Capital budgeting decisions are common in any type of company. Owners and managers must make decisions about how to make use of the company’s capital assets to best advantage. In order to manage the process, several factors must be taken into consideration, including the current value of those assets, the average cash flow over the course of the business year, the level of debt carried by the business, and any expansion goals or projects that are currently under consideration.
One of the essentials of making sound capital budgeting decisions is to understand the scope of resources available to manage the day-to-day operations of the business. The goal is to ensure that revenue coming from all sources, including customer payments, dividends from investments and other means, is sufficient to sustain the operation. Within this scope, owners and managers must set workable operating budgets that ensure the company is operating efficiently. Failure to do so means waste in the production process that ultimately cuts into the profits and moves the company to a less financially secure position.
Along with revenue generation, making capital budgeting decisions also has to do with the management of debt. Most companies carry some sort of debt, both short- and long-term. Allocating income to manage those debts is extremely important, not only in terms of keeping the debt current and avoiding late fees and penalties, but also structuring that debt in a way that maximizes the benefits in terms of cash flow and utilizing tax breaks to reduce the tax obligation of the firm.
Expansion and improvements are very important when making capital budgeting decisions. Since most expansion or improvement projects will be funded using a combination of resources on hand and incurring some amount of debt, managers must budget in a way that allows the company to devote enough resources to the projects, optimizing the chances for those projects to become self-sustaining and ultimately generate a profit. In the interim, the financing must not interfere with the maintenance of the day-to-day operation or place the business in any type of financial jeopardy.
Making capital budgeting decisions means balancing the necessities of today with the projected income and expenses of tomorrow. This requires the ability to understand all the factors that impact the production capabilities of the business, possible shifts in consumer demand and the marketplace in general, and the ability to create a functional capital budget that will make the most of the company’s resources. Even after setting the budget, the process will continue, as managers make decisions to help tailor the budget to emerging changes in the marketplace that were not apparent at the time the budget was originally implemented. For this reason, capital budgeting is an ongoing process, not an event that takes place once each business year.