What is Investment?
Investment is typically an asset that is created with the only intention of allowing the money to grow. The wealth which is created can be used for a variety of objectives like - meeting the shortages in income, saving up for retirement, or fulfilling other and certain specific obligations like repayment of loans, payment of tuition fees, or purchase of other assets, etc.
Studying Investment, we will come across – Gross Investment and Net Investment. In this regard, we will discuss these two. Our main focus will be on the difference between these two investments – Gross Investment and Net Investment.
Difference Between Gross Investment and Net Investment
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In this section, we will discuss the difference between Gross Investment and Net Investment.
The fundamental difference between the gross investment and net investment is the consideration of depreciation between them both. In the gross investment, the expenditure which is being calculated doesn’t consider the amount of depreciation. On the other hand, while estimating the net investment, there is a consideration of calculating the amount of depreciation while calculating the expenditure.
In order to know the difference between these two even clearer, we must first answer these questions – ‘What is Gross Investment?’ and ‘What is Net Investment?’
Gross Investment Meaning
What is Gross Investment?
Gross investment is the total expenditure on the purchase of the fixed assets and the inventory that is accumulated during a financial year. In simpler words, gross investment is the sum total of expenditure that is incurred on the fixed assets and inventory during a financial year. Hence, if you say to define Gross Investment -
Gross Investment is referred to the total expenditure which is expensed out for buying capital goods over a long time period, without accounting for the amount of depreciation. For a company, gross investment is the amount which the company has invested in particular assets or the business as a whole without considering the amount of depreciation for the same (for the assets).
The Formula For Gross Investment
The formula for Gross Investment = Expenditure during the year on (Fixed assets + Inventory stock)
Which Inventory is Included, Which is Not?
Here, in the inventory stock, the unsold inventory stock is also included. This is done because the unsold stock of goods that lies with the producers is being treated as their purchases of the stock during the entire financial year.
What Actually Does to the Stock of Capital?
This is the expenditure of the fixed assets, the purchases of the new assets, as well as the replacement of the expenditure for the existing ones, which are included. As we also know, the fixed assets are used for another several years. And, they have some life potentiality for their use. Which becomes obsolete or worn out after a passage of a specific time period. Consequent to the same, these require some replacement as well. Hence, the replacement of these fixed assets, owing to their depreciation is a part of being the gross investment. But it never increases the total existing stock of capital. Thus, we see, the calculation only maintains the existing stock of capital.
After we have discussed and answered ‘What is Gross Investment?’, we will discuss Net Investment.
Meaning of Net Investment
The concept called - Net investment refers to the purchases of any new assets during a financial year. Net investment indicates the increase in the stock of capital which is done during a financial year.
The net investment is the actual addition that is made to the capital stock in a given time period. The Net Investment when taken into account is the depreciation which is calculated by subtracting the depreciation from the gross investment.
Calculation or Formula of Net Investment
If we are able to deduct the depreciation or the expenditure on the replacement of the fixed assets from the gross investment, we will get the net investment. Thus, it can be calculated as,
Net investment = Gross investment – Depreciation (expenditure on replacement of worn-out fixed assets)
Maintenance of the Existing Capital Stock
The net investment leads to the total stock of capital. Depreciation as a part of the gross investment replaces worn-out assets. Therefore, it helps in maintaining the existing capital stock.
After knowing the meaning of Gross Investment and Net Investment. We will know the difference between the two. For this, we will chart out the differences for better understanding.
Gross Investment Vs Net Investment
Are Investment and Savings the same?
The main question to be addressed is ‘What is Investment? Why does it become crucial when asked about savings on the same page?
Savings simply means putting other things aside which is a part of your earnings over time. The saved amount of money is subjected to no risk and, thus, it does not help you earn any profits or any returns. However, the value appreciation will remain stagnant, this happens as there is no addition over and above what you add in each month.
On the other hand, the Investment is based on the concept of earning the returns or profit on the money which you first put in a fund or you have spent on the asset which you have purchased. Remember that, there is the involvement of risk which makes the investment more profitable.
When we understand ‘what is an investment,’ remember that there is an exact and direct relation between the returns and risk, meaning that more significant is the risk involved, higher are the chances of earning a greater amount of returns. This is the reason you must check the risk profile of what you are investing.
FAQs on Difference Between Gross Investment and Net Investment
1. What is the main difference between gross investment and net investment?
The primary difference lies in the treatment of depreciation. Gross investment refers to the total amount spent on new capital assets (like machinery or buildings) in a given period. In contrast, net investment is the gross investment minus depreciation. Essentially, net investment shows the actual addition to an economy's capital stock after accounting for the wear and tear of existing assets.
2. How is net investment calculated from gross investment?
The calculation is straightforward. You subtract the value of depreciation from the gross investment to find the net investment. The formula is:
- Net Investment = Gross Investment - Depreciation
Here, depreciation represents the consumption of fixed capital during the period.
3. Can you explain the difference with a simple example?
Certainly. Imagine a taxi company buys 10 new cars for ₹1 Crore. This is its gross investment. However, during the same year, the existing fleet of cars lost ₹30 Lakhs in value due to wear and tear. This loss is the depreciation. Therefore, the company's net investment is ₹1 Crore - ₹30 Lakhs = ₹70 Lakhs. This is the true increase in the value of its capital stock.
4. Why is net investment often considered a better indicator of economic growth?
Net investment provides a more accurate picture of an economy's health because it reflects the real increase in its productive capacity. A high gross investment might be misleading if depreciation is also very high, as it would mean the country is merely replacing old assets. A positive and rising net investment signifies that the economy is adding to its capital stock, leading to higher potential output and genuine economic growth.
5. What role does depreciation play in distinguishing between these two concepts?
Depreciation, also known as the consumption of fixed capital, is the core element that separates gross from net investment. It represents the value an asset loses over time due to use, age, or obsolescence. Gross investment ignores this loss and only tracks new spending. By subtracting depreciation, we get net investment, which reveals the true, or 'net', change in the capital stock.
6. Is it possible for net investment to be negative? What would that mean?
Yes, net investment can be negative. This happens when the total depreciation of existing capital assets in a year is greater than the gross investment made during that same year. A negative net investment is a sign of economic trouble, as it indicates that the economy's capital stock is shrinking. It means the country is not even investing enough to replace its worn-out assets, leading to a decline in its overall productive capacity.
