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What is Capital Rationing?
Capital rationing is a strategy opted by companies that restrict the company’s investment in only one project at a given point of time. When several investments are available, the business needs to invest in the most profitable one.
Companies that rely on capital rationing usually have higher return on investment. This is simply because the company chooses the option where profitability is guaranteed and at its maximum.
Benefits of Capital Rationing
Capital rationing often leads to the most successful projects and hence it often guarantees the highest return on investment. Investors are interested in capital rationing because this gives them the idea of which investment project is going to be most successful.
Sometimes the cash in an investor's hand may be less or the cash flow may take some time to occur. In such instances, capital rationing helps investors and companies use the process that leads to higher returns for limited investments.
Capital rationing also tells the investors whether to stay longer before making a capital investment decision. For example, if an investor thinks that a certain stock will give a better return after six months, then taking the capital rationing principle, the investor may wait for six months before making investments in that stock.
Easy to manage as limited projects are considered
Capital rationing considers only the top few investment projects and hence, it is easier for the firms to manage. As there is a limit to the number of projects requiring high investments, capital rationing reduces the homework needed and offers a less pricey viable option for the investors. Therefore, it is better to choose when limited cash is there in hand or when the most preferred stock has to be chosen.
Having increased flexibility
Capital rationing lets investors keep some cash in hand for a good opportunity that may arise suddenly. Having enough cash in hand is useful for companies because it helps investors earn great rewards by investing in largely profitable projects just in time.
Capital rationing helps investors in earning a greater return on investment (ROI) by adjusting the capital decisions made at critical points of time.
Identified Lack of Resources
When a company lacks resources such as manpower, talent, or energy, it may take a capital rationing decision not to invest in such a project. Such reasons not only save time and money but are also beneficial in the longrun for the company.
To conclude, the capital rationing part of capital budgeting can be used as an advantage in gaining better returns by investing money in right projects. Capital rationing helps investors save time and money and is a great tool for those who seek better profitability from their investments.
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