Meaning of Capital Budgeting
Capital Budgeting is the process of making investment decision in fixed assets or capital expenditure. Capital Budgeting is also known as investment, decision making, planning of capital acquisition, planning and analysis of capital expenditure etc.
Objectives of Capital Budgeting
The following are the objectives of capital budgeting.
1. To find out the profitable capital expenditure.
2. To know whether the replacement of any existing fixed assets gives more return than earlier.
3. To decide whether a specified project is to be selected or not.
4. To find out the quantum of finance required for the capital expenditure.
5. To assess the various sources of finance for capital expenditure.
6. To evaluate the merits of each proposal to decide which project is best.
Features of Capital Budgeting
The features of capital budgeting are briefly explained below:
1. Capital budgeting involves the investment of funds currently for getting benefits in the future.
2. Generally, the future benefits are spread over several years.
3. The long term investment is fixed.
4. The investments made in the project is determining the financial condition of business organization in future.
5. Each project involves huge amount of funds.
6. Capital expenditure decisions are irreversible.
7. The profitability of the business concern is based on the quantum of investments made in the project.
Limitations of Capital Budgeting
The following are the limitations of capital budgeting.
1. The economic life of the project and annual cash inflows are only an estimation. The actual economic life of the project is either increased or decreased. Likewise, the actual annual cash inflows may be either more or less than the estimation. Hence, control over capital expenditure can not be exercised.
2. Capital budgeting process does not take into consideration of various non-financial aspects of the projects while they play an important role in successful and profitable implementation of them. Hence, true profitability of the project cannot be highlighted.
3. It is also not correct to assume that mathematically exact techniques always produce highly accurate results.
4. All the techniques of capital budgeting presume that various investment proposals under consideration are mutually exclusive which may not be practically true in some particular circumstances.