What is Net Capital Spending?
Definition: Net capital spending is the amount of money that a firm uses to acquire fixed assets in a given accounting period. Companies in a phase of rapid growth or in an expansion drive tend to spend more on fixed assets, in a bid to accelerate the production or the delivery of services.
Spending can be on things such as property, machinery, plant, or equipment. Likewise, capital spending can include everything right from repairing a production facility to building a new facility. Such investments are usually made with the aim of increasing the production scope.
Firms with operations in capital-intensive industries boast of the highest level of net capital spending. Firms with operations in these industries must spend more in a bid to strengthen their competitive edge and fend off competition in the production process. Some of the industries with high capital spending include telecommunication, oil, exploration as well as manufacturing.
Purchased fixed assets tend to lose their value during their useful life. Therefore, the net capital spending equals the difference between what the company spends on fixed assets and depreciation that occurs. Financial analysts rely on straight-line depreciation to calculate the amount of depreciation that affects the value of fixed assets.
Net Capital Spending Formula Calculation
When it comes to calculating net capital spending, it is important to know the opening balance of the net fixed assets of a company at the beginning of an accounting period. The information is taken from financial statements.
Likewise, it is important to ascertain the net fixed asset of a company at the end of an accounting period. The information is also taken from the financial statement of a firm in question.
Conversely, depreciation expense is ascertained, which refers to the reduction in the value of assets over a given period.
Likewise, net capital spending would be:
Net Capital Spending= Net Fixed Assets Value (at the end) –Net Fixed Assets Value (at the beginning) + Depreciation Expense
Net Capital Spending Example
Consider company ABC with net fixed assets worth $800,000 at the end of an accounting year. The value of the net fixed assets at the beginning of the accounting year was $900,000. The yearly deprecation charged in the income statement was $80,000. Conerly the net capital spending would be
Net Capital Spending = $900,000- $800,000+$80,000= $180,000
A higher net capital spending shows that a firm or a business is committing big sums of money on acquiring fixed assets crucial to the survival of the business. However, if the investments don’t bear the desired results, then a company might end up incurring huge losses that might affect cash flows.
Net capital-spending can; therefore, tell you how much a company is investing in existing as well as new fixed assets in a bid to grow the business.
Net Capital Spending Pros and Cons
Advantages
Net Capital Spending provides valuable information on the growth trajectory of a company. A company in a phase of rapid growth is likely to incur a lot on fixed purchases in a bid to ramp up the production process. A company experiencing a slower rate of growth is likely to be spending less on new fixed-asset investment.
Net capital spending value enables stakeholders as well as would-be investors to get an idea about a company’s financial health. A company spending more on fixed assets would most likely boast of sound financial health.
Disadvantages
One of the biggest risks associated with increased capital spending is failure to accrue desired results from investments. Should investments fail to generate the desired results in terms of returns, then a firm is always at risk of plunging into financial problems.
Capital spending also requires a good level of planning of budgeting to avert the risk of funds going to vain.
Summary
Net capital spending denotes the amount of money spent on capital assets minus depreciation incurred in an accounting period.