Capital Budgeting
The forecasting and budgeting of capital expenditure are important factors in the management of a business. The expansion of the existing plant and equipment and the introduction of technological improvements represent major factors in economic growth and contribute to increased productivity. As business expands, it becomes necessary to invest in fixed assets and it is quite natural that every business would expect a return adequate to the capital invested.
Steps in Capital Budgeting
1) Estimation of available funds for investment.
2) Preparation of list of alternative investment proposals.
3) Evaluation of the various projects by means of a number of techniques and selection of the most profitable ones.
Objectives of capital budgeting
1) The first objective of capital budgeting is to spread the available investible funds over the capital projects in an optimum combination so as to maximize the total profits accruing from all the investments put together.
2) Employment generation, employee compensation and satisfaction, provision for research and development etc.
3) It aims at controlling capital expenditure by forecasting the long-term financial requirements and thus enables to plan in advance to raise funds at the most appropriate time.
4) It determines the total amount of money to be invested on long-term project so that it may be controlled in line with the company’s financial policies.
5) It tries to compromise between the availability of funds and requirements of capital projects.
Classification of Capital Expenditure Budget
1) Initial capital expenditure budget
2) Replacement and expansion capital expenditure budget
3) Annual capital budget.
Factors to be considered in Project Evaluation
1) Financing source mix
2) Feasibility regarding:
a) Technical
b) Commercial
c) Financial
d) Managerial and
e) Economic feasibility.
Methods of Capital Budgeting
1) Long-range budgets and
2) Short-range budgets.
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