What is Capital Budgeting? What do you mean by Capital Budgeting?

 Capital Budgeting is acquiring input with long term return” Richard and Green Law

According to the definition of Lyrich, “Capital budgeting consist in planning development of available capital for purpose of maximising the long term profitability of concern.

Need and importance of capital Budgeting

Huge Investment: Capital budgeting required huge investment of funds, but the available funds are limited, therefore the firm before investing projects, plan are control its expenditure.

Long Term:- Capital Expenditure is long term in nature or permanent in nature. Therefore financial risk involved in the investment decision are more. If higher risk are involved, it need careful planning of capital budgeting.

Irreversible: The capital investment decision are irreversible , are not changed back, once the decision is taken for purchasing a permanent asset, it is very difficult to dispose of those assets without involving huge losses.

Long term effect: - Capital budgeting not only reduces the cost but also increases the revenue in long term and will bring significant changes in the profit of the company by avoiding over or more investment or under investment.

CAPITAL BUDGETING PROCESS

Capital budgeting is difficult process to invest of available funds. The benefit will attained only in the near future but, the future is uncertain. However, the following steps followed up for capital budgeting, then the process may be easier.

Identification of various investment: The capital budgeting may have various investment proposals, the proposal for the investment opportunities may be defined from the top management or may be even from the lower rank. The head of various department analyse the various investment decision and will select proposal submitted to the planning committee of competent authority.

Screening or Matching the Available resources: the Planning committee will analyse the various proposal and screening. The selected proposal are considered with the available resources of the concern. Here resources referred as the financial part of proposal. The reduces the gap between the resources and the investment cost.

Evaluation of proposal: after screening, the proposals are evaluated with help of various method, such as payback period proposal, net discovered present value method, accounting rate of return and risk analysis. Proposal are evaluated by independent proposal, contingent of dependant proposal and partially exclusive proposal. 

Independent proposal are not compared with another proposal and same may be accepted or rejected.

Fixing property: after the evaluation, the planning committee will predict which proposal will give more profit or economic consideration. If the project or proposal are not suitable for the concern’s financial condition, the project are rejected after consideration other nature of proposal.

Final approval: the planning committee will approves the final proposals, with the help of the following:

Profitability

Economic constituents

Financial violability

Market condition

Implementation: the competent authority spends the money and implements the proposal. While implementing the proposal, assign responsibilities to the proposal, assign responsibilities for completing it, within the time allotted and reduce the cost for this purpose.

Performance review of feedback: the final stage of capital budgeting is actual result compared with standard results.  The adverse or unfavourable result identified and removing the various difficulties of the project.

KINDS OF CAPITAL BUDGETING EVALUATION

The method of evaluations are classified as follow:

1. Traditional Method (Non- Discount method)

Payback period method

Post pay- back method

Account rate of returns

2. Modern Method (Discount method)

Net Present Value

Internal rate of return method

Profitability Index method