Understanding Capital Budgeting
Capital Budgeting is our way of contributing to your business’s plan for long-term investments. Not only will we help manage these budgets in your books, but it is also essential to manage this budget to help make it successful. Overall, these reports can help you decide what moves you should make.
To close your books means making sure that all the pieces of information are accounted for so that the information provided in reports (such as a balance sheet and income statement) will be accurate for that period. Accounting is a tool you can tell us.
When allocating, capital is usually more involved than just deciding whether to purchase an asset; but more about more significant concerns. Do we launch this new product or service? If yes, when? To best make this decision, we can utilize a combination of financial projection computations.
In creating a capital budget, we often use:
- Internal Rate of Return: Popular within capital budgets, it is a single rate of return that includes a fuller picture. The valuable part of this calculation is that it depends on the cash flows of a particular investment, not on outside data. Within this rule, an asset is acceptable if the internal rate of return exceeds the required return.
- Net Present Value: An investment is worth taking when you know if it is more valuable than the cost, but how you figure that out takes financial projections from a professional. The net present value applies to a series of cash flows occurring at different times. This value should then be added to your business context to know whether the investment is suitable for your specific organization.
- The Payback Rule: How long will it take to recover your initial investment? This length of time will help you understand if the investment is worth the initial cost. The first step of the rule is to calculate the payback period on the investment. Once this is defined, you can then analyze the data with specifics of your business. Specifically, if you look at the rule, you cannot see the complete picture. A finance professional can help determine this rule’s essential questions, such as looking past the fact that the rule only considers future cash flows from the investment or how to choose the suitable cutoff period.
- Average Accounting Return: this average is calculated by dividing your average net income by your average book value. Based on this rule, a project is acceptable if its average accounting return exceeds a target average accounting return. Again, there are many contexts to consider within this rule, such as how it ignores time value, a lack of a cutoff period, or how it doesn’t look at cash flow vs. market value.
- The Profitability Index/Benefit-Cost Ratio: This index calculates the present value of the future cash flows divided by the initial investment. The popularity of this ratio is due to the ease of incomprehension of the proportion – regardless of the professionals on your team, a profitability index can help paint a picture of the investment’s potential. This is closely related to the net present value, which can be used together to help confirm a decision.
The Full Cycle CFO Difference
Why Choose Our Team For Your Budgeting?
Full Cycle CFO knows the importance of effective capital budgeting. Capital budgeting, especially for new asset acquisitions or projects, benefits from an expert who can look at these projections to decide if it will be profitable in the long term.
A CFO can give you a realistic projection, including the time value of money, to determine the efficacy of a venture. Like Full Cycle CFO, an outsourced CFO company has the expertise to do these analyses and get you the information you need. We have a team of experts who have worked in the industry that can give you the value of an entire accounting department and a CFO all wrapped into one. We can help you plan your budgets to make them successful and be there along the way to make sure you are staying on track.
Capital budgeting is critically important to the long-term success of a business. Significant asset acquisitions or project venture decisions without a proper capital budget analysis can lead to disastrous effects on your business because they usually involve large amounts of money. We know the value of a dollar and how important it is to your business to keep those assets safe. We offer the benefit of custom capital budgets for all your business’ investments and provide you with all the advice and information you need to make informed decisions for your business’s future.