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Investing in PP&E
A company investing in PP&E is a good sign for investors. A fixed asset is a
sizable investment in a company's future. Purchases of PP&E are a signal that
management has faith in the long-term outlook and profitability of its company.
PP&E are physical, tangible assets expected to generate economic benefits and
contribute to revenue for many years.
Liquidating PP&E
PP&E may be liquidated when they are no longer of use or when a company is
experiencing financial difficulties. Of course, selling property, plant, and
equipment to fund business operations is a signal that a company might be in
financial trouble. It is important to note that regardless of the reason a company
has sold some of its property, plant, or equipment, it's unlikely the company didn't
realize a profit from the sale.
For example, when purchasing a building for retail operations, the historical
cost could include the purchase price, transaction fees, and any improvements
made to the building to bring it to its destined use. The value of PP&E is adjusted
routinely as fixed assets generally see a decline in value due to use and
depreciation.
Amortization is used to devalue these assets as they are used. However, the
land is not amortized because of its potential to appreciate in value. Instead, it is
represented at its current market value. The balance of the PP&E account is
remeasured every reporting period, and, after accounting for historical cost and
amortization, is called the book value. This figure is reported on the balance
sheet.
Intangible assets are nonphysical assets, such as patents and copyrights. They
are considered to be noncurrent assets because they provide value to a
company but cannot be readily converted to cash within a year. Long-term
investments, such as bonds and notes, are also considered noncurrent assets
because a company usually holds these assets on its balance sheet for more
than one fiscal year. PP&E refers to specific fixed, tangible assets whereas
noncurrent assets are all of the long-term assets of a company.
Property, plant, and equipment are physical or tangible assets that are long-term
assets that typically have a life of more than one year. Examples of property,
plant, and equipment (PP&E) include:
Property, plant, and equipment assets are also called fixed assets, which are
long-term physical assets. Industries that are considered capital intensive have a
significant amount of fixed assets, such as oil companies, auto manufacturers,
and steel companies.
Analysts and potential investors will frequently review a company's PP&E to see
where and how the company is spending its money on fixed assets that could
help the company increase its profitability.
Characteristics of Property, Plant, and Equipment (PP&E)
Fixed assets have a useful life assigned to them, which means they have a set
number of years the assets will have economic value to the company. Fixed
assets also have a salvage value, which is the value remaining at the end of the
asset's life. Salvage value is also called scrap value.
Meanwhile, fixed assets undergo depreciation, which divides the cost of fixed
assets, expensing them over their useful lives. Depreciation helps a company
avoid a significant cash outlay in the year the asset is purchased.
Depreciation also helps spread the asset's cost out over a number of years
allowing the company to earn revenue from the asset.
How to Calculate Property, Plant, and Equipment (PP&E)
It's important for a company to accurately record its PP&E on its balance sheet.
Analysts and potential investors will frequently review a company's PP&E to see
where and how the company is spending its money on fixed assets that could
help the company increase its profitability.
It's also important for companies to track their PP&E in case they need to sell
assets to raise money. While most fixed assets depreciate over time and are not
easily converted to cash, some assets such as real estate can increase in value
over time, providing a company with a possible option for raising cash.
Where:
AD = Accumulated depreciation
To determine net PP&E, add gross PP&E to capital expenditures. From this
amount, subtract accumulated depreciation.
KEY TAKEAWAYS
It's important to know where a company is allocating its capital, whether the
company is making capital expenditures, and how the company plans to raise the
capital for their projects. If new equity is issued, the stock price might decline due
to dilution of the shares. If cash is used, the company may be unable to pay
dividends in future quarters. If the company obtains financing from a
bank or private equity firm, the company will have debt-servicing costs
associated with the additional long-term debt.