Capital Budgeting in Business Investments

Capital Budgeting in Business Investments

Businesses often need to deal with the need to invest significant amounts of money on assets that will be useful for several years. Here are a couple of examples:

•    Equipment to enhance an unsafe work environment

•    Equipment to check the consistency of items as requested by the client

•    Equipment in packaging, labelling, and shipping items according to the client’s requirement

•    Equipment to minimise labour expenses (Also see 5 Benefits to Employ an Accountant) and improve the quality of goods

•    Purchase of a building instead of renting space

Expenses for long-term assets are described as capital expenditures and recorded as assets on the balance sheet (Also see Relationship between the Balance Sheet and Income Statement). Throughout the years that these assets are utilised, their expenses are methodically transferred from the balance sheet to the income statement through Depreciation Expenditure (Also see Useful Accounting Practices for Small Businesses).

Capital Budgeting

Limitations such as money, time and logistics often hinder a business from growing with a lot of significant expense projects at the same time. Instead, a company will rank the projects based on profitability and priority. The company chooses which capital expenditure projects will be carried out by using capital budgeting method (Also see Tricks From Millionaire Business Owners).

At the top of the capital expenditure projects list are projects with no possible option exists, for example, setting up an upgraded sewer to replace the leaking, correcting code violation and remedying a hazard. Then, the remaining are ranked based on the profitability through capital budgeting model.

Capital Budgeting Models

There are many capital budgeting models that could be used to evaluate and rank capital expenditure projects. Here are four typical models for assessing business investments:

1.    Payback

2.    Accounting rate of return

3.    Internal rate of return

4.    Net present value

Every model has its pros and cons; most financial managers choose the internal rate of return and the net present value models. This is because both models consider the cash flows over the whole project, and the future cash flow is discounted to show the time value of money. All these first boils down to have a true and fair financial statements and this is what you can expect from accounting firm in Johor Bahru