Question

Imagine you are the Corporate Financial Officer (CFO) of a Fortune© 500 company.

• Describe to your classmates the process your company would use in approving the capital expenditure budget. Remember that companies try to minimize expenditures.
• What evidence would you submit to top management to support your request for requested expenditures the company needs and why?

Answer 1

The process of budgeting for capital expenditures (CAPEX) is essential for a business to operate and grow in a healthy and profitable way. Capital expenditures are expenses a company makes to sustain and expand its business over a period of years.

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capital budgeting involves very large expenditures, and it is management that must make the evaluation as to whether the investment in assets is worth the cost. Capital expenses almost always impact operational expenses as purchased items need to be maintained and the "big picture" needs to be considered.

Management must make the call on whether capital expenditures come directly from company funds or if they must be financed. Financing increases the debt level of a firm, which also needs to be taken into consideration. Leasing is an option as well, one that becomes appealing if a company is purchasing assets such as computers or other technology equipment—items that can quickly become obsolete.

In deciding on capital expenditure for a certain item, a company's management makes a statement about its view of the company's current financial condition and its prospects for future growth.

Capital budgeting decisions also give an indication regarding what direction the company plans to move in the years ahead. Capital expenditure budgets are commonly constructed to cover periods of five to 10 years and can serve as major indicators regarding a company's "five-year plan" or long-term goals.

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Capital Expenditure Planning

Preparing a capital expenditure budget varies from one company to another depending on such factors, such as the nature of the company's business and the size of the company.

Separating Expenditure Budgets: Most companies budget their capital expenditures separately from other expenditures. Having a separate budget from operational expenses, for example, makes it simpler for companies to calculate the respective tax issues.

Department Input: Much of the need for CAPEX comes from the assessment of department heads, who run the day-to-day operations of a certain group.

Implementing a Budget Limit: Determining the max spend on capital is a crucial early step in CAPEX planning. Making a thorough assessment of CAPEX needs, whether this is for maintenance, new acquisitions, or growth, from different departments, determines the range in how much to budget for CAPEX.

Measuring Capital Expenditure Returns: Once the input from different departments has been assessed, a budget decided based on need and business growth, and capital expenditures completed, it's imperative a company determine the returns on their capital expenditure.

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The steps involved in the capital budgeting process are:

(i) Project Generation

(ii) Project Evaluation: Estimation of benefits and costs

(iii) Project Selection: projects are screened at multiple levels.

(iv) Project Execution.: The formal plan for the appropriation of funds is called the capital budget.

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