BBC Content Team
Finance: Capital Budgeting
Updated: Sep 14, 2019
When we are talking about capital budgeting, “capital” represents long term investments, fixed assets, for example, capital investments in buildings, while “budgeting” represents the plan that consists of the anticipated revenue and other expenses related to the investment for the duration of the project. So the term capital budgeting is the process of determining which long term capital investment should be picked at a particular time based on the potential profit.
Capital budgeting gives businesses a financial measurement that is for more pricer capital spending, for things like new equipment, maintenance, upgrading existing equipment, as well as building purchases, building maintenance, and renovations. All and all capital budgeting uses multiple calculations to assess capital spendings and larger-scale projects. The first measurement model is future capital accountant profit by period. It could be based on quarters or years. Another one based on quarters or years is future cash flows by period. You could also use the present value of the company’s cash flow, discounting those cash flows with a specific interest rate.
The reason capital budgeting can be so important for long-term projects is that, with that much time and money at stake, it becomes the go-to barometer progress, cost risks, and potential return on investment for the company. Most companies turn to capital budgeting for other uses as well, companies can leverage capital budgeting in other financial management areas. For example leasing projects, day-to-day working capital spending, for research and as a measurement tool for new and existing purchases, and for assessing potential corporate bond issues. There can be too much at risk not to use capital budgeting, being able to measure big projects regularly allows decision-makers to make better-informed decisions going forward. There comes a point in big projects when there is no return for the company, where they need to have precise data on the projects, which capital budgeting can provide.
Capital budgeting is a highly useful financial analysis tool that helps a company plan, implement, and make decisions on long-term assets. It can provide a plan for long-term success for companies' projects, as well as assist other financial needs.