The Do’s And Don’ts Of Capital Budgeting

Doing a financial audit, capital budgeting, or any other investment calculation requires a lot of effort, practice, and experience. You cannot afford to commit mistakes even to the smallest decimal value while computing, as this, will result in an overall loss for the business, probably in hundreds and even thousands.

Hence, even the smallest of things can contribute to the deepest loss. Therefore, it is essential to scrutinize every element of a capital budget individually before planning the next course of action. In lieu of this, here is a list of what you must do and what you must avoid doing while carrying out a capital budget for any investment project.

The Do’s Checklist

  1. Base all your decisions on all the cash flows that are involved in the investment project. This will include even the incremental cash flows.

  2. Always remember to make proper adjustments for all the risks involved in the project, such as the opportunity costs of the capital locked.

  3. Accept projects that will maximize the income for the shareholders or accept those that are in line with their interests.

  4. Always accept investment projects that estimate a higher rate of return on the capital invested.

  5. Evaluate the turnaround period and accept proposals with the shortest turnaround time, as it will generate profits early.

  6. Similarly, choose projects that offer quick break-even points to start generating profits at the earliest.

  7. Do not forget to include and calculate the effect of all the taxes involved in each transaction.

  8. Always identify all the possible opportunities available in hand and evaluate the pros and cons of each opportunity individually, before discarding any option, in order to select the most economically profitable option.

  9. All operational costs must be listed out before commencing budgeting and every cost must be evaluated separately. Additionally, the cost of implementation of each must be studied in parallel, in case it is approved.

The Don’ts Checklist

  1. Do not include cash flows that consider the time value of capital or money. This can be ignored.

  2. Do not accept projects that are against the interests of the stakeholders, offer a low return on investments, have longer turnaround periods, and extended break-even points. All these will delay profit generation and may even result in the shutting down of the business.

If you ensure to keep in mind these very basic and simple rules of budgeting, then you can prepare an excellent budget plan to determine the feasibility and future prospect of your investment project.