What is the meaning of the term ‘net’?
In the world of business, finance, and accounting, the term ‘net’ refers to the final amount remaining after all deductions, such as expenses, losses, and taxes, have been deducted.
Contrarily, the term ‘gross’ refers to the amount before the deduction of any expenses, losses, and taxes.
The term ‘net’ is used in numerous ways in business, finance, and accounting. The intention of this article is to explain the following usages of the term in accounting, finance, and business:
- Net cash
- Net cash flow
- Net current asset value per share (NCAVPS)
- Net debt
- Net debt per capita
- Net debt-to-EBITDA (earnings before interest, taxes, depreciation, and amortisation) ratio
- Net domestic product (NDP)
- Net exports and net imports
- Net income
- Net investment
- Net loss
- Net profit margin
- Net receivables
- Net sales
- Net tangible assets (NTA)
- Net worth
What is net cash?
Net cash refers to the liquidity position of a company, allowing analysts, owners, and investors to interpret the financial and liquidity situation of the company at a specific point in time.
Net cash is calculated in the following way:
Net cash = Cash balance – Current liabilities
Where:
- Cash balance comprises funds that are highly liquid, readily available to use, such as:
Cash in the form of banknotes, coins, current (cheque) accounts, savings accounts, and money orders, to name a few.
Cash equivalents like money market funds and treasury bills. Cash equivalents are considered liquid assets, meaning they can quickly and easily be converted into cash.
- Current liabilities[1] include financial and non-financial obligations. Typically, current liabilities are payable in a time frame of 12 months or less.
In addition, net cash may also indicate the amount of cash remaining after the completion of a financial transaction and the deduction of all related expenses.
What is net cash flow?
Net cash flow is not the same as net cash.
Net cash flow represents a business’s net increase (decrease) in cash over a particular period of time.
To calculate net cash flow, the following formula is used:
Net cash flow = Cash flows from operating activities (CFO) + Cash flows from investment activities (CFI) + Cash flows from financing activities (CFF)
Where:
- Cash flows from operating activities (CFO) comprise cash generated from a business’s main operating activities, such as sales of goods and provision of services. In other words, operating activities include all the activities that are reported on a business’s income statement under operating income and operating expenses.
- Cash flows from investment activities (CFI) refer to cash inflows and outflows related to the sales and purchases of long-term assets, such as equipment and vehicles.
- Cash flows from financing activities (CFF) involve the long-term debt and equity of a company. All the activities affecting the long-term liabilities and equity of a company will be represented in this section of the statement of cash flows.
Examples of financing activities are, amongst others:
- Cash received from the issuance of shares.
- Dividends paid to shareholders.
- Loans received or repaid.
The net cash flow will either be:
- a surplus (cash inflows exceed cash outflows), or
- a deficit (cash outflows surpass cash inflows).
The net cash flow of a company enables shareholders and other stakeholders to see how efficiently a company manages its cash flow, determining whether a company has cash available to honour its short-term obligations.
What is net current asset value per share (NCAVPS)?
Net current asset value per share, NCAVP for short, is a metric to determine the attractiveness of a company’s shares.
It is a term and measure that was introduced by Benjamin Graham (1894 – 1976), an American economist and investor, who preferred to value a company fundamentally according to its net current assets, instead of focusing on performance according to earnings.
Basically, NCAVPS represents the liquidation value of a company on a per-share basis. (Investopedia defines liquidation value as follows: ‘If a company were to go out of business and sell all its physical assets, the value of these assets would be the company’s liquidation value.’)
Shares trading below NCAVPS, allow traders and investors to purchase a company at a value that is less than its current assets.
NCAVPS is calculated by using the following formula:
NCAVPS = Current assets – (Total liabilities + Preference shares)/Number of shares outstanding
Where:
- Current assets = cash and cash equivalents, and other assets that can be converted into cash within 12 months or less.
- Total liabilities comprise long-term (non-current) and current liabilities.
- Shares outstanding are the shares issued to shareholders, including shares held by institutional investors and company insiders.
What is net debt?
Net debt is a financial metric that determines a company’s capability to honour all its debts if they were to be paid off straight away.
Put differently, net debt indicates how much cash and liquid assets would remain in a company if all its debt were due immediately.
The net debt calculation is an indication of whether a company is overleveraged, implying that the company has too much debt compared to its cash and other liquid assets.
Net debt with a negative figure means a company’s liquid assets exceed its total debt – an indication that the company is financially stable. Conversely, a positive net debt implies that a company has more debt than liquid assets. However, a company’s net debt has to be rated in context, meaning the type of company and the industry in which the company operates, has to be taken into consideration.
The formula to calculate net debt is:
Net debt = Short term debts + Long-term debts – Cash and cash equivalents
Where:
- Short-term debts are financial obligations that are payable within 12 months or less.
- Long-term debts are financial obligations that are due after 12 months.
- Cash equivalents are liquid assets that can easily and quickly be converted into cash.
What is net debt per capita?
Simply put, net debt per capita is a measure that indicates how much debt is held by an authority (government, municipality) per resident or citizen of the authority.
Net debt per capita can be applied to the government of a country, indicating how much debt per citizen is held by a national government. It is also applicable to a municipality, showing how much debt per resident is held by the municipality.
Net debt per capita is, inter alia, an indication of:
- how leveraged an authority (national government, municipality) is, and
- whether a government or other authority will be able to repay all its debts if they were all due immediately.
The measure may also have an effect on the credit rating of the particular authority.
The formula for net debt per capita is:
Net debt per capita = (Short-term debt + Long-term debt – Cash and Cash equivalents)/Population
What is the net debt-to-EBITDA (earnings before interest, taxes, depreciation, and amortisation) ratio?
The net debt-to-EBITDA ratio is a debt ratio that compares a company’s debt and its earnings before interest, taxes, depreciation, and amortisation.
It measures a company’s financial leverage and how long (years/months) a company will take to repay its debt if it carries on operating at the same level and its debt is held constant.
Generally, a low net debt-to-EBITDA ratio is preferred by investors and analysts because it shows that a company has not an unacceptably high level of debt and should be able to honour its debt obligations.
On the contrary, a company with a high net debt-to-EBITDA ratio may have a debt-risk, because it is excessively burdened with risk.
The formula to calculate the net debt-to-EBITDA ratio is:
Net debt-to-EBITDA ratio = Net debt/EBITDA
Where:
- Net debt = Short-term debt + Long-term debt – Cash and Cash equivalents
- EBITDA = Earnings before interest, taxes, depreciation, and amortisation
What is net domestic product (NDP)?
Net domestic product (NDP) refers to the net book value of all the finished goods and services provided within a country’s geographic borders during a specific period of time.
NDP is a key indicator of a country’s economic health and growth. A rise in NDP would indicate a growing economy, while a decline in NDP is an indication of an economic downturn.
The NDP of a country is calculated by deducting depreciation on a country’s capital assets, such as housing, vehicles, and machinery, from its gross domestic product (GDP).[2] (The depreciation is called capital consumption allowance (CCA).)
The formula to calculate the NDP of a country is:
Net domestic product = GDP – Depreciation on capital assets
What are net exports and net imports?
Net exports, and net imports, are described as the difference between the total of goods and services exported to other countries and the total of goods and services imported from other countries.
When the export of goods and services exceeds the import of goods and services, it is defined as net exports. Vice versa, net imports of goods and services by a given country occur when its imports are more than its exports.
The net export/import of a country can be calculated as follows:
Net exports/imports = Value of exports – Value of imports
Where:
- The value of exports is the amount of revenue generated by a given country for goods and services from foreign countries.
- The value of imports is the amount of money that a specific country has paid for goods and services received from foreign countries.
When the answer of the calculation has a positive value, the particular country generated net exports and is known as a net exporter. Countries such as China, Germany, and Canada are examples of net exporters.
Contrarily, when the outcome of the calculation is a negative value, the specific country is a net importer with net imports. Countries such as the USA and Spain are net importers.
A positive net export figure (exports exceed imports) is an indication that a country benefits from a trade surplus. Conversely, a negative net export number implies a country is prone to a trade deficit.
What is net income?
Regarding businesses, net income appears as the last item on a company’s income statement. Hence, it is referred to as the bottom line.
Net income represents the income of a company after the following items have been deducted from sales revenue:
- Cost of goods sold (COGS)
- Operating expenses
- Selling, general, and administrative expenses (SG&A)
- Depreciation
- Amortisation (if applicable)
- Interest expenses
- Taxes
In accounting, three names are used interchangeably for net income, namely net profit, net earnings, and net income. There is no difference between the three terms.
Net income is indirectly reported on the balance sheet of a company as part of the retained earnings, which is an equity account.
Assuming that no dividends are paid during a particular financial year, a company’s retained earnings will be calculated as follows:
Retained earnings at end of current financial year = Retained earnings at the close of the previous financial year + net income of the current financial year
With regard to individuals, net income refers to an individual’s income after statutory deductions, such as UIF (Unemployment Insurance Fund), PAYE tax, and Workman’s Compensation contributions, and union subscriptions (if applicable).
What is net investment?
Net investment refers to the total amount of money that is spent by a company to acquire capital assets, less the depreciation associated with the assets.
Expenses to acquire, install, maintain and repair capital assets are referred to as capital expenditure (CAPEX).
Capital assets comprise all the assets used in the operations of a company, such as property, plant and equipment (PP&E), and software.
The net investment figure provides a more realistic picture of the value of the capital assets.
The formula for calculating net investment of a company is:
Net investment = Capital assets – Depreciation
An analysis of the net investment of a company enables management, analysts, and other stakeholders to obtain an accurate picture of the growth of a company. For example:
- If net investment is rising over time, then the company’s growth is increasing.
- If net investment is declining over time, then growth is slowing down.
- If there is no change in net investment, then the company is at a standstill, deprived of any growth opportunities.
- If net investment is negative, the company’s capacity is shrinking.
What is a net loss?
In accounting, a net loss refers to a situation when a business’s expenses are higher than its revenue generated during a specific period of time, such as a financial quarter or year.
As with a net profit, a net loss is called the bottom line because it is the last line on a business’s income statement.
The formula to calculate net loss is the same as for the calculation of net income/profit, namely:
Revenue – Expenses = Net income/profit or net loss
If the result of the calculation is positive, it represents a net income. Vice versa, if the outcome provides a negative figure, it indicates a net loss.
Simply put, net loss indicates the amount of money a business lost during a given financial period.
What is net profit margin?
Net profit margin is a profitability ratio in accounting, measuring how much net income (net profit) a company generates as a percentage of revenues received.
Put differently, net profit margin indicates the amount of net profit a company receives for each South African rand (ZAR) (or any other currency) of revenue gained.
Some analysts describe the ratio as the ‘big-picture view’ of a business because it takes all the revenue and expenses into consideration.
It is one of the most important indicators of a company’s financial well-being, enabling shareholders to determine if a company is generating enough from sales and whether operating and other expenses are under control.
The formula for net profit margin is:
Net profit margin = Net profit after tax/Total revenue x 100
Net income and sales can interchangeably be used for net profit and revenue respectively.
Net profit margin is the most often used profitability ratio and is also called profit margin, net profit ratio, or net profit margin ratio.
What are net receivables?
The amount of net receivables of a business refers to the amount of money owed by its trade debtors who were allowed to buy goods and/or services on credit, minus the amount owed that will probably never be paid.
Money owed by trade debtors is called accounts receivable (AR), commonly referred to as receivables.
The practice of granting credit to customers always carries a credit risk that trade debtors will default on their payments when they are due.
To obtain a more accurate and reliable figure of what a business will eventually receive from its trade debtors, the business allows for doubtful accounts. An allowance for doubtful accounts[3] is a method used in accounting to record the number of accounts receivable that a business considers uncollectible.
Typically, the allowance for doubtful accounts is calculated as a percentage of the total receivables. For example, an allowance of 4% on a total of R480 000 receivables will be R19 200.
The net receivables amount is calculated as follows:
Net receivables = Receivables – Allowance for doubtful accounts
Thus, if the allowance for doubtful accounts is 4%, the percentage of net receivables will be 96% (100% – 4%).
A considerable difference between receivables and net receivables could be an indication of a problem with the collection activities of the business or with its credit-granting policy.
The nearer a business’s net receivables percentage is to 100%, the more effective are its collection procedures.
What are net sales?
Net sales refer to the gross sales of a business minus the following deductions:
- Sales returns – Occur when refunds are granted to customers when they return products to a business, usually because of defects or malfunction.
- Sales allowance – A reduction in the price paid by a customer, due to a problem with the sold product, such as a minor defect.
- Sales discount – Refers to a reduction in the price of a product or service, usually offered by a business to encourage a customer to make an early payment.
What are net tangible assets (NTA)?
The formula to determine a company’s net tangible assets (NTA) is:
Total assets minus intangible assets minus total liabilities.
Where:
- Total assets comprise tangible assets, also known as physical assets, and intangible assets.
- Intangible assets are items such as goodwill, patents, copyrights, and trademarks.
- Total liabilities include current and non-current (long-term) liabilities.
The total amount of net tangible assets is sometimes called the company’s book value or net asset value.
The value of NTA is important for a company because:
- NTA enables the management of a company to verify its asset position with the exclusion of its intangible assets.
- A high NTA allows a company to acquire financing more easily.
- NTA is useful to determine a company’s liquidity and solvency levels.
What is net worth?
Simply put, net worth is the value of everything an individual, business, or corporation owns, minus the liabilities they owe.
Put in other words, net worth is the value of the assets (financial and non-financial) of a person or a business minus the liabilities (debt) the person or company owes.
In finance, net worth is referred to as a snapshot of the current financial position of an individual or entity, indicating financial health.
Net worth can be described as either:
- positive (total assets exceed total liabilities), or
- negative (total liabilities exceed total assets).
[1] See the article, ‘Liabilities in Accounting Explained for Dummies,’ for more information about current liabilities
[2] Refer to the article, ‘South Africa’s Gross Domestic Product (GDP) – A Useful Guide’, for more about South Africa’s GDP
[3] See the article, ‘Allowance for Doubtful Accounts Explained for Dummies’, for more detail about this subject
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