What is Capital Budgeting?

Capital Budgeting is a process that businesses undertake to evaluate the potential returns, as well as the risks involved, in the new opportunities proposed for the company’s growth. Usually, these opportunities refer to tangible fixed assets.

Also known as investment appraisal, this will guide the businesses to make the most out of their allocated funds in producing projects that can boost their gains. All findings from different types of studies are utilized to come up with a decision on whether to push the project through or not.

Steps in Capital Budgeting

It has five steps that take a lot of time to accomplish:

1. Finding new opportunities to increase profit

Businesses compete for patronage, influence, and profit, but the goals don’t end by reaching the expected sales. A business must grow continuously and its continuity should come with an increase in income. To achieve this, new opportunities are sought out, designed, and studied.

These endeavors, which are also considered investments, take various forms such as the installation of new or updated systems, opening of additional branches, and launch of new products or services. Business analyses are performed to find the best method in the implementation of the project that will optimize the profit generation while minimizing risks and costs.

2. Estimation of costs

The research, which will be both external and internal, will depend on what type of project to fulfill. If the company aims to set up another office, it needs to create a fund allocation for the construction or renovation materials, labor, government-mandated permits, supplies, and welfare of a new workforce.

Aside from getting the estimated expenses for the implementation and operation, financial planning also includes cost reduction without compromising the integrity of the project.

3. Planning the projected profit

As they are expensive and long-term investments, there should be an assessment with the impact it can bring to the business. The goal of the project can affect the brand reputation but it all boils down to finances. As mentioned, a business goes into new opportunities to earn more.

How it is done should have verifiable data such as the results of similar projects in the past or statistics that are tested and proven. The key is to have expected earnings over a specified period. It’s not only to keep the company’s sales at a consistent level but also to see inclining growth of the earnings.

4. Risk management

Everything is prone to risks, whether evident or unforeseen, and project coordinators know the importance of being prepared. A miscalculated risk can irreversible damages that may disrupt or cancel the project. Even a finished project, not well structured against pitfalls, can also fail upon its launching which brings a major financial loss.

When all the possible risks are assessed, the company can create plans on avoiding or cushion its ill effect when it occurs. It also gives the company a picture of where the adjustments should be from the expected profit.

5. Project implementation

Once a project is approved and finalized, the company follows an execution plan. It includes the calendar of project phases, records of cash outflows upon the implementation, cost monitoring, and data for the benefits it generates from day one up to the end (or as long as the business operates).

Advantages of Capital Budgeting

Here are the benefits businesses can reap from budgeting carefully:

• Wiser investment decisions
• Assessment of investment plans
• Balanced investment
• Risk recognition and management
• Better control over expenses
• Optimized income generation

Disadvantages of Capital Budgeting

These are drawbacks, on the other hand, when project mismanagement occurs:

• Decisions are usually expensive and irreversible
• Doesn’t completely erase the risks unforeseen
• Factors that affect the project may also depend from the managers
• Improper assessment can also affect the company