What is Net Investment
Net investment is the amount spent by a company or an economy on capital assets, or gross investment, less depreciation. Net investment helps give a sense of how much money a company is spending on capital items used for operations, such as property, plants, equipment and software. Subtracting depreciation from this amount, or capital expenditure (CAPEX) (since capital assets lose value over their life because of wear and tear, obsolescence, etc.), provides a more accurate picture of the investment's actual value. Capital assets include property, plants, technology, equipment and any other assets that can improve the productive capacity of an enterprise. The cost of capital assets also includes upkeep, maintenance, repair or installation of said assets.
BREAKING DOWN Net Investment
If gross investment is consistently higher than depreciation, net investment will be positive, indicating that productive capacity is increasing. Conversely, if gross investment is consistently lower than depreciation, net investment will be negative, indicating that productive capacity is decreasing, which can be a potential problem down the road. This is true for all entities, from the smallest companies to the largest economies.
Net investment is therefore a better indicator than gross investment of how much an enterprise is investing in its business, since it takes depreciation into account. Investing an amount equal to the total depreciation in a year is the minimum required to keep the asset base from shrinking. While this may not be a problem for a year or two, net investment that is negative for a prolonged time period will render the enterprise uncompetitive at some point.
Net Investment Calculation
A simple example will show how net investment is calculated. Suppose a company spends $1 million on a new piece of machinery that has an expected life of 30 years and has a residual value of $100,000. Based on the straight-line method of depreciation, annual depreciation 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 net investment is:
Net Investment = Capital Expenditures – Depreciation (non-cash)
Continued investment in capital assets is critical to an enterprise's ongoing success. The net investment amount required for a company depends on the sector it operates in, since all sectors are not equally capital intensive. Sectors such as industrial products, goods producers, utilities and telecommunications are more capital intensive than sectors such as technology and consumer products. Therefore, comparing net investment for different companies is most relevant when they are in the same sector.