5 Steps of the Capital Budgeting Process

There are various capital budgeting techniques that a company can use to evaluate investment projects and make appropriate decisions.

The amount of money that a company has in its investment account are not always enough to pursue all or many projects. Yet there are always several investment options and opportunities to choose from. The firm can decide to buy or lease an equipment instead of acquiring a marketing firm. Deciding to choose one opportunity instead of another is should be based on an objective analysis. The capital budgeting process is a series of steps that a company follows to choose investment projects and allocate scarce capital to the most valuable investments. There are various approaches that a firm can use to identify viable projects, but the most common steps involved in the capital budgeting process are described as follows

Step 1: Identify Investment Opportunities or Projects

The first step in the capital budgeting process is to explore available investment options. A company may consider up to five projects that are consistent with their business model and organizational objectives. To identify viable opportunities, the company should conduct analysis of their external and internal business environment. This allows them to determine the best strategies and assess their ability to meet the needs of each project. For instance, external environment analysis may involve the evaluation of technological factors and trends. This could lead to the identification of an opportunity to acquire a new technology or software. But the analysis should not end there. The company should continue exploring other investment options.

Step 2: Evaluating Projects

After identifying more than one investment opportunities, the company uses various investment appraisal techniques and criteria to evaluate each project. When evaluating investment options, the company should choose the most appropriate capital budgeting technique to ensure that they get the best results. The assessment of alternative projects should also consider the company’s mission and vision. This step of the capital budgeting process involves assessing the costs and risks of each investment option. The manager should evaluate the total cash inflows and cash outflows to determine whether the project is viable.

Step 3: Selecting the Best Option

In the third step of the budgeting process, the company chooses the project that has the best returns and little costs or risks. Every business has diverse requirements and therefore, the approval over a project comes based on the objectives of the organization. Before approving a project, the company’s management must assess the costs and returns of each option based on the most accurate criteria, considering the discount rates, risks, and future projected returns. The most viable, profitable, and sustainable project is chosen based on the results of the analysis done in step 2. This must get approval from the top management and sponsors before we proceed to the fourth step of the budgeting process.

Step 4: Implementation of the Project

The investment project that has been chosen based on objective analysis is implemented. Implementation of a project involves allocating financial resources, human resources, and assets to the project. The process also entails developing a plan that identifies specific courses of action and putting the project’s activities into action. For instance, if the project is to deploying a new software, the company may create a project team that will manage the implementation of the new software. The actions may include allocating money, hiring IT experts, and purchasing the new software, training employees to use it, and deploying it across the organization.

Step 5: Evaluation and Monitoring

Once the project has been implemented, the management team will review its performance to ensure that it meets the intended results. Evaluation involves the process of analyzing and assessing the actual results over the estimated outcomes. The company should monitor results to identify flaws and eliminate for future project proposals. Evaluation also enables the firm to track performance and ensure that the project has achieved the intended outcomes. If not, corrective action is taken to minimize losses and increase returns.

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