Capital Budgeting

Capital budgeting is a financial tool companies use to maximize their profits. It is the process whereby a company or business evaluates the efficacy and importance of a particular investment or expenditure. Capital budgeting deals with large-scale financial decisions. Some of these types of decisions might be whether or not to purchase new equipment, build a new wing of a hospital, or to purchase or acquire a competitor business. These business purchases and investments are called capital expenditures. Capital expenditures are generally expensive; a company likely can only sustain a small number of them at any given time. For this reason, capital budget is crucial to a company’s success because it allows the company to carefully weigh the risks and benefits of each investment possibility, then ultimately choose the options that best fit the company’s vision (Averkamp, 2017).

Effective capital budgeting requires carefully assessing the financial implications of each potential decision. This can be done by looking at a number of different financial measures, such as the internal rate of return. The internal rate of return calculates, as a percentage, the interest rate a project must generate to make its return equal to its investment. It presents this figure in present-day dollars. Another metric often used for assessing capital expenditure projects is the payback period. The payback period is a calculation of the number of years it will likely take for the dollar amount of the initial project investment to be repaid to the company. In addition to measuring long-term likely financial outcomes, smart companies make efforts to thoroughly assess the risks of any given project. Utilizing all these assessment tools allows a company to get a more clear, well-rounded view of the risks and benefits of each project under their consideration (Averkamp, 2017).

* Averkamp, H. (2017). Should capital budgeting decisions be based on cash flows orrevenues and expenses? Retrieved from https://www.accountingcoach.com/blog/capital-budgeting-decisions

* Averkamp, H. (2017). What is capital budgeting? Retrieved from https://www.accountingcoach.com/blog/what-is-capital-budgeting