Motley Fool's Five Steps Of Capital Budgeting

Capital Budgeting encourages managers to accurately manage and control their capital expenditure. By providing powerful reporting and analysis, managers can take control of their budgets.

Capital budgeting is the process of assessing the profitability of future business projects, such as starting a new product or service line, in context of a business's resources and return requirements. This type of analysis is vital for small businesses, since choosing the right business opportunity (Cromwell, 2014). Under capital budgeting, you calculate the WACC for your business and the IRR for the project, and if the IRR is greater than the WACC, it is a profitable project you should pursue.

According to Lee, Johnson, & Joyce (2008), Capital budgets assist in deciding how much of each type of investment is necessary, and assist in evaluating available revenues (including loans) to finance those investments.

There are major decisions that financial advisors have to make in their daily lives. The first decision is investing decision which is capital budgeting decision. Capital budgeting is when a firm invests its funds in wanting fixed and current assets. This is a decision based on fixed assets taken. There are so many factors that affect investing capital budgeting like cash flow, return on investment, risks involved, and investment criteria. Capital budgeting has many important reasons such as long term growth, large amounts of funds involved, risks involved and permanent decisions (Samiksa).

Capital budgeting is the process of making long-term planning decision relating to planning for capital assets as to whether or not money should be invested in the long term projects

These decisions involve commitment of huge funds that too for a longer period which also changes the risk complexion of business. This decision, if undertaken judiciously, helps in providing the benefits of maximization of wealth not only for the concerned organization and industry but also for the economy as a whole. On the other hand, if this decision is not given its due importance, it will ultimately lead to the decline and demise of even a growing prosperous organization. Capital budgeting decision is considered to be the most important and crucial decision among the four decisions mentioned above because it, to a great extent, influences the survival, growth and value of a business enterprise. In the words of Porwal (1976), “Capital budgeting is one of the important vehicles to achieve objectives of a business concern”. Van Horne (1994) provides an argument according to which capital budgeting decision is the most important of the three decisions when it comes to the creation of value. It is considered under inorganic growth of an organization. Organic growth is brought about by daily investments in the business in terms of financial resources, hard work, careful investigations of quality, proper planning, serious team work, research and development, acquisition of technical knowhow etc. Inorganic growth in terms of acquisitions of new business may lead to quick growth without investments in any of the items mentioned above apart from financial resources. Capital

Capital budgeting, which is also called "investment appraisal," is the planning process used to determine which of an organization 's long term investments such as new machinery, replacement machinery, new plants, new products, and research development projects are worth pursuing. It is to budget for major capital investments or expenditures.

According to Investopedia, capital budgeting is “the process in which a business determines whether projects such as building a new plant or investing in a long-term venture are worth pursuing” (Investopedia, 2015). Capital budgeting is very important topic when managing a company and its finances. It could cause a significant amount of damage or it could further solidify the company’s foundation in their respective field. Companies have a variety of ways to manage their money and projects, whether is through qualitative analysis or information. This analysis or information may come from the cash inflow/outflow and the company’s assets.

In todays economic climate every company or organization is looking for a way to get ahead of its competition. Every owner, CEO, or president is looking for away to keep his or her company or organization on solid financial ground. The one thing that they realize is, in order for a company or organization to stay solvent they will need to find away to stay competitive in their perspective markets. They have found that this may be done by some type of investment(s), in the form of acquisition, and or merger. In the world of business, capital budgeting is one of the most important steps that a company or organization can take. This process is called Capital budgeting. Capital budgeting is a process that attempts to determine the future.

In a company, when evaluating multiple opportunities for investment, capital budgeting is an important tool that is used. Every company has a certain amount of capital available that they need to use in the most effective way possible. Capital budgeting involves analysis techniques, planning and justifying how capital dollars are spent on long term assets and projects. It provides methods through which projects are evaluated to decide whether they make sense for a particular business at a point in time. It also provides a basis for choosing between projects when more than one is under consideration at the same time (Lasher, 2013, p. 458-475). There are capital budgeting techniques that are applied and used in capital budgeting decisions, and each having some strength and weaknesses between them.

Capital budgeting can be defined or seen as a designed process which involves management of available resources to select long time investments that will generate high return on the investment of those resources, Brealey, R. A et al (2006). Companies are into businesses with the main aim of making profit, therefore, it is vital for companies to know how to evaluate

Capital budgeting allow businesses determine best profit generating investment plan and evaluate its profitability. The Capital Budgeting process involve distinct departments and authorities such as, the marketing department for analyzing the market potential for selected plan. Similarly financial analyst for analyzing and recording the cash outflow and cash inflow, and to ensure shareholders get benefitted.

An organization's planning division, using input from the entity's other sectors, can identify capital budget needs in physical terms, as in the case of acquiring and converting an existing building into business incubator space. From these descriptions, preliminary costs can be gathered and an appropriateness of need can be made to determine which projects should be contained in a "capital improvement plan." The capital improvement plan lists the projects to be undertaken over a multi-year period, such as five to ten years. Not a legal document, but a planning instrument, the capital improvement plan contains more than just numbers; it also contains narratives justifying each item in the plan, along with the alternatives considered [ Post, Troy’s study(As cited in the Mikesell 1995, 224-225).]

Regardless of the industry, any organization that is navigating their operations without observing all directions is putting themselves in an enormously risky situation since for a company to succeed they must be constantly aware of their financial situation. Capital budgeting is the process of planning expenditures that generate cash flow and that are also expected to go beyond more than a year. Any organization that is taking on a new project, or making a new investment, needs to determine whether this will be the most efficient use of their funds and whether this course of action will lead to an increase of wealth for the organization. Throughout this process, several principles should be kept in the forefront of the decision makers’ mind because they can serve as a form of guidance to avoid losing focus as they establish their budgeting plans. The four principles evaluated, and their importance, consequences, and benefits will be determined to understand their significance in this process better.

Capital budgeting is the process in which the company plans whether to purchase or do investment in certain projects or long term assets such as new machinery, equipment, new products, research and development etc. There are many techniques which can be use make decision more easy and reliable.