In: Accounting
Capital budgeting is key to every corporation’s long term success. In the article you read this week on product failures, you can see that a lot of good companies struggle to make good capital investment decisions. Putting together everything you’ve learned about cost measurement, CVP analysis, budgeting, sunk costs, and corporate strategy in, how will you advise your company to make smarter capital investments? Please cite work if taken from soneone else.
Capital budgeting is a step by step process that businesses use
to determine the merits of an investment project. The decision of
whether to accept or deny an investment project as part of a
company's growth initiatives, involves determining the investment
rate of return that such a project will generate. However, what
rate of return is deemed acceptable or unacceptable is influenced
by other factors that are specific to the company as well as the
project. For example, a social or charitable project is often not
approved based on rate of return, but more on the desire of a
business to foster goodwill and contribute back to its
community.
Capital budgeting is important because it creates accountability
and measurability. Any business that seeks to invest its resources
in a project, without understanding the risks and returns involved,
would be held as irresponsible by its owners or shareholders.
Furthermore, if a business has no way of measuring the
effectiveness of its investment decisions, chances are that the
business will have little chance of surviving in the competitive
marketplace.
Businesses (aside from non-profits) exist to earn profits. The
capital budgeting process is a measurable way for businesses to
determine the long-term economic and financial profitability of any
investment project.
Capital budgeting is also vital to a business because it creates a
structured step by step process that enables a company to:
Unlike other business decisions that involve a singular aspect
of a business, a capital budgeting decision involves two important
decisions at once: a financial decision and an investment decision.
By taking on a project, the business has agreed to make a financial
commitment to a project, and that involves its own set of risks.
Projects can run into delays, cost overruns and regulatory
restrictions that can all delay or increase the projected cost of
the project.
In addition to a financial decision, a company is also making an
investment in its future direction and growth that will likely have
an influence on future projects that the company considers and
evaluates. So to make a capital investment decision only from the
perspective of either a financial or investment decisions can pose
serious limitations on the success of the project.