Capital budgeting decisions of a firm have a pervasive influence on the entire spectrum of entrepreneurial activities they require a complex combination and knowledge of various disciplines for their effective administration, for example, Economics, Financial Mathematics, Economic Forecasting, cash-flow projection and timing techniques and techniques control. In order to the all these elements, a financial manager must keep in mind the three dimensions of capital budgeting programme.
Policy, Plan and Programme: These three P’s constitute a sound capital budgeting decision. Professor Joel Dean proposes 10 specific elements to an orderly investment programme, which are as follows :
Steps in Capital Budgeting Process in Financial Management
(1) Creative Search for Profitable Opportunities – The first stage in the capital expenditure programme should be the conception of a profit making idea. It may be rightly called the organization of investment proposals. The proposals may come from a rank and file worker of any department or from any line officer. To facilitate the origination of such ideas a periodic review and comparison of earnings, costs, procedures and product line should be made by the management.
(2) Long-range Capital Plans – When a specific proposal is made to management, its consistency with the long-range plans of the company must be verified. It requires the determination of overall capital budgeting policies
before hand based upon the projections of short and long-run developments.
(3) Short-range Capital Budget – Once the timeless and priority of a proposal have been established, it should be listed on the one year capital budget, as an indication of its approval.
(4) Measurement of Project Worth – This stage involves the tentative acceptance of the proposal with other competitive projects within the selection criteria of the company. Small projects under a certain rupee amount could be approved by the departmental heads. Larger projects should be ranked according to their rate of return. Any one or more tests of profitability may be used for
(5) Screening and Selection – This stage involves the comparison of a proposal with other projects within the selection criteria of the firm. This is done either by financial manager or by a capital expenditure planning committee. Such criteria should encompass the supply and cost of capital and the expected returns from alternative investment opportunities. Once the proposal passes this stage, it is authorized for outlays.
(6) Establishing Priorities – Then comes the stage of establishing the priorities. When the accepted projects are put in priority, it facilitates their acquisition or construction, avoids costly delays and serious cost over-runs.
(7) Final Approval: Once the financial manager have reviewed top the projects, he will recommend a detailed programme, both of capital expenditures and of sources of capital to meet them, to the management Possibly, the financial manager will present several alternative capital-expenditure budgets to the top management, it will finally approved the capital budget for the firm.
(8) Forms and Procedure – This is a continuous phase that involves the preparation of reports for every other phase of the capital expenditure programme of the company.
(9) Retirement and Disposal – This phase marks the end of the cycle in the life of a project. It involves more than the recovery of the original cost plus an adjustment for replacement programmes.
(10) Evaluation – An important and last step of the capital budgeting process is an evaluation of the programme after it has been fully implemented.
- Was the net investment greater than anticipated ?
- Were the expected net cash benefits after taxes actually realized ?
Management can improve its capital budgeting techniques for the future as a result of an evaluation of past performance. Such an evaluation also has the advantage of forcing departmental heads to be more realistic and careful.
