Need and Importance of Capital Budgeting
Need and Importance of Capital
Capital budgeting means planning for capital assets.Capital budgeting decisions are vital to any organisation as
●Whether or not funds should be invested in long
chase of plant and machinery etc. term projects such as setting of an industry.
●Analyse the proposal for expansion or creating addiTo decide the replacement of permanent assets such as building and equipments.
To make financial analysis of various proposals regarding capital investments so as to choose the best out of many alternative proposals.
The importance of capital budgeting can be well understood from the fact that an unsound investment decision may prove to be fatal to the very existence of the concern.
arises mainly due to the following:
The need significance or importance of capital budgeting
(1) Large Investments-Capital budgeting decisions, generally, involve 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 ex-
penditure involves not only large amount of funds but also funds for long-term or more or less on permanent basis. The long-term commitment of funds increases the financial risk involved in the investment decision. Greater the risk involved, greater is the need for careful planning of capital expenditure, i.e. Capital budgeting.
(3) Irreversible Nature- The capital expenditure decisions are 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 budg-
eting decisions have a long-term and significant effect on the profitability of a concern. Not only the present earnings of the firm are affected by the investments in capital assets 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. Capital budgeting is of utmost importance to avoid over investment or under investment in fixed assist.
(5) Difficulties of Investment Decisions- The long
term investment decisions are difficult to be taken because fixed assets.
(i) decision extends to a series of years beyond the current accounting period,
(ii) uncertainties of future and
(iii) higher degree of risk.
(6) National Importance- Investment decision though taken by individual concern is of national importance because it determines employment, economic activities and economic growth.
Thus, we may say that without using capital budgeting techniques a firm may involve itself in a losing project.Proper timing of purchase, replacement, expansion and alternation of assets is essential.