Capital Budgeting

Meaning Of Capital Budgeting: 

Capital Budgeting is the process of preparing the long - term planning for the purpose of financing funds for required capital expenditure for a proposed project in order to get returns from the project over a long period in future.                                                                                                                                    The basic features of Capital Budgeting decisions are as follows:

     1.  Current Funds are exchanged for future benefits.

     2.  Investment in long- term activities.

     3.  Future benefits accrue to the firm over a number of years.

Importance Of Capital Budgeting: 

The Capital Budgeting decision are crucial business decisions due to following reasons:   

1. Substantial Expenditure: Capital is a scarce resource and capital budgeting decisions involve the decision on investment of substantial amount of funds. It is therefore necessary for a firm not to take quick decisions as incorrect decisions would not only result in a loss of profits but may cause substantial losses and may also account for the failure of the firm.

 2.  Long-term Effect: The effect of capital budgeting remains in force over a long- period. So, if any wrong decision is taken by a firm through its capital budgeting process, then the firm may suffer loss over a long period and as a result of it, the existence of the firm may be in danger. On the other hand, if correct decision is taken, then a lot of profit may be earned. So, it is necessary to think judiciously before taking such decision. 

 3.  Heavy Investment: A large amount of money has to be invested for incurring long- term capital   expenditure. So, a firm has to take up sufficient care before taking such investment decision and it has to take advance arrangement for procuring the required funds in order to finance the capital expenditure.

 4.  Irreversibility: Most of the long - term investment decisions are irreversible. Once they are taken, the firm may not be in a position to reverse them back without incurrence of huge costs as it is difficult to find a buyer for the secondhand capital items.

 5.  Complexity: The capital investment decision involves an assessment of future events, which  infact  is difficult to predict. Further it is quite difficult to estimate in quantitative terms all the benefits or the costs relating to a particular investment decision. 

 6.  Avoidance of losses: Capital Budgeting is necessary to avoid losses. A firm can take correct  decision with the technique of capital budgeting. As a result of it, it is possible for the firm to avoid the expected losses.