Meaning of Capital Budgeting
Capital Budgeting refers to the investment decisions in capital expenditure incurred by which the benefits are received after one year. Capital expenditure is the expenditure which is occurred in the present time but the benefits of this expenditure or investment are received in future.
Capital expenditure is incurred on the fixed assets to acquire them or to improve them which gives benefits over a period of time. Capital Budgeting involves the planning and controlling of investment of funds which are to be invested in the capital assets as capital expenditure. It is a process of deciding whether to invest or not in a long-term investment whose returns are realized after five or ten years or more.
Nature of Capital Budgeting
Long Term Effect
Capital budgeting is a long-term process, the long-term investment can give favourable returns or negative returns over a period of time. Future of the company is based on the investment.
the future of the company depends on the return on the short-term investment, it can help in the growth of the firm and the wrong decision can endanger the survival of the firm.
High Degree of Risk
There is a high degree of risk in long-term investment as the decision is based on the estimated returns in the future. In the modern era fashion, taste and preference lead to high risk as the customers can switch from the product in this long-term. The company has to think about the future needs and wants of the customers to obtain gains.
Huge funds are to be invested in the capital budgeting, long-term assets are purchased for a longer period of time. Large amount of funds is required and there is a high risk in taking decision that where the funds are to be invested as mentioned above the capital budgeting can lead to growth of company and can also become the reason of downfall of the company that’s why the decision should be taken after proper analysis.
The long-term decision making is irreversible in most of the cases, it is a long-term process and the decision once taken has a huge investment invested in it as capital expenditure.
The company can not reverse it back easily because of high investment of funds. The sale of high-value assets is not easy, there is a problem in selling assets of high value in the market.
Impact Competitive Strength
The future competitive strength of the firm is also based on the future decisions. The future profit of the firm is determined by the decision which has been taken in the present and the cost of the product is also defined by the decisions. If the decision is in favour then the firm can sell the product at a higher price than the competition in the market and vice-Versa.
Impact on Cost Structure
Cost structure is affected by the vital decisions, the firm has to fix the costs of the supervision, insurance, interest etc. If the investment does not generate returns then the profitability of the firm is affected. Future profitability of the company totally depends on the cost structure.
Scope of Capital Budgeting
use of machinery
Due to advancements in technology Human are replaced by the machinery in production. These types of machinery can produce products at a cheaper rate. Capital budgeting helps in finding out the cost to acquire the machinery.
Capital budgeting helps in deciding whether to buy or lease a Machinery for production and Decision to replace old machinery with new. Other decisions are also made with information through capital budgeting.
Capital Budgeting directly influences the profitability of the business. It Help in reducing the cost of operations to business by taking decision for long term capital. It helps to provide proper information about current expenditure and future benefit, that saves the unnecessary expenses.
Capital Budgeting has an effective role in accelerating the overall performance of business organizations. By providing the long term assets by acquiring Plant and machinery that Improves the Performance of the production department.
Selection of machinery
Various types of machines are available in the market for production. The cost of the machine is different based on their capacity. Capital Budgeting helps in deciding which one to buy for our organization.