Capital Budgeting
Capital Budgeting
A significant area of decision-making is to determine whether or not capital expenditure should be made. Capital expenditure should be made. Capital expenditure is one which is intended to benefit future periods and is normally associated in accounting with the acquisition and improvement of fixed assets. However, there are certain other expenditures, like research expenses and costs of advertisement compaign directed towards new products or expansion of firm’s market. that may also be considered expenditure on par with the acquisition of fixed assets. as the benefits arising from such expenditure are spread over a longer period of time certainly more than one year. In some situations, the goals of the firm will be advanced by increasing firms total assets (or capital expenditure): in other situations, goals are served better by rejecting the expansion. It is in this context that the forecasting and budgeting of capital expenditure becomes a vital part of policy making and management function.
It has been estimated that about 20-25 percent of our total expenditure (Government, Corporations and households taken together) are incurred on capital projects as a result of planned industrialisation and economic growth in the country. And , its share has been increasing. Hence the importance of capital investment decisions also arise on account of certain characteristics of such expenditure which distinguishes it from other short-term, revenue expenditures. Firstly capital expenditure has a long term effect on the entire operations of the firm and such decisions are irreversible. Secondly, investment decisions normally involve large sums of money and scarce resources which have alternative uses. This not only involves the question of opportunity cost but may also result in a major departure from what the firm has been doing in the past. Thirdly, there is generally a time-lag between capital outlays and the returns or revenues, they generate, Fourthly, the capital assets deteriorate in productivity as time goes by. This creates the problems of depreciation, etc., which must be taken into consideration at the time of decision-making as it will affect the future profits and cash flows, Lastly, the investment is fixed assets is made for wealth generating capacity. That is their utility lies in their productivity and usefulness rather than in their realizable value.
