To maintain a balance between expense and income, one should emphasise budgeting. Only after making a budget can one plan for savings as well as investment. While it comes to the matter of investment, the factor of capital budgeting arises. Generally, large investors and big companies are considered big companies who wish to make a budget during acquisition.
However, this concept of capital budgeting can help in managing personal finance too. Here we will discuss it briefly to easily understand why you should opt for capital budgeting and what techniques.
What is capital budgeting?
It is a means of calculating the exact amount invested on a large scale to get a good return. It is often observed that potential investors often became confused about deciding whether to invest vast amounts on a large scale or hold maximum funds and invest small amounts.
Generally, investors start thinking before investing when it comes to the factor of buying a fixed asset. While repairing fixed assets will cost a minimum amount, the replacement will surely cost higher.
Moreover, the fixed asset may not provide a good investment return, and the price will depreciate as time passed. Resolve the problem, and capital budgeting can help. As mentioned earlier, it is also can be applied in our daily life. For instance, if you have been using a car for three years and suddenly started troubling the engine, there are two options left for you. Either you buy a new car or repair it.
Whether you used car finance in Ireland to buy or repair it, surely there created a cause of expense. Now, the capital budget process can help you decide whether to buy a new car or adjust by expending a small amount.
Undeniably, if you buy a new car instead of repairing it, it will be a decent return because the validation of repairing can’t support you in the long run.
It aims to be fulfilled by a capital budget.
As discussed, investment in capital expenses for an organisation is vast and leaves a long-term effect. For this reason, budgeting is essential. During planning the budget generally, a company works on the following mentioned aims.
- The project should earn a profit –
Large companies always work with several new projects. Where the investment amount is enormous, the primary goal of the investment should be a high return. Therefore, by making a budget and analysing the portability, a company moves forward for investment.
- Cost should not be higher than budget –
After analysing profitability, the second thing that should take care of is over budgeting. Expenditure should be under control, and the total amount should not exceed the calculated one through capital budgeting.
Source of the fund should be determined –Although there are stable investors in large companies, the fund source should not be misled. To continuous inflow of funds, there should be a balance between investment and return.
The method of capital budgeting
- First, recognise worth investing project –
The first and foremost thing to consider to plan a perfect capital budget is recognising a worthy investment project. It can be a new product launching program or providing financial support to entrepreneurs.
- Assess the complete scheme –
Recognising an excellent investment opportunity is just the beginning. Now an investor should analyse the entire scheme. For instance, if a small company wants to set up a new website for virtual marketing, then there is a need for funds. So before investing money in hiring a web host, make sure that this decision is worthy enough.
- Always look for good revenue earning investment –
After discussing the entire project, the time arrives for selecting the most profitable part of the project. If the investor is receiving multiple investing offers, start screening them by using capital rationing. A format helps to determine the exact rank of that investment proposal in terms of return.
Techniques of calculating capital budget
- Payback period method –
By applying this technique, an investor can quickly evaluate the necessary tenure of investment. However, a short-term assignment is always expected.
- NPV –
Net Present Value is always determined to evaluate the possible amount of return. Therefore, an organisation that possesses more NPV has more capability to generate good future value.
- Accounting rate of return –
It is another essential method of calculating the exact amount which will invest. It involves the mathematical equation of dividing the net amount of income by the expected amount of investment.
- IRR –
Internal Rate of Return always provides an investor with insight into possible outcomes. In addition, it helps to determine if NPV becomes zero. Therefore, a high IRR is required while calculating the potency of investment.