What is Net Investment?
Net investment is the total amount of funds that are spent by a company to purchase capital assets, less the associated depreciation of the assets. The net investment figure provides an accurate depiction of how much is spent on tangible assets such as property, plant and equipment (PP&E) and other capital assets.
Net investment is a good indication of how much is being invested in the productive capacity of a company, especially if it is a very capital-intensive business. If gross capital expenditures are higher than depreciation, then the net investment will be positive, which indicates that the productive capacity of a company is increasing.
However, if the opposite is true, and depreciation is greater than gross capital expenditures, then the net investment will be negative, which indicates that the productive capacity of a company is actually decreasing. It can potentially be a major issue for a company since it shows that there is limited growth potential.
The net investment value is calculated by subtracting depreciation expenses from gross capital expenditures (capex) over a period of time.
Understanding Net Investment
As mentioned, net investment is calculated by subtracting depreciation from gross capital expenditures. Capital assets that are purchased usually deteriorate over their useful lives. The deterioration of assets comes from several factors, such as:
- Breakdown of the assets
- Repair maintenance
In accounting, the deterioration is captured monetarily by the depreciation account, which reduces the carrying value of the capital asset over its useful life. However, depreciation is a non-cash expense; that is, there is no cash outflow associated with it, so it distorts the representation of capital expenditures. In order to get an accurate representation of capital expenditures, the non-cash depreciation expense should be taken out.
Capital expenditures include assets that are purchased in order to undertake new projects and investments by a company. It is usually in the form of property, plant, equipment, buildings, technology, etc. It also includes investments made to maintain or upgrade current capital assets. Capital expenditures represent how much funds are being used to either maintain or increase the scope of a company’s operations.
Analysis with Net Investment
Net investment can be a metric utilized to measure a company’s individual performance or compare it against competitors. In horizontal analysis, net investment can be analyzed over time for an individual company to see what pace it has been growing at historically.
- If net investment is increasing over time, then growth is accelerating
- If net investment is decreasing over time, then growth is slowing
- If net investment is zero, then the company is stagnant and not growing
- If net investment is negative, then the company is shrinking
Net investment can also be compared to industry competitors. If the net value for a company is higher than the competition, it can indicate that the company demonstrates a higher growth potential than its competition. Additionally, if a company reports a lower value than its competitors, then it can face limited growth potential.
Net investment can be used to measure a company’s individual capital expenditures, but the analysis should be conducted with respect to the context of the business. Generally, a company can allocate capital in two ways: (1) it can reinvest in the business or (2) return capital to shareholders. It can be broken down further:
Capital allocation is important in driving value creation for shareholders and debtholders. The optimal use of a company’s capital should be analyzed, and capital expenditures are an important factor in capital allocation. Whether a company believes in its own productive capacity enough to invest further in itself through capital expenditures is an important indicator of a strong company. However, capital expenditures that are very high and are not reflected in a strong return on invested capital (ROIC) is an indication of poor capital allocation.
Net Investment in Economics
From an economics perspective, net investment is not applied to an individual company’s capital expenditures, but instead to an entire country or region. It is a figure used as a component in calculating a region’s gross domestic product (GDP). It indicates the domestic private investment being made by companies and governments and is a primary indicator of overall economic growth.
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