What is Net Capital Spending?
Net Capital Spending (NCS) measures the difference between a company’s capital expenditures and depreciation in a given period.
How to Calculate Net Capital Spending (Step-by-Step)
In corporate finance, the net capital spending (NCS) metric is measured to track the current state of a company’s growth trajectory as well as to support capital budgeting decisions.
The net capital spending of a company represents the amount spent on purchasing fixed assets in a particular period. The fixed asset (i.e. PP&E) categorization refers to non-current, tangible assets that can provide economic value for more than twelve months.
For instance, manufacturers must constantly replace existing machinery and equipment to offer their customers high-quality products and reliable, on-time delivery (e.g. for the avoidance of unexpected downtimes from machine failures and quality control), as well as to abide by regulations and ensure the safety of their employees.
In order to calculate net capital spending, the year-over-year change in a company’s net fixed assets (i.e. the ending net fixed assets minus the beginning net fixed assets) is added to the depreciation expense recorded in the current period.
Net Capital Spending Formula (NCS)
The net capital spending formula is as follows.
- Net Fixed Assets: “Ending Net Fixed Assets” refers to the current period balance, whereas the “Beginning Net Fixed Assets” refers to the prior period’s ending balance. The values of each can be found on the non-current assets section of the balance sheet.
- Depreciation: “Depreciation” is the Capex as recognized in the current period, which can be found on the cash flow statement (CFS) or in the footnotes and supplementary sections if consolidated with amortization expense.
How to Interpret Net Capital Spending (High vs. Low Industries)
The reliance on capital spending, or “capital expenditures”, is determined by the industry in which the company operates within (i.e. capital-intensive vs. capital-light). Thus, the net capital spending is of more relevance to capital-intensive industries as opposed to service-oriented industries like consulting, where most of the incurred costs in the business model are related to labor.
As mentioned earlier, the net capital spending metric can also provide insights into the stage of growth at which the company is currently. If a company’s net capital spending is on the higher end relative to comparable companies in the same (or an adjacent) industry, the company is implied to be in a period of high growth.
Companies exhibiting higher growth than their industry peers tend to possess higher net capital spending than those with lower growth.
However, a company with a disproportionate amount capital expenditures relative to its competitors is not necessarily a positive sign. In fact, the company might be trailing behind the rest of the industry in terms of growth and thus be attempting to catch up by spending a significant sum of capital on purchasing fixed assets.
If capital spending – i.e. the change in the net fixed asset balance across a period – is equal to the depreciation expense, then the net capital spending is zero. Net zero spending signals that the company is likely mature and in the later stages of its lifecycle with limited growth opportunities, which is conceptually identical to a company’s depreciation as a percentage of its capital expenditures converging to a ratio of 1.0x (or 100%).
Net Capital Spending in Capital Budgeting: Project Decisions
Thus far, we’ve discussed net capital spending in terms of tracking the trend in capital expenditures and depreciation as part of analyzing a company’s current (and future) growth profile.
It is important to note, however, that the term “net capital spending” can also refer to the sum of the initial investment and the after-tax salvage value, which is more commonly used for capital budgeting (i.e. decision-making around which potential projects to pursue).
The initial investment is the cost of undertaking the project, while the after-tax salvage value is the tax-affected fair market value of the asset, i.e. the fixed asset is assumed to be sold at a later date.
The purpose of computing the net capital spending as described above is to forecast the total cash flows of a project (e.g. operating cash flow, net working capital, and NCS).
Once complete, the net present value (NPV) of the project’s forecasted cash flows is calculated alongside the internal rate of return (IRR) to help decide whether to accept or reject the project.
Net Capital Spending Calculator – Excel Model Template
We’ll now move on to a modeling exercise, which you can access by filling out the form below.
Net Capital Spending Calculation Example
Suppose a company started the current year (2022) with a net fixed asset balance of $10 million, which is the beginning balance ending balance in the prior period (2021).
By the end of 2022, the company’s net fixed assets were $15 million, reflecting an increase of $5 million from the end of 2021.
- Beginning Net Fixed Assets = $10 million
- Ending Net Fixed Assets = $15 million
In 2022, the depreciation expense recognized on the income statement (and added back on the cash flow statement) was $3 million.
- Depreciation Expense = $3 million
Thus, we’ll enter our assumptions into the net capital spending formula to arrive at $8 million for the fiscal year ending 2022.
- Net Capital Spending ($15 million – $10 million) + $3 million = $8 million