Cloud computing is an example of an OPEX. The advantages of cloud computing being an OPEX include it not requiring any large upfront costs or long-term investments (you don’t have to buy any expensive servers or workstations) and that you can deduct its full cost from your taxable income the same year that you paid for it.
Business expenses can be categorized as either capital expenditures (CAPEX) or operating expenses (OPEX). A capital expenditure is the purchase of an asset, usually an expensive one, that you expect to use for more than a year. Examples of capital expenditures include real estate, vehicles, factory machinery, and computing equipment.
Operating expenses, on the other hand, are the ongoing, recurring costs of operating your business. Examples include employee salaries, the purchase of office supplies that will be used within the year (like printer ink, toner, and paper), year-to-year software licenses, and cloud computing.
Cloud computing is an OPEX because it’s paid for on a recurring basis, usually every month. For the most part, a business’s only mandatory capital expenditures with the cloud will be the end-user devices its employees use to access their cloud-based solutions, such as PCs, thin clients, or tablets.
With the cloud, businesses don’t have to purchase any expensive onsite hardware, like servers and high-capacity storage devices. Most of the capital expenditures are the cloud provider’s responsibility—it’s the one that has to purchase and maintain all of the components of its cloud infrastructure, including servers, storage devices, networking equipment, cabling, backup generators, HVAC, and the actual datacenter buildings.
The main alternatives to cloud computing, in contrast—installing applications and storing files on the hard drives of users’ PCs, or hosting your IT solutions on your own onsite servers—involve more capital expenditures and less OPEX.
If a business hosts its IT solutions on its own onsite servers, for example, then it will have to purchase servers (obviously), storage devices, networking equipment, and cabling. And if a business installs its applications directly on users’ devices, then it will have to purchase PCs that are capable of processing applications and storing files themselves—which means that it can’t minimize its capital expenditures by relying on low-cost, low-functionality devices such as thin clients or old PCs, as it can with the cloud.
In both cases, you’ll probably end up paying tens of thousands of dollars on computing equipment every three to five years, which is the average effective lifespan of most IT hardware.
Cloud computing has several advantages over onsite IT as a result of being an OPEX. First, it doesn’t have the large upfront costs of purchasing onsite IT hardware.
Many cloud solutions don’t require any upfront costs at all, but even when there is an onboarding or setup fee, this fee is still a fraction of what you would pay to set up your own centralized, onsite IT systems. The cloud’s low upfront costs allow even businesses that don’t have a lot to spend on IT—such as startups, small businesses, and large businesses that are trying to reduce their IT costs—to afford to set up a fast, secure, and reliable IT infrastructure, or to expand or improve their existing infrastructure.
In contrast, if these businesses that don’t have a lot to spend on IT had to spend tens of thousands of dollars on hardware in order to set up, expand, or improve their IT systems, they’ll probably have to settle for a lower-quality IT infrastructure than what they could deploy in the cloud for the same amount of money in order to reduce their costs as much as possible, or else forgo setting up or upgrading their IT altogether.
Another advantage of cloud computing being an OPEX is that it doesn’t require any long-term investments in expensive IT hardware.
When a business purchases onsite IT hardware such as servers, high-capacity storage devices, and PC workstations, it is basically stuck with that hardware for the extent of its lifespan. One of the problems with being permanently stuck with a unit of hardware is that businesses’ IT requirements—including how many servers and PCs they need—change all the time, as variables such as the total number of employees that a business has and the number of applications that it uses goes up and down. If a business’s IT requirements decrease between the time it purchased the IT hardware and the time the hardware reaches the end of its lifespan (if it downsizes its workforce or experiences a decline in sales or customers, for example), then it will end up stuck with thousands of dollars’ worth of IT hardware that it doesn’t need, and it won’t get its full return on its initial investment in the hardware.
The other problem with being stuck with IT hardware for three to five years is that IT hardware manufacturers are constantly (and, often, dramatically) improving their products from year to year, so it’s not unusual for IT hardware to be outdated even only halfway through its lifespan.
With cloud computing, in contrast, you’re unlikely to get stuck with IT assets that you don’t need without getting a full return on your initial investment, since with the cloud you can simply cancel or scale down your IT solution at any time if your IT requirements decrease. Even if your cloud solution required you to sign a contract or “reserve” the solution for a certain period of time, you still have more flexibility with these contracts or “reserved instances” than if you purchased IT hardware, since the average length of these contracts is only one to two years.
In addition, there’s no danger of being stuck with outdated assets with the cloud, since you can always migrate from your current cloud solution to one with a more advanced hardware or software backend, and cloud providers are always upgrading their baseline infrastructure.
The final key advantage of cloud computing being an OPEX, in addition to the advantages of letting businesses avoid paying large upfront costs or having to make permanent, long-term investments in expensive IT hardware, is that you can deduct all of your operating expenses from your taxable income the same year that you pay those operating expenses. With capital expenditures, in contrast, you can’t deduct the full cost of a CAPEX from your taxable income the same year that you paid the CAPEX—you can only deduct a fraction of the CAPEX each year that you use the purchased asset.
So for example, if you purchased an $8,000 server and expected to use it for four years, you would only be able to deduct $2,000 from your taxable income for the server every year for four years, instead of being able to deduct the full $8,000 the year you purchased the server.
Now, you might be saying to yourself, “A one-time $8,000 deduction or an $8,000 deduction spread out over four years, what’s the difference? You’re still getting an $8,000 deduction in the end.” However, according to the time value of money (TVM) principle, it’s usually better to have x amount of money today than to obtain the same amount in the future, because money tends to add value over time—whether you’re investing that money in the stock market or on some aspect of your business, such as sales, marketing, or new employees or equipment.
So for example, let’s say that with an $8,000 deduction you end up paying $1,000 less in taxes, and then you invest this $1,000 in a marketing campaign that ends up increasing your revenues by $2,000 in one year. The next year, you invest this surplus $2,000 into expanding your marketing campaigns, which ends up increasing your revenues by $4,000.
You continue reinvesting your increased revenues into expanding your marketing efforts, so that at the end of the fourth year you end up with $20,000 more in revenues per year than when you originally paid the OPEX.
In contrast, if you only deducted $2,000 from your taxable income that first year, then you’d only reduce your taxes for that year by $250, and you would only have $250 to invest in a marketing campaign, and your revenues would only increase by $500. The next year, you’d have an additional $250 in tax savings to invest, but only a $500 increase in revenues, so you’d only have $750 to invest in expanded marketing campaigns, instead of the $2,000 that you’d have if you’d deducted the full $8,000 from your taxable income the year before. And so on, until at the end of four years the amount that your revenue has increased will be a lot less than the $20,000 in the other example.
The bottom line: cloud computing being an OPEX allows you deduct all of your IT costs from your taxable income the same year that you pay those IT costs, which will allow you to invest more money back into your business.