1.0 INTRODUCTION
In modern times, the efficient allocation of capital resources is
a most crucial function of financial management. This function involves Organization’s
decision to invest its resources in long-term
assets. This is important to the
firm because, in general, all the Organizational profits are derived from the
use of its capital investment in assets, which represent a large commitment of
financial resources, and these funds usually remain invested over a long
period.
The future development of a firm hinges on the capital previously
accepted, undertakings which turn out to be less attractive to the organization
than was originally thought, and divesting the resources to the contemplation
of new ideas and planning. In this note therefore, we will consider the
process, benefits and the key issues involved in capital budgeting.
2.0 OBJECTIVES
By the end of this note, you should be able to:
·
explain the term capital budgeting
·
discuss the process involved in capital budgeting
·
identify the benefits of capital budgeting.
3.0 MAIN CONTENT
3.1 Capital Budgeting
Process
Capital budgeting (also known as investment appraisal) is the
planning process used to determine whether a firm’s long-term investments such as
new machinery, replacement machinery, new plant; and new product and research
development projects are worth pursuing. It is prepared for major capital or
investment expenditure.
The process involved in capital budgeting include:
1. Identify required
capital projects and alternatives
2. Analyze and evaluate all proposals and alternatives, emphasis should
be given to validly of underlying data
3. Decide on and select best alternatives
4. Develop the capital expenditure budget
5. Strategic and tactical plans
6. Establish control of capital expenditures during the budget
year by using periodic performance report by responsibility center .
3.2 Capital Expenditure
and Key Issues in Capital Expenditure Budgeting
Capital expenditure refers to the use of funds to obtain
operational assets that will help earn future revenues as well as reduces
future cost. It includes fixed assets such as property, plant, equipment and
major renovation. Investments require the outlay of resources now to earn benefits
in future and this involve the planning and controlling phases.
An issue in planning capital expenditure is the problem of
ensuring that a company has the capacity to produce, required or be able to
deliver the goods and services that will be needed to meet its sales and
services plans. Major issues in controlling the actual expenditure are
consistent with the plans and that fund is available when the expenditure is
needed.
3.2.1. Key issues in capital expenditure budget
Project orientation
Time dimension
Classification
Major capital addition for example, acquisition of land and new building
Minor capital expenditure for example, recurring replacement
One of the important
elements from capital expenditure budget perspective involves cash outflow and
cash inflows.
Cash outflow include the cost of project in terms of cash outlay
at various times during the life span of a project.
Cash inflow involves the expected cash revenues, net of cash operating
expenses by period been carefully planned.
3.3 Benefits of Capital
Expenditure Budget
1. It enables management to plan resources to be invested in
capital additions to satisfying customers’ demand and ensure growth.
2. Its planning process helps avoid:
·
idle operating capacity
·
excess capacity
·
investment that earn less than an adequate
·
returns on funds invested.
3. The rationing of capital among alternative projects
4. Focuses the attention of management on cash flows, a critical
and often neglected problems
5. Increase co-ordination among responsibility centers.
4.0 CONCLUSION
The above discussion showed that capital budgeting is very crucial
in a firm thus managers should take it seriously. The note highlighted the process
of capital budgeting, the key issues to capital budgeting and the benefits
derivable from capital expenditure budgeting.
5.0 SUMMARY
This note has highlighted the meaning of capital budgeting. The
process of capital budgeting was considered alongside the benefits of capital budgeting
expenditure. It was shown that capital expenditure is vital to an Organization.
0 comments:
Post a Comment