Capital Budgeting Process

Capital Budgeting is a complex process which may be divided into the following phases:

1. Identification of potential investment opportunities.

2. Assembling of proposed investments.

3. Decision making

4. Preparation of capital budget and appropriations.

5. Implementation

6. Performance review

Identification of potential investment opportunities 

The the capital budgeting process begins with the identification of potential investment opportunities. Typically, the planning body (it may be an individual or a committee organised formally or informally) develops estimates of future sales which service as the basis for setting production targets. This information, in turn,  is helpful in identifying required investments in plant and equipment.

Imaginative identification of investment ideas it is helpful to:

1. Monitor external environment regularly to scout investment opportunities

2. Formulate a well-defined corporate strategy based on a thorough analysis of strengths, weaknesses, opportunities and threats.

3. Share corporate strategy and perspective which persons who are involved in the process of capital budgeting.

4. Motivate employees to make suggestions.

Assembling of investment proposals: 

Investment proposals are identified by the production department and other departments are usually submitted in a standardized capital investment proposal form. Generally, most of the proposals, Before they reach the capital budgeting committee for some body which assembles them, are routed through several persons. The purpose of routing a proposal through several persons is primarily to ensure that the proposal is viewed from different angles. It also helps in creating a climate for bringing about coordination of interrelated activities.

Investment proposals are usually classified into various categories for facilitating decision making, budgeting and control. An illustrative classification is given below:

1. Replacement investments

2. Expansion investments

3. New product investments

4. Obligatory and welfare investments

Decision making: 

A system of rupee gateways usually characterizes capital investment decision making. Under this system of executive are vested with the power to ok investment proposals up to certain limits. For example, in one company the plant superintendent can ok investment outlays upto ₹200000, the works manager up to ₹500000, and the managing director upto ₹20,00,000. Investment requiring higher outlays need the approval of the board of directors.

Preparation of capital budget and appropriations:

Project involving smaller outlays and which can be decided by executive at lower level open covered by a blanket appropriation for expeditious action. Projects involving larger outlays are included in the capital budget afterwards  necessary approvals. Before undertaking such projects an appropriation order is usually required. The purpose of this check is mainly to ensure that the funds position of the firm is satisfactory at the time of implementation. Further, it provides an opportunity to review the project at the time of implementation.

Implementation: 

Translating an investment proposal into a concrete project is a complex, time consuming, and risk fraught task. Delays in implementation, which are common, can lead to substantial cost-overruns. For expeditious implementation at a reasonable cost, the following are helpful :

1. Adequate formulation of projects: The major reason for delay is inadequate formulation of projects. Put differently, if necessary home work in terms of preliminary studies and comprehensive and detailed formulation of the project is not done, many surprises and shocks are likely to spring on the way. Hence, the need for adequate formulation of the project cannot be over emphasised.

2. Use of the principle of responsibility accounting: Assigning specific responsibilities to project managers for completing the project within the defined time-frame and cost limits is helpful for expeditious execution and cost control.

3. Use of network techniques: For project planning and control several network techniques like PERT (Programme Evaluation Review Technique) and CPM (Critical Path Method) are available. With the help of these techniques monitoring becomes easier.

Performance review: 

Performance review, or post completion audit, is a feedback device. It is a means for comparing actual performance with projected performance. It may be conducted, most appropriately, when the operations of the project have stabilised. It is useful in several ways:

1. It throws light on how realistic were the assumptions underlying the project;

2. It provides a documented log of experience that is highly valuable for decision making;

3. It helps in uncovering judgemental biases:

4. It induces a desired caution among project sponsors.