QS Study

The significance of Capital Budgeting

Capital budgeting is also vital to a business because it creates a structured step by step process that enables a company to:

  • Develop and formulate long-term strategic goals the ability to set long-term goals is essential to the growth and prosperity of business. The ability to appraise/value investment projects via capital budgeting creates a framework for businesses to plan out future long-term direction.
  • Seek out new investment projects – knowing how to evaluate. investment projects give a business the model to seek and evaluate new projects, an important function for all businesses as they seek to compete and profit in their industry.
  • Estimate and forecast future cash flows – future cash flows are what create value for businesses over time. Capital budgeting enables executives to take a potential project and estimate its future cash flows, which then helps determine if such a project should be accepted.
  • Facilitate the transfer of information – from the time that a project starts off as an idea to the time it is accepted or rejected, numerous decisions have to be made at various levels of authority. The capital budgeting process facilitates the transfer of information to the appropriate decision makers within a company.
  • Monitoring and Control of Expenditures – by definition a budget carefully identifies the necessary expenditures and R&D required for an investment project. Since a good project can turn bad if expenditures aren’t carefully controlled or monitored, this step is a crucial benefit of the capital budgeting process.
  • Creation of Decision – when a capital budgeting process is in place, a company is then able to create a set of decision rules that can categorize which projects are acceptable and which projects are unacceptable. The result is a more efficiently run business that is better equipped to quickly ascertain whether or not to proceed further with a projector shut it down early in the process, thereby saving a company both time and money.