What Is Capital Budgeting?

Capital budgeting is basically an audit that is completed by a business in order to determine which venture, or company asset, is worth the investment. The specific item up for evaluation can be anything from real estate, equipment to the actual product the company produces. A thorough evaluation is done on the item to determine if it was a gain to the company or if it created a loss.

Once the evaluation is complete the company should be able to justify the expenditures for that investment or asset. Some of the key components of capital budgeting are an outlay of the initial investment, terminal cash flow, any benefits from the investment whether cash or savings, and any financial obligation associated with the investment or asset such as loans, or annual taxes.

Since most companies are in business to make money, it is important to learn how to evaluate what the company spends it's money on. Aside from lack of funding, bad business investing makes up a large percentage of why many companies fail in their first year of operation. Those who utilize a capital budgeting plan are more knowledgeable on how their company invest its money and can readily determine if it should shift its course, or if the investment it not producing a return.

Are investors more likely to invest in companies that employ capital budgeting?

Many businesses use capital budgeting in order to make sure that assets are allocated to the proper channels. In many cases, investors are more likely to put money into businesses that use capital budgeting instead of some other budgeting method. With this type of budgeting, a business has to be able to justify investments and expenses. Capital budgeting looks at each company investment on an individual basis. If the investment is not performing well, the money from the company will not continue to be allocated to it. For an investor, this means that your investment dollars are watched very closely.

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