Introduction
In business, the investment is common to observe. It is very obvious that you have to spend money first. After investing the money, the use of a proper plan makes it possible to get benefits. The investment in a business is not random. It requires planning and different calculations. The way of planning for investment is termed as capital budgeting. If you invest without planning, there are strong chances of loss in the business. The risk factor also increases that may cause trouble.
On the other hand, proper planning before investment shows you the term and conditions for generating profit in the end. The final decision is made through capital budgeting. One of the most important things is to make it clear in your mind that capital budgeting requires long term investment. As per its importance, this article aims to discuss pros and cons of capital budgeting techniques.
What are Five Capital Budgeting Techniques?
There are five capital budgeting techniques. Names of these techniques are mentioned below:
- Internal rate of return
- Net present value
- Profitability index
- Accounting rate of return
- Payback period
The selection of budgeting techniques depends on the objective of the project. The net present value technique is used very frequently. Each technique provides benefits in a particular way.
What are the Pros of Capital Budgeting Techniques?
Following are some pros of capital budgeting techniques:
- Plan framework
- Evaluate risk factor
- Manage investment
- Monitor cash flows
Let’s discuss these pros briefly.
Plan Framework
Capital budgeting techniques are the tools that are used to make a plan for business investment. The plan includes all steps in the right sequence. In this way, you can end up making the most beneficial decision for your business. First of all, you have to see what kind of opportunities are available. Make a list of all available opportunities and analyse each opportunity. Critical evaluation of each opportunity is necessary to make a long-term plan for long-term investment.
Evaluate Risk Factor
Another best thing about capital budgeting techniques is its risk evaluation. By using budgeting techniques for your business, the risks associated with plans can be identified. The budgeting techniques analyse and evaluate all good and bad aspects of a project. If the risk factor is more, it is better to go for another project or idea. The less value of risk enhances the chances of successful completion of the project.
Manage Investment
Long-term investment requires great attention till the end of a project. Suppose, you have two projects. In this regard, you can use capital budgeting techniques and calculate the cash flow of each project. Cash flow includes inflow as well as outflow. Also, check out the market value of each project. All these calculations can be identified through budgeting techniques. Based on end results, you can invest in a beneficial project.
Monitor Cash Flows
The worth of a project and decision of investment are not the only things. It matters a lot to go for the right amount of investment. The extra investment would not benefit you. All of the excessive amount will go to the side of loss. Similarly, less amount of investment will cause improper end results. In order to avoid such unpleasant results, the exact amount of investment is necessary. Capital budgeting techniques determine the right amount of investment based on the value and objective of the business.
What are the Cons of Capital Budgeting Techniques?
Following are some cons of capital budgeting techniques:
- Unpredictable
- Un-repairable
- Focus on financial aspects only
- High-risk factor
Let’s discuss these cons briefly.
Unpredictable
In any kind of project, the unusual circumstances can change the whole scenario. At the time of using capital budgeting techniques, assumptions are made. You can say that there are some ideal conditions that can change the calculated value. The wrong values will generate the wrong cash flow. Similarly, the time of project completion is not always correct. These aspects of budgeting techniques make it unpredictable if the investment will work or not.
Un-Repairable
It is necessary to keep all of the disadvantages of capital budgeting techniques in your mind. You know well that capital budgeting is a long term investment programme. This long term programme is irreversible. This is the major limitation of capital budgeting. The investment decision needs your great attention. Otherwise, you would have to face serious consequences. Make sure that the techniques you are using are the most suitable as per the objective of the project.
Focus on Financial Aspects Only
In the generation of revenue, financial and non-financial aspects of a project play an important role. The capital budgeting techniques only consider the financial aspects of a project. The missing non-financial aspects can lead you toward the wrong decision of investment. The non-financial factors cover all of the meetings with stakeholders and other staff. Also, it covers the working and dealing practices of an organisation.
Furthermore, a change in technology demands new working techniques and conditions. If you do not adopt new techniques, the designed product may not get worth in the market. So, no use of non-financial factors makes your investment decision uncertain.
High-Risk Factor
The risk factor is high because of the uncertain nature of the plan. A large amount of investment needs continuous monitoring and care. In large investments, the failure can cause a complete shutdown. Many organisations have faced huge business losses because of wrong investment decisions. So, you can see how capital budgeting techniques can cause huge losses in any business.
Final Thoughts
The above-mentioned points can help you understand the value of capital budgeting techniques. Do not skip the use of budgeting techniques because of their cons. You can surely overcome the cons of budgeting techniques with high monitoring. Although you cannot avoid all of the cons, you can overcome them. It is preferred to have experience before using these techniques. Also, the final decision is made after a critical evaluation that needs high experience.
Author Bio:
Robert Fawl is a professional Content writer & Content Marketer. Based in London, Robert is an author and blogger with experience in encounter composing on various topics including but not limited to Essay Writing, Dissertation Writing, Thesis Writing Services and Assignment Writing etc.
