Net InvestmentExplained & Defined
Net Investment is the remaining value of the capital assets after deducting the related depreciation expenses.
What is Net Investment?
Net Investment refers to the remaining value of the tangible and capital assets invested after deducting its related depreciation.
The computation provides information about the actual amount spent for capital investment, especially for capital-intensive companies, and the relative depreciation of both the tangible assets (Property, Plant, Equipment, etc.) and capital assets.
To compute the Gross Capital Expenditure of the company, the following formula is used:
Gross Capital Expenditure = Net Investment + Depreciation
Net investment can measure the productive rate of capital assets.
An indication that investments are a good choice is when the gross capital expenditures exceed the depreciation amount.
A negative effect happens when the depreciation exceeds gross capital expenditures which means that the productive capacity of the company is already decreasing.
Net Investment Formula
To compute the Net Investment amount, the total capital expenditure is first determined and the depreciation will be subtracted.
Net Investment = Capital Expenditure – Depreciation
Understanding Net Investment
The value of Capital Assets deteriorates over time, which means that in order to accurately depict the value of the net investments, the total depreciation related to the capital assets must be deducted.
There are several factors that result in the deterioration of assets and they include the following:
- Breakdown of Assets
Accounting for deterioration is through the depreciation method and the carrying value of the asset is determinable after deducting such depreciation.
It is to be noted that whenever depreciation is recognized, it does not affect the company’s cash flow because it is characterized as a non-cash expense.
Since non-cash expenses do not accurately depict the value of capital expenditure, removal of such is needed.
Companies that are capital-intensive, or require to purchase assets such as property, plant, equipment, technology, land, or building to undertake a new project or to upgrade existing ones invest heavily to expand the scope of the current business operations.
Net Investment Analysis
The management and users may use the net investment to assess the company’s performance and also compare its performance to companies belonging to the same industry.
One way to analyze a company’s performance is through horizontal analysis. The analysis pattern is from one accounting period to another.
- An increase in net investment corresponds to growth acceleration.
- A decrease in net investment corresponds to a slow growth movement.
- A zero net investment means that the company’s status is not growing.
- A negative net investment means the company is about to shrink.
Net Investment can also be used to compare companies belonging to the same industry.
A higher net investment amount compared to the competitors indicate higher growth potential.
There are two methods for businesses to allocate capital: re-investment in the business and distribution of returns to shareholders.
Shareholders and creditors see capital allocation as a company’s strategy for capital appreciation.
It is vital for a company to properly plan the areas the capital investment should be allocated.
Because capital allocation corresponds to big expenditures, not carefully planning its allocation will just mean money wasted for the company.
All spending must be appropriately accounted for and failure to do the same will reflect badly on the management.
Net Investment in Economics
From an economic point of view, net investment is a method used to account for the entire nation or region’s capital expenditure and forms part of the Gross Domestic Product (GDP) computation.
It is the aggregate expenditures made by the private companies and the government and provides an indication of the economic growth overall.