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Steps Involved in Capital Budgeting

Capital budgeting is a multi-step process companies use to determine if large expenditures or investments are worthwhile. It involves identifying potential opportunities, estimating costs and cash flows, assessing risks, and implementing approved projects. Specifically, the 5 steps are: 1) identifying opportunities, 2) estimating costs, 3) estimating cash flows/benefits, 4) assessing risks, and 5) implementing approved projects along with tracking costs and cash flows.

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53 views

Steps Involved in Capital Budgeting

Capital budgeting is a multi-step process companies use to determine if large expenditures or investments are worthwhile. It involves identifying potential opportunities, estimating costs and cash flows, assessing risks, and implementing approved projects. Specifically, the 5 steps are: 1) identifying opportunities, 2) estimating costs, 3) estimating cash flows/benefits, 4) assessing risks, and 5) implementing approved projects along with tracking costs and cash flows.

Uploaded by

Sauhard Alung
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Steps Involved in Capital Budgeting

The 5 Steps to Capital Budgeting

Capital budgeting is a multi-step process businesses use to determine how worthwhile a


project or investment will be. A company might use capital budgeting to figure out if it
should expand its warehouse facilities, invest in new equipment, or spend money on
specialized employee training.

The capital budgeting process consists of five steps:

1. Identify and evaluate potential opportunities

The process begins by exploring available opportunities. For any given initiative, a company
will probably have multiple options to consider. For example, if a company is seeking to
expand its warehousing facilities, it might choose between adding on to its current building or
purchasing a larger space in a new location. As such, each option must be evaluated to see
what makes the most financial and logistical sense. Once the most feasible opportunity is
identified, a company should determine the right time to pursue it, keeping in mind factors
such as business need and upfront costs.

2. Estimate operating and implementation costs

The next step involves estimating how much it will cost to bring the project to fruition. This
process may require both internal and external research. If a company is looking to upgrade
its computer equipment, for instance, it might ask its IT department how much it would cost
to buy new memory for its existing machines while simultaneously pricing out the cost of
new computers from an outside source. The company should then attempt to further narrow
down the cost of implementing whichever option it chooses.

3. Estimate cash flow or benefit

Now we determine how much cash flow the project in question is expected to generate. One
way to arrive at this figure is to review data on similar projects that have proved successful in
the past. If the project won't directly generate cash flow, such as the upgrading of computer
equipment for more efficient operations, the company must do its best to assign an estimated
cost savings or benefit to see if the initiative makes sense financially.

4. Assess risk

This step involves estimating the risk associated with the project, including the amount of
money the company stands to lose if the project fails or can't produce its previously
anticipated results. Once a degree of risk is determined, the company can evaluate it against
its estimated cash flow or benefit to see if it makes sense to pursue implementation.
5. Implement

If a company chooses to move forward with a project, it will need an implementation plan.
The plan should include a means of paying for the project at hand, a method for tracking
costs, and a process for recording cash flows or benefits the project generates. The
implementation plan should also include a timeline with key project milestones, including an
end date if applicable.

Capital budgeting is the process of determining whether a big expenditure is in a company's


best interest. Here are the basics of capital budgeting and how it works. 

Capital Budgeting Basics

A company undertakes capital budgeting in order to make the best decisions about utilizing
its limited capital. For example, if you are considering opening a distribution center or
investing in the development of a new product, capital budgeting will be essential. It will help
you decide if the proposed project or investment is actually worth it in the long run.

1. Identify Potential Opportunities

The first step in the capital budgeting process is to identify the opportunities that you have.
Many times, there is more than one available path that your company could take. You have to
identify which projects you want to investigate further and which ones do not make any sense
for your company. If you overlook a viable option, it could end up costing you quite a bit of
money in the long term. 

2. Evaluate Opportunities

Once you have identified the reasonable opportunities, you need to determine which ones are
the best. Look at them in relation to your overall business strategy and mission. See which
opportunities are actually realistic at the present time and which ones should be put off for
later. 

3. Cash Flow

Next, you need to determine how much cash flow it would take to implement a given project.
You also need to estimate how much cash would be brought in by such a project. This
process is truly one of estimating--it takes a bit of guesswork. You need to try to be as
realistic as you can in this process. Do not use the best-case scenario for your numbers. Most
of the time, you need to use a fraction of that number to be realistic. If the project takes off
and the best-case scenario is reached, that is great. However, the odds of that happening are
not the best on new projects.
4. Select Projects

After you look at all of the possible projects, it is time to choose the right project mix for your
company. Evaluate all of the different projects separately on their own merits. You need to
come up with the right combination of projects that will work for your company immediately.
Choose only the projects that mesh with your company goals.

5. Implementation

Once the decisions have been made, it is time to implement the projects. Implementation is
not really a budgeting issue, but you will have to oversee everything to be sure it is done
correctly. After the project gets started, you will need to review everything to make sure the
finances still make sense.

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