Capital budgeting involves choosing projects that add value to a company. The capital budgeting process can involve almost anything including acquiring land or purchasing fixed assets like a new truck or machinery. Corporations are typically required, or at least recommended, to undertake those projects that will increase profitability and thus enhance shareholders’ wealth.
However, the rate of return deemed acceptable or unacceptable is influenced by other factors specific to the company as well as the project. For example, a social or charitable project is often not approved based on the rate of return, but more on the desire of a business to foster goodwill and contribute back to its community.
The following Procedure may be adopted in the process of capital budgeting
Identification of Investment Proposals:
The first step is to explore the available investment opportunities. The organization’s capital budgeting committee is required to identify the expected sales in the near future. After that, they make the identification of the investment opportunities keeping in mind the sales target set up by them. There are points which are needed to be taken care of before starting the search for the best investment opportunities. It includes monitoring of the external environment regularly to get an idea about the new opportunities of investment.
Screening the Proposals:
After the identification of the investment opportunities, the second process in capital budgeting is to gather investment proposals. Before reaching the committee of the capital budgeting process, these proposals are seen by various authorized persons in the organization to check whether the proposals given are according to the requirements and then the classification of the investment is done based on the different categories such as expansion, replacement, welfare investment, etc. This classification into the various categories is done to make the decision-making process more comfortable and also to facilitate the process of budgeting and control.
Decision Making Process in Capital Budgeting
Decision making is the third step. In the stage of decision making, the executives will have to decide which investment is needed to be done from the investment opportunities available, keeping in mind the sanctioning power available to them.
Preparation of capital Expenditure Budget:
Proposals meeting the evaluation and other criteria are finally approved to be included in the capital expenditure budget. The decision making the next step is the classification of the investment outlays into the higher value and the smaller value investment.
Preparation of a capital expenditure budgeting and incorporation of a particular proposal in the budget does not itself authorize to go head with the implementation of the project. The investment proposal under consideration is implemented, i.e., put into a concrete project. There are several challenges that can be faced by the management personnel while implementing the projects as it can be time-consuming.
The last stage in the process of capital budgeting is the evaluation of the performance of the project. Review of performance is the last step in the capital budgeting. In this, the management is required to compare the actual results with that of the projected results. The correct time to make this comparison is when the operations get stabilized.