Capital Budgeting is a step by step process that businesses use to determine the merits of an investment project. The decision of whether to accept or deny an investment project as part of a company’s growth initiatives involves determining the investment rate of return that such a project will generate. However, what rate of return is deemed acceptable or unacceptable is influenced by other factors that are specific to the company as well as the project. For example, a social or charitable project is often not approved based on a rate of return but more on the desire of a business to foster goodwill and contribute back to its community.
Capital budgeting is important because it creates accountability and measurability. Any business that seeks to invest its resources in a project, without understanding the risks and returns involved, would be held as irresponsible its owners or shareholders. Furthermore, if a business has no way of measuring the effect mess of its investment decisions, chances are that the business will have little chance of surviving in the competitive marketplace.
Businesses (aside from non-profits) exist to earn profits, the capital budgeting process is a measurable way for businesses to determine long-term economic and financial profitability of any investment project.