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 proposals investments
3. Decision making
4. Preparation of capital budget and appropriations
5. Implementation
6. Performance review

Identification of Potential Investment Opportunities: The capital budgeting process begins with the identification of potential investment opportunities. Usually, the planning body (it can be an individual or a committee, formal or informal) develops estimates for future sales which serve as the basis of setting production targets. This information, in turn, helps one to identify required investments in plant and equipment.

For imaginative identification of investment ideas, it is helpful to: (a) monitor external environment regularly to scout for investment opportunities; (b) formulate a well defined corporate strategy based on a thorough analysis of strengths, weakness, opportunities, and threats; (c) share corporate strategy and perspectives with persons who are involved in the process of capital budgeting, and (d) motivate employees to make suggestion.

Assembling of investment Proposals: Investment proposals identified by the production department and other departments are usually submitted on a standardized capital investment proposal form. Generally, most of the proposals are routed through several persons before the reach the capital budgeting committee or some other body which assembles them. The purpose of this is primarily to ensure that the proposal is viewed from different angles. It also helps in creating a climate for the 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 gateway usually characteristics the capital investment decision making in practice. Under this system, executives are vested with the power to okay investment proposals up to certain limits. For example, in one company the plant superintendent can okay investment outlay up to Rs 100,000 the works manager up to Rs 500,000 and the managing director up to Rs 2,000,000. Investments requiring higher outlays need the approval of the board of directors.

Preparation of capital Budget and Appropriations: Projects involving smaller outlays and those can be decided by executives at lower levels are often covered by a blanket appropriation for expeditious action. Projects which need larger outlays are included in the capital budget after necessary approvals. Before undertaking such projects, an appropriate 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 of the project. Further it provides an opportunity to review the project before implementation.

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

1. Adequate formulation of projects: the major reason for delay is inadequate formulation of projects. In other words, if necessary homework in terms of preliminary studies and comprehensive detailed formulation of the project has not been done, many surprises and shocks are likely to spring on the way. Hence, the need for adequate formulation of the project cannot be over emphasized.
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 such as PERT (Program Evaluation Review Techniques) and CPM (Critical Path Method ) are available. With the help of these techniques monitoring of a project becomes easier.