We live in a world where knowledge is the most important key that we have at our fingertips and one of the necessary steps in the professional career of every successful academic, businessman, doctor, professor, etc. This is the reason why it is always important to set aside the paradigms and mental burdens that prevent us from preparing correctly and professionally with the necessary knowledge to achieve the most optimal result in any scenario and therefore success in everything we want to undertake. transmit, teach and promote.
The companies that transcend have understood that not everything is a good idea, money to execute it and customers who pay for it. Starting a business in this modern world, which moves at an exorbitant speed and requires us to be updated every day and have the necessary knowledge to be prepared for any setback, is not something easy (if you want to be successful). Systems and tools are needed for our business and investment to be healthy.
So, “What tools could be useful to us to make a correct and successful investment?”; This is where we address our main topic, the capital budget. In the current essay we will address the characteristics and benefits of capital budgeting in our world today, as well as how we carry out a capital budget, and finally a conclusion about it.
We must first know what a capital budget is.
A capital budget is a plan that contains the information for making long-term investment decisions, such as:
- Long-term fixed asset investments. Development of new production lines, market research, long-term debt cancellation, investments in integrated computer or manufacturing systems, etc., decisions to replace the facilities that a company currently has.
There are many reasons why management should develop a capital budget, thus we have:
- It allows planning the capital outlay.
Coordinate capital expenditures in relation to:
- The financial need in cash The investment committed to the operating activities The projection of the company's sales The projection of the profitability of the investment The capital return on the investment The return on investment recovery Allows the control of the capital.
The main aspects that we must take into account when preparing a capital budget are the following:
- The generation of proposals based on financial need The compilation of information on each capital project The evaluation of capital investment projects The selection of the investment project
In the modern world, when a company makes a capital investment, it incurs a current cash outflow, expecting future benefits in return. They generally extend beyond one year into the future. Some examples include investment in assets such as equipment, buildings and land, as well as in the introduction of a new product (in today's world it is normal for a new product to come out every month and for it to meet the need for one that would already become obsolete), a new distribution system or a new R&D program (research and development). Therefore, the future success and profitability of any business today depends on investment decisions made in the present time.
An investment proposal must be judged on whether it provides a return equal to or greater than that required by investors. Assuming the required rate of return is known and the same for all investment projects, this assumption implies that the selection of any investment project does not alter the nature of our company's business risk.
An investment project can be expressed in the form of the probability distribution of available cash flows. Given the probability distribution of a cash flow, we can express the risk quantitatively as the standard deviation of the distribution. As a result, the selection of an investment project can affect the nature of the company's business risk, which, in turn, can affect the rate of return required by investors. All these are constants that we must bear in mind when preparing our capital budget and choosing our investment project.
And what are the benefits of capital budgeting?
As mentioned above, a capital budget provides numerous benefits from the point of view of administrative planning and control, allowing executives to plan the amount of resources to be invested in the company, in order to avoid the misuse of total capacity. of our company, factory, etc.
A capital budget is also beneficial because it requires sound capital expenditure decisions on the part of the company. The capital budget also focuses the attention of top management on cash flows, in addition, a capital budget intensifies the coordination between the responsibility centers and the company's management.
But how do we develop a capital budget?
First, we must calculate our initial investment, the total of the resources required to generate our project, which would be our fixed assets achieved or planned to be purchased in the future, such as: land, buildings, machinery, plant and equipment, also including our working capital.
Next step we must calculate our cash flows, as well as our recovery period and calculate our recovery value, after we define our discounted cash flow, which would be any method of evaluation and selection of projects that adjusts cash flows over time to value of money in time.
Depending on the discount chosen, that is, the minimum acceptable rate of return, the risk of the project can be determined. The three main methods of discounted cash flow are:
- Internal rate of return (IRR): Discount rate that equals the present value of expected cash flows with the initial outflow. At time 0, the IRR is the interest rate that discounts the series of future net cash flows to equal the present value of the flow. Our acceptance criteria is as follows; the IRR is compared with the required rate of return, if the IRR exceeds the required rate the project is accepted, otherwise it is rejected. Net present value (NPV):In an investment it is the present value of a proposal's net cash flows minus its FSI. In a conventional project, the highest NPV occurs when the discount rate is zero, when the discount rate increases, the NPV decreases. The project is accepted when the NPV is greater than zero. Profitability Index (IR): Also called the cost-benefit ratio, it is the ratio between the present value of future net cash flows and the FSI. The proposed investment is acceptable when the profitability index is one or greater, which indicates that the present value of a project is greater than its FSI and that the NPV is greater than zero.
As a conclusion of the current essay, we can understand that at present it is vitally important to carry out financial analysis before making a long-term investment or starting a business, since these provide us with a broad overview of the life of our company. investment, as well as it helps us to delimit those projects that are tentatively dangerous or harmful not only for our investments, but for our companies and well-being in general.
Capital budgeting will never be unimportant as asset expansion typically involves very large expenses and before a business or individual can spend a large amount of money, they must have sufficient and available funds. Therefore, a company contemplating a larger capital expenditure program should establish its financing several years in advance so that the required funds are available.
Therefore, we can say that life moves by leaps and bounds, and that the world does not wait for anyone, we must always be prepared and prevent future financial problems, always using our knowledge and experience for the sake of our own future.
www.banxico.org.mx/portal-mercado-valores/index.html. (sf).
Saxena, AK (2015). Capital budgeting principles: bridging theory and practice. Academy Of Accounting & Financial Studies Journal, 19 (3), 283-293.
Gitman, L. & Zutter, C. (2012). Principles of Financial Management (12th Ed.). Mexico: PEARSON EDUCATION.
