I believe that currently it is very important to have tools that help us manage and monitor our finances, in the end the most important thing is to interpret and use the information to make more and better decisions. This knowledge helps us to be prepared and alert to the changes that society promotes in the different financial markets, we live in a moment in history where what is “new” today, tomorrow may be “obsolete”, constant change is good but adapting to it is even better.
Introduction.
This time we will talk about how to prepare a capital budget base file, all of us who are immersed in financial matters have heard this term more than once and we must be clear that preparing a capital budget represents planning and managing investments in a set period of time, usually long-term investments. Through this process we are able to identify, analyze, develop and evaluate investment opportunities that can be profitable for the company. So we can say, in a very general way, that this evaluation is done by checking whether the cash flows generated by the investment in an asset exceed the flows required to carry out said project.
Importance of making a correct capital budget.
We must bear in mind that making a capital budget incorrectly can have very serious consequences for any company, on the other hand, carrying it out correctly brings many benefits, for example, when we talk about investing in fixed assets that have the objective of growth in technology we are talking about significant outflows of money and long periods of time, then; If this investment is made incorrectly, it can set the course between a successful company during that period of time and another company that would have many liquidity problems.
For this type of investment, the company must have sufficient and available funds, we can summarize then that a correct capital budget can help us better determine the opportunity in the acquisitions of assets as well as their quality.
At the time of making our capital budget we need to consider all the aspects that make up our company, since they incur significantly in the daily operation, as we forget some details, the uncertainty that our exercise generates will be. To begin with, you have to make a list of the necessary assets, for example, land, machinery, furniture, etc., this in order to calculate the required investment and the value to be depreciated.
On the other hand, we must calculate our expected income derived from the sale of our products or services with the idea that the longer the sales, we must perform this calculation based on volume and amount to be able to compare each 1 of the years. Just as we consider increases in sales, in the same way we expect an increase in costs to happen, at least in variable costs (costs dependent on sale), MO, Raw Material, Indirect costs. In the case of fixed costs and expenses, we can include them in 2 main categories: salaries and administrative expenses, unless there is a clause or previous indication, they will be maintained in the same way throughout the project or in a period of time, that is, its activity is independent of the sale.For this first part, it is very important to know how to distinguish and classify fixed costs from variables, as well as direct and indirect expenses, I suggest to emphasize the main activity, the sale, and what consequence it has on the expense or cost in case of decreasing or increase, that is, if we sell fewer products, the raw material we use to produce these products will be used to a lesser extent, costs decrease, on the other hand, the accountant's salary will not be affected for any reason, this expense being fixed will behave in the same way month after month.The raw material that we use to produce these products will be used to a lesser extent, costs decrease, on the other hand, the accountant's salary will not be affected for any reason, this expense, being fixed, will behave in the same way month after month.The raw material that we use to produce these products will be used to a lesser extent, costs decrease, on the other hand, the accountant's salary will not be affected for any reason, this expense, being fixed, will behave in the same way month after month.
It is time to review one of our "pillars" in our project, investment, and I call it a pillar because the structure we choose will be decisive for the life of the project, I will explain it carefully in the following paragraphs, we can emphasize at this point that There are 2 ways to obtain resources, 1 is the contribution that each 1 of the partners is willing to make and the other is to seek financing through a bank loan.
Both options have pros and cons, we will review some:
- Pros investment partners.
- Rate of return lower than that of any loan.Risk reduction, as it is shared.
- Cons investment partners.
- Long time to collect the cash Uncertain amounts of money.
- Financing pros.
- Cash availability The borrower creates experience to acquire new loans.
- High interest rates Despite the diversity of programs, the schemes are not very flexible.
With this classification we can realize that it is important to define and modify the financing structure, seeking at all times to reduce the levels of debt to be acquired. In a couple of paragraphs I referred to "investment as a pillar", this because the more we can reduce the initial investment of a project, the recovery of it will be prompt and in a better way, understanding that the initial investment is the necessary amount to meet the company's obligations in all their context.
Since we gather and define assets, costs, expenses, financing, it is time to carry out a series of exercises to determine the financial indicators and evaluate the position and viability of the project. These indicators or financial ratios are used to observe the relationship between the financial statements, their administrative reading gives us the opportunity to anticipate future conditions and determine the actions to take to influence the result.
Each and every one of these indicators is important, but in this case and for the capital budget issue, we must focus on 2, the IRR and the NPV. The Internal Rate of Return (IRR) is the rate of return offered by the project. That is, it is the percentage of profit or loss that an investment will have. The internal rate of return (IRR) gives us a relative measure of profitability, that is why it is expressed as a percentage.
The selection criteria using this indicator is the following where "k" is the chosen flow discount rate.
If IRR> k, the investment project will be accepted. In this case, the internal rate of return that we obtain is higher than the minimum rate of return required of the investment.
If IRR = k, we would be in a situation similar to that which occurred when NPV was equal to zero. In this situation, the investment would take place if there are no more favorable alternatives.
If IRR <k, the project must be rejected. The minimum profitability that we ask of the investment is not reached.
When talking about Net Present Value (NPV) we are taking all the money that we expect to receive from an investment and we transfer those returns to today's values (discount flows to present value), to decide if the investment is feasible or not feasible. Then, we can define as an acceptance criterion that any investment that obtains a positive net present value will generate an increase in the value and wealth of the investor, otherwise any investment that does not achieve a positive NPV could detract from value and therefore worsen our current situation so we should not do it.
In conclusion, we must be aware that when preparing a capital budget it is necessary to include each and every one of the elements of the company, make a list and a correct classification of them, so that we can define, plan and closely monitor the entire life of our project. Don't forget this in your next business decision.
