The capital budgeting is one of the crucial decisions of the financial management that relates to the selection of investment and course of actions that will yield returns in the future over the lifetime of the project. The process of capital budgeting can be divided into 6 steps as follows;
PROCESS OF CAPITAL BUDGETING
- 01. Identifying Potential Investment Opportunities
- 02. Assembling of Investment Proposal
- 03. Decision Making
- 04. Capital Budget and Appropriation
- 05. Implementation
- 06. Performance Review
01. Identifying Potential Investment Opportunities
The first step in the capital budgeting process is to identify the investment opportunities. There is generally a committee that identifies the expected sales from a certain course of action and then the investment opportunities are identified keeping these targets as a basis.
Before initiating the search for potential investment, the company management should monitor the external environment to find out the investment opportunities. encouraging the employee suggestions is also a good source of finding out investment opportunities.
02. Assembling of Investment Proposal
Once the investment opportunities are identified, several proposals are submitted by different departments. Before reaching the capital budgeting process committee, the proposals are routed through several persons to ensure that the proposals are in line with the requirements and then classifying these according to their categories i.e. replacements, expansion, new products, etc.
03. Decision Making
At this stage, the executives decide on the investment opportunity on the basis of the monetary power each has with respect to the sanction of an investment proposal.
04. Capital Budget and Appropriation
The next step in the capital budgeting process is to classify the investment outlays into the small value and higher value. The smaller value investments are okayed by the low-level management and are covered by the blanket appropriations for the speedy actions.
If the value of the investment is higher, then it is included in the capital budget after the necessary approvals.
For implementation at a reasonable cost, the management of the company uses various techniques which includes responsibility accounting, networking techniques like PERT and CPM, etc.
06. Performance Review
Once the project has been implemented, the next step is to compare the actual performance against the projected performance. The ideal time to compare the performance of the project is when its operations are stabilized.