Capital budgeting is not always given the importance it duly deserves. Every investor comes across situations where he is to take crucial investment decisions. Be it to choose one project among the best in front of him or to finalize the capital that is worth investing in it at that point, every decision taken has long-term impacts.
What is Capital budgeting
As the name indicates this is the process of budgeting and getting into the details of the capital being invested. It might be for a business to invest in expansion or purchase of new equipment or an investor investing in a new project. Capital budgeting takes into account the worth of the investment and analyses whether the investment should really be made and other such aspects.
Why should every investment be preceded by capital budgeting?
- There is a capital involved:
Money saved is money earned. And investments that fetch great returns are the best forms of savings. They help the available funds earn an income for the investor. Irrespective of the size of the capital careful consideration is important. Even the smallest mistakes can lead to major losses.
- Every wrong decision affects the credit performance
When a business makes a loss due to the lack of proper capital budgeting it would cost the business a huge amount in the long run. The business’ credit performance might also be affected. The wrong decision taken during an investment might also create credibility issues at times.
- The impacts exist for a long time
Most capital budgeting decisions have long-term impacts. The capital being invested would be analyzed on various parameters like the payback period for example. This would indicate the time required to be able to recover the capital. There are some cases where the capital might be locked in for a long time. The liquidity is not always the same. So if the business or the investor is in need of funds in the near future the capital that was earlier invested might not be accessible. So capital budgeting decisions should also take into account the long-term financial plans in order to make better choices.
On the whole, some of the decisions taken might be irreversible and might leave behind a permanent remark on the investor. The credibility of an investor is often weighed based on the choices made. So capital budgeting is something that cannot be ignored.