Capital Budgeting
Capital Budgeting refers to strategic
planning and capital allocation in a firm. Capital Budgeting a financial
decision making process. It is one of the most important function of financial management and corporate finance. It is also referred to strategic asset
allocation. Thus from the above things we can conclude that Capital Budgeting
is a capital expenditure process of making decisions regarding the large
investments in assets or any other investment deals which involves strategic allocation
of capital in assets of a firm.
Capital Budgeting Process
Capital budgeting involves the
following steps,
§ Identification of potential investment opportunities
§ Assembling of proposed investments
§ Decision Making
§ Preparation of Capital Budget and Appropriation
§ Implementation
§ Performance Review
Now let us understand the Capital Budgeting process in detail step
by step
§ Identification of potential investment opportunities:
Capital Budgeting first step
is identification of potential deals for investment (it may be in plant or
machinery or any other investment deals).
A committee for planning estimates the future sales and production
targets which help to identify the required investments to be made in Plant and
Machinery, R&D and other areas of
investment. Identification of potential deals is helpful to
·
Study
external environment to identify potential opportunities.
·
Formulation
of corporate strategy based on SWOT
·
Sharing
of Corporate strategy with those who are involved in the process.
·
Motivating
employees to give suggestions
§ Assembling of proposed Investments:
The proposals which are identified by production or other
departments before submission of proposals to capital budgeting committee is
being studied from different angles and a report is prepared and submitted to
the committee. This helps to bring coordination of interrelated activities. In
this stage investment deals are classified as
·
Replacement
Deals
·
Expansion
Deals
·
New
Product Development Opportunities
·
Obligatory
and Welfare Deals
§ Decision Making
The decision is made regarding the where to invest from the
opportunities identified by the executives. Based on the level of management or
positions limit is assigned for the approving deals. For example a plant
manager can approve investment opportunity till 5 lakhs. In this way the limits
for making decision regarding the investment opportunities is being decided and
setup by the company for various levels.
§ Preparation of Capital Budget and
Appropriation
Based on the project budget estimation the small or large the
approval varies from executives to top management level. If small capital
expenditure is to be made the decision can be made by executives but if large
investments are required then top management approval is needed as it is
related to the firm’s financial management and its stability.
§ Implementation
This is one of
the most complex, time consuming and risk fraudulent task. Delay in the
implementation will raise the costs.
§ Performance Review
It is a process
of comparing actual performance with the projected performance. It is conducted
when the operations of the project have stabilized. It is useful in several
ways
·
It
throws light on realistic data to assumptions underlying projects.
·
It
provides documents that are helpful in decision making
·
It
uncovers the judgmental bias.
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