A firm incurs two types of expenses i.e.
1. Revenue Expenditure:
The benefits of which are supposed to be exhausted within
the year concerned and their planning and control is done through various
2. Capital Expenditure:
The benefits of which are expected to be received over long period a series of years in future like building, plant, machinery or to undertake a program on
- Research and development of a product
- Diversification in to a new product line
- Replacement of a machine
- Expansion in production capacity
- Promotional campaign
Capital expenditure involves investment of substantial funds for longer period and the benefits of such investment are in the form of increasing revenues or decreasing costs. Wrong decision under this head may effect future earnings, employment capacity, quantity and quality of production. Hence, long term planning and right decision to incur or not to incur such expenditure is a crucial responsibility of management.
The techniques used by management to carry out this responsibility is known as capital budgeting. Hence planning and control of capital expenditure is termed as capital budgeting.
According to Milton â€œCapital budgeting involves planning of expenditure for assets and return from them which will be realized in future time periodâ€.
According to I.M pandey â€œCapital budgeting refers to the total process of generating, evaluating, selecting, and follow up of capital expenditure alternativeâ€
Nature / Features of Capital budgeting decisions:
Following are the features of capital budgeting decisions;
1. Long term effect
Such decisions have long term effect on future profitability and influence pace of firms growth. A good decision may bring amazing/good returns and wrong decision may endanger very survival of firm. Hence capital budgeting decisions determine future destiny of firm.
2. High degree of risk
Decision is based on estimated return. Changes in taste, fashion, research and technological advancement leads to greater risk in such decisions.
3. Huge funds
Large amount/funds are required and sparing huge funds is problem and hence decision to be taken after proper care/analysis
4. Irreversible decision
Reverting from a decision is very difficult as sale of high value asset would be a problem.
5. Most difficult decision
Decision is based on future estimates/uncertainty. Future events are affected by economic, political and technological changes taking place.
6. Impact on firmâ€™s future competitive strengths
These decisions determine future profit/ cost and hence affect the competitive strengths of firm.
7. Impact on cost structure
Due to this vital decision, firm commits itself to fixed
costs such as supervision, insurance, rent, interest etc. If investment does
not generate anticipated profit, future profitability would be affected.
May 26, 2017