Capital budgeting is important and as a business owner, one should understand the significance of doing capital budgeting.
The objectives of capital budgeting:
- It helps to find out what the capital expenditure that will be profitable is
- It helps to determine whether the replacement of any asset that is existing and fixed will be able to generate better income than what it is was already generating
- It helps to decide whether a particular project should or should not be selected
- It helps to understand the finance that is required in for the expenses
- It helps to find out about the sources for the capital expenditure
- It lets one evaluate the merit of the proposal and knows which project is the best
The features of capital budgeting are:
- It involves an investment of the funds for getting future benefits
- It helps to spread the benefits over years
- The long-term investment is fixed
- The investments that are made determine the financial condition of the organization in the future
- Each project will need lots of funds
- The future benefits that are expected will be spread over the years
- The investment is made for a long-term and is fixed
- The investment that is made helps to determine what the financial condition of the business will be in the future
- The fund involved in every project will be huge
- The decision to make a capital expenditure is totally irreversible
- The profitability of a business is based on the investment quantum made into the project
Capital budgeting involves lots of risks and it estimates large profits. The time period between the initial investment made and the estimated return is also very high.
The importance of capital budgeting for an organization:
Capital expenditure is a long-term investment and this involves lots of risks financially. This is why it is important that one does proper planning when capital budgeting is needed.
The investment is huge and irreversible. The fund is limited and thus it is important that one does thorough planning through the entire process. Once you purchase an asset then you would have to incur a loss to sell it and thus the nature of the expense is totally irreversible.
The capital expenditure is done to reduce the cost of the business as well as make the company profitable. It also helps to avoid any underinvestment. You need to do proper planning and thorough analysis to help the business running in the long run.