Net investment is the amount spent by a business or a capital economy, or gross investment, less depreciation. Net investment determines the amount of money a business spends on capital used for its operations, such as real estate, factories, equipment and software. By subtracting depreciation from this amount, or capital expenditure (CAPEX) (since fixed assets lose value during their useful life due to wear, obsolescence, etc.), gives a a more precise picture of the real value of the investment. Fixed assets include real estate, factories, technology, equipment and any other asset that can improve a company’s production capacity. The cost of fixed assets also includes the upkeep, maintenance, repair or installation of these assets.
Break down a net investment
If gross investment is systematically greater than depreciation, net investment will be positive, indicating that production capacity is increasing. Conversely, if gross investment is systematically lower than depreciation, net investment will be negative, indicating that production capacity is decreasing, which may be a potential problem along the way. This is true for all entities, from the smallest businesses to the largest economies.
Net investment is therefore a better indicator than gross investment of the amount a business invests in its business, because it takes depreciation into account. Investing an amount equal to total depreciation in a year is the minimum required to prevent the asset base from shrinking. While not a problem for a year or two, a negative net investment for an extended period of time will make the business uncompetitive at some point.
Calculation of net investment
A simple example will show how the net investment is calculated. Suppose a company spends $ 1 million on a new machine with an expected life of 30 years and a residual value of $ 100,000. Under the straight-line method, the annual amortization would be $ 30,000, or ($ 1,000,000 – $ 100,000) / 30. Therefore, the amount of net investment at the end of the first year would be $ 970,000.
The formula for calculating the net investment is as follows:
Net investment = capital expenditure – depreciation (excluding cash)
Continued capital investment is essential to the continued success of a business. The amount of net investment required for a business depends on the sector in which it operates, as not all sectors are capital intensive. Sectors such as industrial products, producers of goods, public services and telecommunications are more capital intensive than sectors such as technology and consumer products. Therefore, comparing net investments for different companies is more relevant when they are in the same sector.