Net Capital SpendingThe amount a business spends to acquire capital assets

Patrick Louie

Date Published: September 21, 2022

A business will inevitably spend its money to pay for expenses such as rent, maintenance, salaries and wages, etc.

These are unavoidable and necessary expenses that keep a business’s operations running.

Hence, why we commonly refer to these as operating expenses.

Now, aside from operating expenses, a business may also spend its money to pay debts.

Or it may spend its money to purchase properties.

For example, a manufacturing business may spend its money to purchase a new set of machinery and equipment.

We generally refer to this kind of spending as capital expenditure or capital spending.

Not all businesses will spend the same amount on capital expenditures.

For example, a business that purely deals in providing services will have zero to low capital expenditures.

This is because service-based businesses typically don’t use fixed assets in their operations.

However, a business that mainly manufactures its products will likely have higher capital expenditures than a service-based business.

This is because a manufacturing business would need certain machinery and equipment for its manufacturing process, not to mention the building to house such a process.

With that said, you’d be justified to question whether or not a business’s structure supports its capital expenditures.

You’d want to know if a business is spending the right amount on capital expenditures.

One of the tools that can help with this is a metric commonly referred to as “net capital spending”.

Basically, net capital spending measures how much a business has spent on capital expenditures in a particular period.

In this article, we will be talking about net capital spending.

What information does net capital spending tell us?

How does one calculate a business’s net capital spending?

What does it provide for a business?

We’ll try to answer these questions as we go along with the article.

What is Net Capital Spending?

net capital spending

Net capital spending is a metric that measures how much a business spends to acquire capital assets (or fixed assets) during a particular period.

Depending on how one sees it, net capital spending may be a measure of a business’s growth in terms of fixed/capital assets.

Or one could simply see it as the amount that the business spent on capital expenditures for a particular period.

To further understand net capital spending, let’s take a look at the formula for calculating it:

Net Capital Spending = Ending Balance of Net Fixed Assets – Beginning Balance of Net Fixed Assets + Depreciation Expense (for current period)

The components for calculating a business’s net capital spending can be all found in its financial statements, specifically its balance sheet and income statement.

Both the beginning and ending balances of net fixed assets can be typically found on the balance sheet.

Net fixed assets can be computed by subtracting accumulated depreciation from the costs of the fixed assets.

For example, let’s say that a piece of equipment has a cost of $15,000 and its corresponding accumulated depreciation of $5,000, then its net fixed asset value is $10,000.

Depreciation expenses can be found on the income statement.

Depreciation expenses represent the amount of reduction in the value of a business’s assets due to normal wear and tear.

Each year, a fixed asset is expected to depreciate until it fully serves its useful life.

In the calculation of net capital spending, the business depreciation expenses for the current year are back.

This is because depreciation expenses reduce the ending balance of net fixed assets.

Not adding back the depreciation expenses figure will understate the net capital spending figure.

What Does Net Capital Spending Tell Us?

At a glance, a business’s net capital spending tells us about how much it spent on capital expenditures (e.g. acquiring fixed assets) for a particular period.

However, it can tell more than that. It can tell us about the growth of a business in terms of fixed assets.

It can also tell when a business is in one of its expansion phases.

More importantly, it can tell us whether the amount spent on the acquisition of fixed assets is reasonable.

I mean, you wouldn’t expect a large amount of net capital spending from a business that doesn’t need that many fixed assets.

What large net capital spending can indicate

A large net capital spending may indicate that a business is in one of its expansion phases.

Typically, if a business wants to expand its operations, it will have to spend a particular on fixed assets.

For example, if a manufacturing business wants to increase its maximum output, it will have to spend money to acquire the necessary machinery and equipment.

In some cases, the increased output may require a new building.

Such a purchase can result in large net capital spending for the period.

It may also indicate that the business is replacing some of its old fixed assets, particularly those that are fully depreciated.

The replacement is necessary to at least maintain the business level of operations.

A fully depreciated asset will typically perform less optimally than a new one, so not replacing may cause operational inefficiencies.

A business has to be careful with its net capital spending though.

A large net capital spending also means that it will be locking up a large amount of money in such assets.

This can be dangerous if the end result leads to a lack of liquidity.

Finally, be wary if a business that doesn’t normally utilize fixed assets has a large net capital spending.

It may indicate a misappropriation of the business’s resources.

What small net capital spending can indicate

A small net capital net spending may tell us the business is currently not expanding.

It could mean that its current fixed assets are enough for its operations.

This is usually the case when the business has only recently undergone an expansion.

Or it could be that the business has recently replaced its old assets with new ones so it doesn’t have to make any replacements for a while.

Businesses that don’t utilize many fixed assets will typically have a small net capital spending.

On the other hand, a business that does utilize many fixed assets will typically have a large net capital spending, although it may not always happen every year.

Net Capital Spending: An Example

Let’s say that you own a business.

Said business has a beginning balance of $355,000 for its net fixed assets.

By the end of the year, the net fixed assets have a balance of $503,000.

According to your business’s income statement, it has a total depreciation expense of $78,000 for the year.

With the information above, we gather the following:

  • Beginning Balance, Net Fixed Assets – $355,000
  • Ending Balance, Net Fixed Assets – $503,000
  • Depreciation Expense – $78,000

Let’s proceed with the calculation of your business’s net capital spending:

Net Capital Spending = Ending Balance of Net Fixed Assets – Beginning Balance of Net Fixed Assets + Depreciation Expense (for current period)

= $503,000 – $355,000 +$78,000

= $226,000

As per computation, the business’s net capital spending for the year is $226,000.

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  1. NYU Stern "Net Capital Expenditures" Page 1 - 15. September 21, 2022