Capital Budgeting Definition, Features and Importance
Capital Budgeting Definition
It is the process of making investment decision in capital expenditure. Further it involves the planning and control of capital expenditure.
In simple words, it is the process of deciding whether to accept or reject project on the basis of the benefits it will provide the company in future.
According To Charles T Horngreen: “Capital Budgeting is the long term planning for making and financing proposed capital outlays”.
According To Lynch “Capital Budgeting consists in planning development of available capital for the purpose of maximizing the long term profitability of the concern.”
From the above definition, capital budgeting is the process by which companies allocate funds to various investment projects.
Features of Capital Budgeting
In order to understand capital budgeting definition, let have a look over its features.
- Exchange of funds for future benefits:
- The future benefits are expected to be realized over a period of time.
- Company invest funds in long term activities.
- They have a long term and significant effect on the profitability of the concern,
- They involve huge funds.
Importance of Capital Budgeting
1. Large Investment
Capital budgeting decision involves large investment of funds. But the funds available with the firm are always limited and the demand for funds far exceeds the resources. Hence it is very important for a firm to plan and control its capital expenditure.
2. Long Term Commitment of Funds
Capital expenditures involves not only large amount of funds but also funds for long term or permanent basis. The long tern commitments of funds increases, the financial risk involved in the investment decision. Greater the risk involved, greater is need for careful planning of capital expenditure i.e. Capital Budgeting.
3. Irreversible Nature
The Capital expenditure decision is of irreversible nature. Once the decision for acquiring a permanent asset is taken, it becomes very difficult to dispose of these assets without incurring heavy losses.
4. Long term Effect on profitability
Capital budgeting decisions have a long term and significant effect on the profitability of a concern. Not only the present earnings of the firm are effected by the investments in capital asserts but also the future growth and profitability of the firm depends upon the investment decision taken today. An unwise decision may prove disastrous and fatal to the very existence of the concern.
5. Difficulties of investment Decisions
The long tern investment decision are difficult to take. These decision extends to a series of years beyond the current accounting period, uncertainties of future, higher degree of risk.
6. National Importance
Investment decision are of national importance because it determines employment, economic activities and growth.