Capital Budgeting is a process of evaluating long-term business decisions that need large amounts of capital. It is a way to find a better deal for the growth of the business. Capital budgeting is often related to important capital decisions that impact the bottom-line of a company. It has certain characteristic features. Here are the features one by one.
Capital budgeting is related to investments of large funds. It is often used to find projects that need large investments. Managers of a company identify the need for a capital budget where large sums of money are required. In capital budgeting decisions, managers analyze different opportunities and find the solution with optimum care.
The decisions taken in capital budgeting are irreversible in nature. Therefore, making the right choices and analyzing the basics is of optimum importance in capital budgeting.
Since the decisions cannot be taken back, managers need to be sure which option will offer the maximum returns. Once applied, the decisions can either make a good profit or large losses. So, taking capital budgeting decisions is key to the existence of a company.
Capital budgeting decisions often carry a high amount of risk. As large amounts of money are invested for a future outcome that is uncertain, it is of a high-risk nature. The large funds required in capital budgeting act like debt for the companies and if the process goes wrong this may even lead to bankruptcy of companies.
Capital budgeting decisions are long-term in nature. They make a long-term impact on profitability. In capital budgeting, the funds are invested in projects that offer the best returns. As the process of getting returns is long, the decisions usually take a long-term profitability point of view.
The decisions of capital budgeting directly impact the cost structure of the company. As large funds are involved in the process, capital budgeting relies on the cost structure of the company. Moreover, as decisions regarding rent, insurance, and production have to be measured, capital budgeting measures directly impact the cost structure of the company.
The decisions taken in capital budgeting are difficult because they are about the future which is uncertain. Managers need to look at many factors before making capital budgeting decisions. However, regardless of the amount of research, there is no guarantee that capital budgeting decisions will yield the desired results. That is why, the decisions of capital budgeting are difficult in nature.
The decisions taken in capital budgeting directly impact the strengths and weaknesses of a company. While a good decision can lead to spectacular profitability, a bad decision can be fatal for the company. That is why capital budgeting decisions are competitive in nature.