6 Importance of Capital Budgeting

Meaning of Capital Budgeting

Capital Budgeting is the process of making investment decisions in capital expenditure. It involves the planning and control of capital expenditure. It is the process of deciding whether or not to commit resources to particular long-term projects whose benefits are to be realized over a period of time.

Below that we will be learning about the importance of capital budgeting.

Definition of Capital Budgeting

Capital Budgeting is the long-term planning for making and financing proposed capital outlays.Charles T Horngreen
Capital Budgeting consists in planning the development of available capital for the purpose of maximizing the long-term profitability of the concern.Lynch

Importance of Capital Budgeting

These are the importance of capital budgeting as follows:

  1. Large Investment
  2. Long-Term Commitment of Funds
  3. Irreversible Nature
  4. Long-term Effect on Profitability
  5. Difficulties of Investment Decisions

Large Investment

Capital budgeting decision involves a large investment of funds. But the funds available with the firm are always limited and the demand for funds far exceeds the resources. Hence it is very important for a firm to plan and control its capital expenditure.

Long-Term Commitment of Funds

Capital expenditures involve not only a large amount of funds but also funds for a long-term or permanent basis. The long-term commitments of funds increase, and the financial risk is involved in the investment decision. The greater the risk involved, the greater is need for careful planning of capital expenditure i.e. Capital Budgeting.

Irreversible Nature

The Capital expenditure decision is of irreversible nature. Once the decision for acquiring a permanent asset is taken, it becomes very difficult to dispose of these assets without incurring heavy losses.

Long-term Effect on Profitability

Capital budgeting decisions have a long-term and significant effect on the profitability of a concern. Not only the present earnings of the firm are affected by the investments in capital assets but also the future growth and profitability of the firm depend upon the investment decision taken today. An unwise decision may prove disastrous and fatal to the very existence of the concern.

Difficulties of Investment Decisions

The long-term investment decision is difficult to be taken because the decision extends to a series of years beyond the current accounting period, uncertainties of the future, and a higher degree of risk. 6. National Importance: Investment decision though taken by individual concern is of national importance because it determines employment, economic activities, and growth.

FAQs about the Importance of Capital Budgeting

What is the importance of capital budgeting?

The importance of capital budgeting is:
1. Large Investment
2. Long-Term Commitment of Funds
3. Irreversible Nature
4. Long-term Effect on Profitability
5. Difficulties of Investment Decisions.