If you’ve ever read a company’s annual report or taken a look at the financial workings of a given entity, you may have come across the terms gross investment and net investment. Given that they are both terms related to investment, it is easy to confuse them. Between the two, it may take me a minute longer to explain net investment but let’s give it a shot.
Gross investment refers to the total expenses that a company makes when it procures capital goods over an outlined period of time. It is important to note that the depreciation in value that transpires over this time frame isn’t accounted for over here. Gross investment simply refers to the amount a company invests in certain assets or the overarching business without considering their fall in value over time.
Net investment, on the other hand, refers to the amount of capital a company directs towards asset acquisition. Capital assets help enhance a given company’s productivity. Popular examples worth noting include implements and tools relevant to the company’s functioning.
Net investment is calculated by subtracting depreciation from the company’s gross investment. This depreciation occurs as the previously purchased fixed assets decline in value over time owing to wear and tear and can become obsolete. By reducing the noncash depreciation that transpires over time, it is possible to arrive at an accurate understanding of what the value of the assets is.
Net investments provide you with a true indicator of the extent to which a company invests in assets as opposed to gross investment. Further, this value serves as an indicator that makes it possible to assess a country’s potential economic production capabilities.
Interestingly, net investments fall under a nation’s gross domestic product or GDP. This figure provides insights into all the expenses that private companies as well as governments direct towards real estate.
With net investments, it is possible to understand a company’s (or country’s) production capacity and whether it’s rising or declining. A positive figure is representative of growth or increased production capacity. On the other hand, a negative figure shows a decline in production capacity.
In instances of gross investment exceeding depreciation, net investment has a positive figure. On the flip side, in instances wherein gross investment falls below depreciation, net investment is negative. In order to ensure that net investment remains positive, a country must invest funds that amount to the same value as depreciation as a whole. This helps prevent the asset base from declining.
It isn’t unusual or abnormal for net investments to have a negative value for a few years. That said, should a negative net investment value persist over the long term, it will indicate the uncompetitive status of the company (or country).
Here’s a table showing the differences between net investment and gross investment
This form of investment makes clear a company’s investment style and whether it directs money to retain its current operations or invests in its future. Net investment provides you with a true understanding of the actual money spent on capital goods. This is done by accounting for the wear and tear that transpires over time.
This value helps enhance an organisation’s efficiency. Since net investment provides a more thorough understanding of a company’s ground reality, it has been explored in greater detail below.
Some of the merits associated with net investment are as follows.
If you invest your money in a company, net investment is a valuable metric that ought to be considered. This is because it helps shed light on a company’s production capacity. Provided net investment continues to rise over time, it indicates that the company is actively investing in assets that will enhance its productivity. Simply put, it is an indication of growth.
On the flip side, a dip in value over time indicates that the company is using old assets to run its business and not making any new purchases. This can lead to a decline in the company’s productivity and can reflect its stagnant or declining value.
It is imperative for a company to make regular investments in capital assets to continue to be successful. These investments provide investors with a sense of confidence in the business model.
As an investor, it is important to keep an eye on the company(/ies) you invest in and its (/ their) net investment value, which should be stable if not rising over time. This is because this rising value helps show that the company is interested in and investing in its future, thereby confirming its existence down the line. By comparing different companies operating within the same industry according to their net investment, investors can determine which company they should invest in.
The appropriate net investment may vary across the company's industry. Capital-intensive sectors like telecommunications, industrial producers and investors feature high net investment values. On the other hand, sectors like those of consumer goods and technology are comparatively less capital intensive, owing to which their net investment requirements are lower.
The Bottom Line - Ultimately, you must compare firms within a given industry in order to understand which company has a better position in terms of net investment. This indicator is a must when analysing a company’s operations. That said, this indicator cannot be viewed as the sole determinant via which an investment decision should be made.
A1. Net investment is calculated by deducting depreciation from capital expenditure.
A2. In order to understand net investment, consider an example of a company that invests in machinery valued at ₹15 lakhs with a life span of 25 years with no residual value. Provided the company follows a straightforward depreciation method, the depreciation value amounts to ₹50,000 per year. This would mean that by the end of the first year, the net investment would be as follows.
In case the company invests in fixed assets the following year, this value would rise. Else, it would decline in accordance with the depreciating value of the machinery.