Process of Capital Budgeting

Process of Capital Budgeting

Capital budgeting is a complex process as it involves decisions relating to the investment of current funds for the benefits to be available in future. The process of capital budgeting is briefly explained below.

Capital Budget - Process of Capital Budgeting

Capital Budget – Process of Capital Budgeting

1. Search of Profitable Opportunities

There is a need of continuous searching for finding profitable opportunities. Such type of proposals may come from a rank and file worker of any department or from any line executive. Hence, the company can conduct review meeting periodically and discuss the matters relating to earning capacity of the company, expecting changes in the business world, cost of capital, capital investment made so far, production process, production technique, marketing strategies, product line and the like.

2. Long Range Capital Plans

Whenever a long term project proposal is submitted before the top management, they are considering the extent of consistency of new plans with existing plan before final selection. It requires the adherence of capital budgeting policies of the company.

3. Short Range Capital Budget

If the project has minimum period for execution and gets maximum priority than other projects, it should be listed on the one year capital budget as an indication of its approval.

4. Measurement of Project Worth

Small projects requires less amount for implementation. This type of project is approved and selected by the department head stage. In the case of large projects which require huge amount for implementation. Hence, the large projects should be ranked according to their profitability. Two or more capital budgeting techniques are used to find the profitability of each project.

5. Screening

Capital expenditure budget committee may screen the proposals to find out whether the proposals are as per the strategies, objectives and policies of the company. Moreover, the profitability of each proposal is also considered in screening stage. If the proposals are not fulfilling the minimum rate of return, objectives, strategies and policies of the company, the same proposal should be rejected immediately.

6. Evaluation of Proposals

The pros and cons of each proposal are properly evaluated before the selection. Moreover, the difficulties connected with each project while implementation are also properly highlighted. If the difficulties are properly anticipated, proper care can be taken by the company whenever such a project is selected for implementation.

7. Fixing Priorities

All the proposals are not profitable. At the same time, all the proposals cannot be rejected. Any one of the proposal should be selected at the cost of some other proposals. In other words, unprofitable and unacceptable proposals are rejected straight away. The remaining proposals are presented before the management in order of merit i.e. rank. The priorities of the proposal are fixed by considering urgency, risk and profitability.

8. Final Approval

The capital expenditure budget committee reviews all the projects in terms of capital expenditure and the sources of capital to meet them. Then, the committee presents the review before the top management for final approval. The top management gives final approval only on the basis of suggestions and reviews provided by the capital expenditure budget committee.

9. Forms and Procedures

This phase involves the preparation of reports for every other phase of the capital expenditure programme of the company.

10. Implementing Proposal

An individual is designated as project manager for project implementation. In this stage, proper authority is given to the project manager and fix the responsibility also. The time and costs are fixed so as to avoid unnecessary delays and cost over runs. Network techniques used in the project management such as Program Evaluation and Review Technique (PERT) and Critical Path Method (CPM) can be applied to control and monitor the project implementation.

11. Performance Review

Project audit is conducted to review the performance of each project separately. The actual capital expenditure is compared with budgeted one. Likewise, actual rate of return is compared with anticipated rate of return. Factors responsible for unfavorable variances should be identified in order to take necessary corrective actions in the future.

12. Retirement and Disposal

This is the last stage of the project life cycle. The old fixed assets should be sold out and the realized amount was used for purchase of new fixed assets or implementing new project in the days to come.

13. Experience of Project Implementation

The future is uncertainty. A project is implemented with great expectation. All the expectations are not coming into true. Generally, the actual is differing from the anticipation. Sometimes, cash inflows is more than or less than the expectation. If so, the management can find the reasons for such variances.

Likewise, the actual expenses are more than or less than the allocated expenses. In this case also, the management gets maximum experience. These experiences are highly useful to the management for improving its capital budgeting programme in future.