THE CAPITAL BUDGET
The investment budget is used to measure the profitability of projects to ensure that the projects increase the value of the company. Investment projects include the following:
- The cost of the project
- The financing of the project.
- The project's net cash inflow (cash flow).
- The profitability of the project.
Cash inflows take into account the time value of money (the discount rate of cash flows over time). The capital budget is based on capital projects spanning several years. It represents a significant amount and relates to the acquisition of fixed assets (purchases of machinery and equipment, acquisition of land for buildings, construction of factories, acquisition of businesses). The capital budget has a significant impact on the long-term financial performance on the business. It is for this reason that it is approved by the management of the company, and in some cases, by the board of directors. It is part of the strategic planning of the company and it must represent an important contribution to the strategy and the financing of the company.
Projects are evaluated using several methods. The most commonly used methods are the payback period, the present value of cash flows and the internal rate of return. The evaluation criteria are based on financial forecasts and according to the risk they run. The company should also consider asset financing as part of its budget process.
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