Capital budgeting is the planning process that is used to determine whether a business’s long-term investments are worth being funded or not. Businesses have a limited amount of capital that can be used on projected. Before you invest a lot of money into something you need to know if you are going to get returns. In order to figure this out the business’s cash inflows and outflows are analysed.
Here are some techniques that capital budgeting consists of:
- Payback period where the time in which the initial cash flow is returned by the project. The lower the period the better it is for the business
- Net Present Value is equal to the initial cash outflow minus the sum of the discounted cash inflows. The higher the net present value the more viable the investment.
- Accounting Rate of Return which is the profitability of the project calculated by the net income divided by the average investment.
- Internal Rate of Return which is the discount rate at which the net present value of the project becomes zero. The higher the internal rate of return the better it is.
- Profitability Index is the ratio of the present value of the future cash flows to the initial investment required for the project. The more profitable the project the better it is for the business.
- Throughput analysis where the amount of material passing through the system is analysed. All costs in the system are treated as operating expenses and the throughput passing through the bottleneck operation must be maximised. This is perhaps the most effective, albeit the most complicated method of capital budgeting.
Via capital budgeting your business can determine if the large investments or expenses are truly worth the money being spent. These can include building a new plant or investing in long-term ventures. You need all the information that you can get before making big decisions involving a lot of capital.
What do we do?
- We will go over the predicted cash outflows and the cash inflows to calculate the risk versus the benefit of the investment or the expense.
- We will analyse if the potential returns generated meet a sufficient target benchmark, also known as investment appraisal.
- We will help you figure out which projects and investments are most likely to yield the highest returns.
- By using capital budgeting techniques we will ensure that you pick projects that are truly worthy of being invested in.