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The Five Stages of a Capital Budgeting Process
Capital budgeting is one of the most important processes businesses need to rely on for growth and profitability. Therefore, careful insight and examination must be applied to the process of capital budgeting in order to get the most out of the process.
Capital budgeting can be broadly categorized into the following five steps.
Identification of Investment Opportunities
The first step of a capital budgeting process is the identification of an investment option. The business considering capital budgeting must find the reason for investment in this step.
The identification may result in a number of ways, such as new product launches or expansion of the current business opportunities. It is an important step because the identification must be correct and should be made at an opportune moment.
Development and Forecast of Benefits and Costs
In the second step of a capital budgeting process, businesses need to find out the costs assuming the necessary developments of the project. A number of factors may influence this step, including cash flows. The businesses must be adept in calculating the costs, forecasts, and benefits to make the capital budgeting process smoother and result-oriented, and should be aligned with the goals of the organization.
Evaluation of Net Benefits
The third step of the capital budgeting process is probably the most important. It includes the estimation of the benefits the company may derive from the project. As profitability and net revenues that can be earned from the project is related to this step, the analysts should be careful in making this step as closely matching to forecast as possible.
Authorization for Progressing and Spending Capital Expenditure
In the fourth step of a capital budgeting process, the business managers must check the first three steps and authorize the process. This is in fact, a management function that relies on finance managers to allow the funds for the project. This step is important due to the fact that allowance of large sums of money to spend may be required in the project and businesses must not overspend or underspend funds to remain competitive in the market.
Control of Capital Projects
The final step of a capital budgeting process includes control of the project in order to optimize the funds allocated and spent for specific tasks. It is a step that should be closely monitored by business managers so that the project runs smoothly and stays on track. The success of a project also relies heavily on this step.
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