Question

What is NPV? What finance approach does a business follow to write up capital expenses? And operating expenses?

Answer 1

NPV stands for net present value. Net present value is the present value of difference in the cash inflows and cash outflows. Let's say a project X is generating $1000 cash inflow over a period of five years and the cash outflow at the begining at the period is $2000, so the net present value here would be total present value of $1000 dollar generated over 5 year period discounted at certain rate and then subtracting the initial cash outflow of $2000. NPV is a capital budgeting method used to determine the optimal allocation of resources.

When capital expenditure occurs, they are treated as an asset and recorded in the balance sheet as asset and written off over a period of time, not written as expenditure in the same year. They are written off the books over a period of time using the depreciation methods. Lets say a company bought a machine worth $500000 and its useful life is 5 years. It will be recorded in the books as an asset and by using straight line depereciation (assuming) every year $100000 will be written off as depreciation.

Operating expense are written off in the same year in which they occurs. Operating expenses go to the income statement of the company and are set off against the income in that year. operating expenses can be in the form of salary, utilities,office supplies, distribution e.t.c.