A management has taken number of decisions with regard to short term investment and long term investment. Whatever be and form of investment, the profitability of the company should be increased or at least maintained.
In the case of long term investment, huge amount is necessary. Such an amount is used for acquiring fixed assets i.e. plant and machinery, land and building, introducing new products, starting of one more unit, expansion, improvement or alteration of existing fixed assets, replacement of existing fixed assets, research and development and the like. The management is going to take a decision for this purpose i.e. capital expenditure decision.
What is Capital Expenditure?
Capital expenditure is the expenditure incurred to get the benefits which are expected in the days to come. Capital expenditure is otherwise called as Capital Investments.
Capital expenditure is incurred at one point of time whereas benefits of the expenditure are realized at different points of time in future.
Classification of Capital Expenditure
The capital expenditure may be classified into the following categories.
1. Expenditure is incurred on the new plant and machinery either for introducing new product or increasing the market potentialities of the existing product.
2. Expenditure is incurred for maintaining normal business operation such as replacing old machines by new ones, establishing new office etc.
3. Expenditure is incurred for business development such as exploration of new market, advertisement etc.
4. Expenditure is incurred for research work.
5. Expenditure is incurred indirectly for production. Such expenditures are health, safety, welfare projects, training and education.
6. Expenditure is incurred for innovation.
Planning and control are inter-linked and consecutive steps for the successful implementation of any programme. Planning done for incurring capital expenditure is followed by control devices to assess the divergences between the expected and achieved results.
Types of Capital Expenditure:
Capital expenditure is classified into three main forms viz:
- Expenditure made to reduce costs;
- Expenditure made to increase revenue;
- Expenditure which is justified on non-economic grounds.
With exercise control over capital expenditure in any of the above categories, the capital expenditure analysis should concentrate on three types of outlays viz:
- Major projects,
- Routine expenditure,
1. Capital Expenditure analysis in major projects: As regards major projects, strategic investment may be made for expansion of productive capacity or achieving product innovation or preparing barriers against capital fluctuations.
2. Analysis in routine expenditures: In the second type of outlay, routine expenditure may be working condition improvement, maintenance expenditure, competition oriented expenditure etc.
3. Replacement in capital expenditure analysis: Thirdly, replacement need may arise to avoid capital wastage for existing equipment to check its disposal value or it may be obsolescence replacement.
In all circumstances, proper attention is to be devoted in analyzing the need for the capital expenditure so that it would be curtailed to the minimum required.
Demand and Supply in Capital expenditure
One important aspect of control device is to match the demand schedule for the capital and the supply of capital from different sources.
Demand comes for capital from all departments and it is at this level control could be exercised to keep the demand at the bare minimum required for the objective inherent in capital investment decisions.
Supply of capital, on the other hand, is a scarce commodity and the company has to incur expenditure for availing it. This necessitates for the finance manager to exercise economy in capital expenditure so that optimum benefit could be obtained with the use of scarce capital sources.
Capital rationing in Capital expenditure
Scarce capital sources due to capital expenditure control establishes the need for capital rationing to impose constraints on capital expenditure under prevailing market conditions and place self-imposed constraints to check the funds being raised from outside agencies like borrowings. Thus, the device of capital rationing is adopted to control capital expenditure.