Capital budgeting is concerned with activities ranging from planning the availability, allocation and control of capital expenditure or long-term as well as short-term investment funds.
What is the purpose of capital expenditure planning
Planning of capital expenditure could be done to finance the capital expenditure plans of the company for short-term or long-term periods and hence the long-term plan budget and short-term plan budget.
Long-term planning of capital expenditure
As regards long-term plan budget, the period covered under the planning is three to five or more years. The planning for such expenditure assumes a composite form involving all aspects of economic forecasts for the outlook of entire industry in which the company performs with its unit and forecast for the company with probable or expected coverage of market share.
On the basis of this forecast
- Plant managers estimate their prospective capital expenditure
- Marketing managers plan their market shares
- Personnel managers assess the requirements for manpower and technical hands to achieve targeted production results
- Finance managers plans for the funds to be made available for investment taking into consideration the above requirements.
The long-range capital budget is continually revised with changing economic conditions, the marketing conditions, the marketing environment, structure of wages and the inflationary pressures in the economy. It is flexible in nature and oriented towards a long-range growth planning for the company.
Short-term planning of capital expenditure
As regards short-period Capital budgeting, involving short-range planning for funds, it covers expenditure for a short duration involving the period covered within one or two years. It does not involve large capital expenditure but covers temporary need for funds for different departments within the company depending upon the degree of urgency, profitability and savings to be achieved with reference to the capital costs to be incurred.
Short run capital expenditure plans get converted into long-term plans of capital expenditure. Short-term capital expenditure plan is known as operating budget and is concerned with revenues and expenses related to firms daily operations.
Significance of planning for capital expenditure:
Significance of planning for capital expenditure is derived only with major investment proposals and the use of funds over a long period. The most important factor affecting the planning horizon is the rate of change in technology in the industry. The advancement in technology may warrant capital investment for short as well as long period depending upon the changing pace of technology and technological obsolescence: long-term plan, however, helps the company to analyze its needs and directions into the distant future involving a technological change.