MEANING OF CAPITAL BUDGETING | NEED AND IMPORTANCE OF CAPITAL BUDGETING | SIGNIFICANCE OF CAPITAL BUDGETING

MEANING OF CAPITAL BUDGETING:

Capital budgeting is the process of making investment decisions in capital expenditures

A capital expenditure may be describe as an expenditure the benefit of which is expected to be received over a period of time exceeding one year. The main characteristic of a capital expenditure is that the expenditure is incurred at one point in time. As well as benefits of the expenditure realized at different points in time in the future. In simple words, we may say that a capital expenditure is an expenditure incurred for acquiring fixed assets.

Examples of capital expenditure:

  • Cost of addition, expansion, improvement or alteration in the fixed assets.
  • Cost of replacement of permanent assets.
  • Research and development project cost.

DEFINITION OF CAPITAL BUDGETING:

According to Charles T. Horngreen,” Capital budgeting is long-term planning for making and financing proposed capital outlays.”

NEED AND IMPORTANCE OF CAPITAL BUDGETING:

LARGE INVESTMENTS:

Capital budgeting decisions, generally, involve a large investment of funds. But the funds available with the firm always limited and the demand for funds. After all, it is very important for a firm to plan and control its capital expenditure.

LONG-TERM FUNDS:

Capital expenditure involves not only a large number of funds but also funds for long term. The long-term commitment of funds increases the financial risk involved in the investment decision. Moreover, greater the need for careful planning of capital expenditure, i.e capital budgeting.

DIFFICULTIES IN INVESTMENT DECISIONS:

The long-term investment decisions difficult, because

  • Decisions extend to a series of years beyond the current accounting period.
  • Uncertainties of future.
  • A higher degree of risk

IRREVERSIBLE NATURE:

The capital expenditure decisions are of irreversible nature. In like manner, once the decision for acquiring a permanent asset taken, it becomes very difficult to dispose of.

PROFITABILITY:

Although this may be true that capital budgeting decisions have a long-term and significant effect on the profitability of a concern. Present earning and as well as future growth depends on the investment decisions of a firm. In short wors, capital budgeting is an importance to avoid over investment.

NATIONAL IMPORTANCE:

Investment decisions through taking from the individual concern of national importance because it determine employment, economic activities economic growth. So we may say that without using capital budgeting techniques a firm may involve itself in a losing project.

 

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