Introduction
Importance of capital budgeting on the financial health of the organization
Capital budgeting is necessary for the development of the organizations strategic goals. Effectiveness in establishing the available resources and the competing opportunities is crucial for the success of a business. Through capital, budgeting management can create a framework for short-term objectives and prioritize the projects depending on how valuable they are.
Investment decisions are not easily reversible (Peterson & Fabozzi, 2002). Reversing such decisions may result in huge losses for the firm as it could involve selling of second-hand plant and equipment whose conversion to other uses is not possible.
Decision made based on proper capital budgeting has a long-term effect on the company. The decision has an effect on the organization’s cost structure (Bhattacharyya, 2011). Acquisition of fixed assets increases the fixed cost that must is recoverable from the benefits over its useful life. A good budgeting decision does not only reduce the cost of the investment but also increase future profit inflows since it prevents over or underinvestment.
Capital budgeting decisions result in the commitment of huge funds. Such commitments result in financial risk. A proper analysis helps to establish the potential financial risks and aim for reducing them as much as possible.
Other reasons that make capital budgeting inevitable are: it aids forecast of future cash flows; helps in seeking out new investments; monitoring and control of expenses; and creation of decision rules (Bhattacharyya, 2011). The decision resulting from capital budgeting is both a financial and investment decision. The techniques are necessary for ensuring the business does not plunge into losses and ensures good financial health.
References
Bhattacharyya, D. (2011). Management accounting. Noida, India: Pearson.
Peterson, P., & Fabozzi, F. (2002). Capital budgeting. New York, NY: Wiley.
