in the short term. Usually, once you spend the money, it has no further advantage.

How can you track OpEx accurately in the cloud?

You’ll need to capture cost data as it occurs, preferably in real-time. Robust cost optimization platforms like CloudZero can help you to not only track your real-time cloud costs but also detect abnormally high cost trends before they become surprise expenses.