Critically reflect on the importance of capital budgeting. Why is this heated subject in many boardrooms? How does capital budgeting promote the financial health of an organization? How will you use the financial techniques you have learned this week to promote the financial health of your organization? A capital budget is very important for a business. It is a heated subject because a decision about capital budgeting can help the business to determine if the proposed investments or project are worth taking or not. There are two things that a business has to take into consideration when it is making a capital budget decision.
First there are financial decisions that have to be made. Second, there is an investment decision that is also made. When the business decided on the investment for a project that they will want to buy with their fund in order to help their business grow; therefore, in order for the business to invest it has to look at the available funds and bottom line of that project.
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For a budget there are costs to take into consideration in order to begin the project. The business must know how much money it has on hand or avaible so that it can invest into the project and begin working on it.
Depending on the investment or project the business might have the funds needed or might have to get other help from outside sources. There are many things that go into an investment for a project. Businesses have to be committed and realize that there are a number of risks that come with any type of investment. Also, the project could cost a lot of money and it will have to deal with certain restrictions that are set with regulations. In most cases, the decision makers will be held accountable for whatever risks or returns that company might come across.
As a result, those who are making the decisions would have to answer to their owners or shareholders if things do not go according to plans. It is important that the business can pay for any new project/investment that it makes. In making decisions on an investment one has to know what returns the investment could make or bring for the business. If the business was to make an investment on a project that was not right or not profitable the smart thing to do would be to not invest in the project or consider it at all. An investment that does not make any money can be wasteful for the business and make it lose a lot of money in the long run.
That is why it is important for those who make the decision to evaluate all of their alternatives, risks, and returns, etc in order to decide on whether or not to reject or accept a project that it might have in mind. As a result, to promote the financial health of any organization one should know the present value of the investment and have a good ideal of how long that investment will take to mature and give back returns. In order to create a capital budget I have to consider the needs of the organization, look at the finances, goals, and position that the business is.
In doing I could make a decision about the needs of that business. Second, I would have to collect, compare, analyze, and evaluate the cash and financial statements in order to compare the cost and revenue. It would give me some lead way into the position of the business when it moves forward to the future. Third, the capital budget would have to be compared to the cash flow, because it will help me to know how important it is to make the investment only if it increases the financial bottom line and increase the total financial performance of the business.
I can use the estimates that I have for the capital that is needed and the financial situation of the business to compare and decided when and how the capital investment will be recovered. If it is an acceptable recovery, it is likely that the upper management will approved the capital budget. Lastly, when all things come into place I can create a budget, make sure that figures are accurate, and present it to upper management, once approved. I will make sure that the funds are available, be there to make sure that everything with the project goes according to plans.
The following are capital budget techniques that a business should use when trying to evaluate, analyze, and decide on which investment to use. Net Present Value are present value of all cash flows connect to an investment Internal Rate of Return is the discounted rate that equates the present value of an investment’s future cash flows with the investment’s cost. Profitability Index Payback Period measures how many years it takes to recuperate the initial investment of a project.