Net Investment Definition Formula Step By Step Calculation

Net Investment Definition

Net investment is the net amount invested by the company on its capital assets, which is calculated as the capital expenditure for the period less non-cash depreciation and amortization for the period, and it indicates how much is the company investing in maintaining the life of its assets and attaining future growth in the business.

Net Investment Explained

Every business, big or small, uses assets to generate revenues and earn profits. These assets go through wear and tear in the normal course of business. The assets essentially lose their useful life, and to maintain the business as a going concernGoing ConcernAny analyst analyzing a company will be left to a basic assumption that the company does not go bankrupt or file a chapter 11 bankruptcy. This basic assumption allows the analyst to think that there is no immediate danger to the company. The company can operate until infinity is called the principle of going concern., the assets base has to replenished by investing capitalInvesting CapitalInvested Capital is the total money that a firm raises by issuing debt to bond holders and securities to equity shareholders. Invested Capital Formula = Total Debt (Including Capital lease) + Total Equity & Equivalent Equity Investments + Non-Operating Cash read more on them. Net investment is an amount the company spends over and above the depreciation on acquiring new assets or maintaining existing assets.

Net investment requirement varies from business to business. For example, a service-based business, which generates all of its business from its workforce, may not require much investment to grow because its major cost will be salaries, which are OpexOpexOperating expense (OPEX) is the cost incurred in the normal course of business and does not include expenses directly related to product manufacturing or service delivery. Therefore, they are readily available in the income statement and help to determine the net profit.read more. On the other hand, a business that generates considerable business from manufacturing or using an intellectual property may have to keep investing in assets for sustainable growth.

Net Investment Formula

Net investment formula is represented as below:

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Where,

Capital Expenditure is the gross amount spent on maintenance of existing assets and acquisition of new assetsNon-cash depreciationDepreciationDepreciation is a systematic allocation method used to account for the costs of any physical or tangible asset throughout its useful life. Its value indicates how much of an asset’s worth has been utilized. Depreciation enables companies to generate revenue from their assets while only charging a fraction of the cost of the asset in use each year.
read more and amortizationAmortizationAmortization of Intangible Assets refers to the method by which the cost of the company’s various intangible assets (such as trademarks, goodwill, and patents) is expensed over a specific time period. This time frame is typically the expected life of the asset.read more is the depreciation and amortization expenses shown on the income statement.

Examples of Net Investment Calculation

Below are examples of net investment calculationInvestment CalculationAn investment calculator computes the amount, including the income earned on the initial amount invested in any investment plan or product which offers compounding earnings.read more

Example #1

Let’s assume a company spent $100,000 in capital expenditureCapital ExpenditureCapex or Capital Expenditure is the expense of the company’s total purchases of assets during a given period determined by adding the net increase in factory, property, equipment, and depreciation expense during a fiscal year.read more in a year and has a depreciation expense of $50,000 on the income statement.

Calculation of Net Investment

=$100000-$50000=$50000

Its net investment in this case is $50,000 ($100,000 – $50,000).

Example #2

Net investment can be understood much better by studying a real-world example of Netflix Inc., the popular video streaming service. Netflix’s business model involves investing in video content by creating shows and movie content of its own and buying streaming rights of other organizations’ content and selling the viewing rights to its huge 150 million subscriber base worldwide.

Netflix has to keep investing in content to maintain a library of content to ensure continuity of payments from its subscribers. If Netflix’s content becomes outdated, and there is nothing new to watch, its subscribers will log-out of Netflix to never come back.

Here is a snapshot of how much Netflix invested in its content in 2018

Source: netflixinvestor.com

The company added more than $13 billion in content assets and amortized more than $7.5 billion in content assets. Using this information Netflix’s net investment can be calculated as shown in the below table:

=$13043437-$7532088=$5511349

The company has a net investment of $5.5 billion.

Note: While Netflix considers the cash flow from these activities as operating, they are certainly investing cash flowsInvesting Cash FlowsCash flow from investing activities refer to the money acquired or spent on the purchase or disposal of the fixed assets (both tangible and intangible) for the business purpose. For instance, the purchase of land and joint venture investment is cash outflow, while equipment sale is a cash inflow.read more as the benefits of the content rights accrue over a long period of time.

Importance of Net Investment

As stated earlier, any company would need to invest in its assets to maintain its growth and to avoid getting obsolete somewhere down the line.

What would happen if the company keeps on sweating its assets and does not invest in new assets? The older asset base will definitely get outdated, inefficient, and will frequently break down. Given this, the company’s production and sales will be impacted and will lead to demand exhaustion, customer dissatisfaction, product returns, and the ultimate demise of the corporation.

For avoiding the demise, managements keep on investing in their company’s existing assets and new assets. Investment in existing assets helps the company retain the level of sales and profits while investment in newer assets could be to keep pace with the new technologies or to create a different source of revenue and profits if the existing business is expected to get obsolete in the future.

Difference between Gross Investment and Net Investment

Gross investment is the company’s capital investment Capital InvestmentCapital Investment refers to any investments made into the business with the objective of enhancing the operations. It could be long term acquisition by the business such as real estates, machinery, industries, etc.read more without deducting depreciation. It tells us the absolute investment the company has made in its assets in a particular year. Though the number in itself is valuable, it is helpful to analyze after nettingNettingNetting is a method of settling pending transactions by offsetting them against each other in favor of one.read more it to determine if the company is only investing in retaining its current business or is also investing in the future.

Advantages

Net investment indicates the replacement rate of the company’s assetsNet investment (if positive), generally helps the company remain in businessIt gives a fair idea to the analysts and investors to understand how serious the company is about its business and shareholdersIt tells us about the capital intensiveCapital IntensiveCapital intensive refers to those industries or companies that require significant upfront capital investments in machinery, plant & equipment to produce goods or services in high volumes and maintain higher levels of profit margins and return on investments. Examples include oil & gas, automobiles, real estate, metals & mining.read more the business (capital intensive businesses guzzle a lot of capital)

Conclusion

The business world is dynamic, and it changes pretty rapidly. Today’s hot product may not even exist tomorrow if it is not adequately nurtured. Managements can not choose to ignore investing in the betterment of their existing businesses and create additional products to increase their sources of revenue.

Take CD/DVD business. For example, the business is dead because of the shift of the video market from CD/DVD to online streaming and the shift of the storage market to portable storage devices. The companies which did not invest in these newer technologies at the right time are now out of business.

One should approach investment in a strategic manner. As a general rule, if the company is investing only as much as it is depreciating, it may be a problem. However, this may not hold true for all businesses. Some business models do not require too much investment and can go on for a long time just by maintaining their brand value. Such businesses have lesser capital expenditure requirements, and they can come out with newer products with minuscule investment in research and developmentResearch And DevelopmentResearch and Development is an actual pre-planned investigation to gain new scientific or technical knowledge that can be converted into a scheme or formulation for manufacturing/supply/trading, resulting in a business advantage.read more. Understanding the strategic requirement of net investment in a business is the key to analyzing the future prospects of the company.