Difference Between Gross Investment and Net Investment
Learn about gross and net investments through examples, and also explore the difference between gross investment and net investment.
If you read a company’s annual report or review its financial statements, you might have come across terms like gross and net investment. Since both terms sound similar, it is easy to confuse them. In this blog, we will cover the major difference between gross investment and net investment.
Comparison Table – Gross Investment vs Net Investment
The main difference between gross and net investment is that gross investment is the total amount of investment made in an economy, while net investment contributes to increasing the capital stock of an economy after accounting for depreciation. Let’s explore the rest.
| Gross Investment | Net Investment |
|---|---|
| Refers to the total amount of investment made in an economy without considering any depreciation in the value of the existing capital stock. | Refers to the depreciation of existing capital stock and reflects the change in the net capital stock of an economy. |
| Includes investment in new buildings, machinery, equipment, and other physical assets. | Considers depreciation. |
| Represents the total amount of new capital added to the economy. | Represents the investment amount for increasing the capital stock of an economy |
| Formula – Gross Investment = Sum of all capital expenditure for acquiring capital goods | Formula – Net Investment = Gross Investment – Depreciation |
| Gives an idea of the amount a company should spend on capital goods. | Suggests how much the company spends on capital assets by considering depreciation, thereby improving the organisation’s efficiency. |
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What is Gross Investment?
Gross investment is the total amount invested in new capital goods, such as machinery, equipment, buildings, and other structures, without accounting for any depreciation or replacement of existing capital.
The gross investment includes an estimate for the value of capital depreciation since the company must invest each year in replacing technologically obsolete or worn-out plants and machinery.
How to Calculate Gross Investment?
The formula for gross investment is:
Gross Investment = Fixed Capital Expenditures + Changes in Inventories
Where,
Fixed capital expenditures refer to the spending on new fixed assets such as machinery, equipment, and buildings.
Changes in inventories refer to the changes in the stock of unsold goods a business holds.
For example, if a business spends Rs. 100,000,000 on new machinery, Rs. 30,000,000 on a new building, and Rs. 10,000,000 in employee bonuses during a year, then the gross investment for that year would be:
Gross Investment = Rs. 100,000,000 + 30,000,000 + 10,000,000 = Rs. 140,000,000
This means that the business has made a gross investment of Rs. 140,000,000 in new capital goods during that year, representing the total amount of money invested in creating or expanding existing assets. Gross investment is an important measure of the level of investment being made in an economy or business, which can impact its future growth and productivity.
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What is Net Investment?
Net investment is the difference between the total amount of money a company spends on capital assets and the depreciation cost of those assets. It indicates how much a company spends to maintain and improve its operations. A positive value indicates that the business operations are leading to expansion. In contrast, a negative value indicates that the business operations are shrinking.
Following are some of the advantages of net investment:
- Indicates the replacement rate of the company’s assets.
- A positive value generally helps the company to stay in business.
- Net investment value analysis helps investors and analysts to understand how serious the company is about the business and its shareholders.
- The value also helps in determining how capital-intensive a business is.
How to Calculate Net Investment?
The formula to calculate net investment is –
Net Investment = Capital Expenditure – Depreciation
Let’s take an example of a company that invests in machinery worth Rs 10 lakhs with a life of 25 years and no residual value. If the firm follows a straight-line method of depreciation, then the value of depreciation is Rs. 50,000 per annum.
At the end of the first year, the net investment calculation is as follows:
Net Investment = Rs. 10,00,000 – 50,000 = Rs. 9,50,000
In the next year, the firm will increase if it invests in fixed assets. Otherwise, the firm’s net investment will be reduced by machinery depreciation.
Example – Difference Between Gross Investment And Net Investment
To understand the difference, consider this example:
A factory starts the year with 20 machines. It purchases five more new machines, while four machines move out of operations.
Now, the gross investment refers to purchasing new machines, which is 5.
While at the end of the year, the total number of machines in operation = 20 + 5 – 4 = 21. This leads to a profit of 21 – 20 = 1 machine, reflecting the net investment.
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