Capital budgeting is the process of making investment decisions in long term assets, which involves measuring a project’s potential risks and expected long-term returns on an investment made. As capital and resources of a company are usually limited or diversified, wisely planned capital budgeting will benefit the company in terms of long-term profitability, expenditure and risk control and wealth maximisation.
A general progress of capital budgeting involves the following processes:
Generating good investment ideas determines not only the direction but also the feasibility of a company’s long-term investment planning and budgeting. Worthy investment ideas may come from senior management or employees from different departments, or sources outside the company.
Assessing each proposed project its expected profitability, based on information gathered of an investment’s future expected cash flows.
Capital Budget Planning
Scheduling projects based on profitability is an important part of the overall budget planning strategy, as a company’s cash flow and available resources must be carefully prioritised and allocated for all its operations.
Better maintenance of existing assets to lengthen their useful life, instead of replacing them with newly invested new assets. Avoidance analysis helps to reduce the total investment that the company makes in its fixed assets.
Identifying the time (number of years) needed for the company to generate sufficient cash flow to pay for initial investment made in the project, which takes into consideration the time period in which there is no return. Projects with a likelihood of faster, more profitable payback are preferred by most businesses.
Following up or tracking all the capital budgeting decisions, which involves comparing actual with projected results and, when necessary, account for why projections do not match with actual performance. A systematic post-audit is essential to fine-tune and troubleshoot a company’s forecasting process.
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