Yes I agree capital budgeting decisions has to be evaluated because of the following reasons-

1. Unlike other business decisions that involve a singular aspect of a business, a capital
budgeting decision involves two important decisions at once: a financial decision and an
investment decision. By taking on a project, the business has agreed to make a financial
commitment to a project, and that involves its own set of risks. Projects can run into
delays, cost overruns and regulatory restrictions that can all delay or increase the
projected cost of the project.
2. In addition to a financial decision, a company is also making an investment in its future
direction and growth that will likely have an influence on future projects that the
company considers and evaluates. So to make a capital investment decision only from the
perspective of either a financial or investment decisions can pose serious limitations on
the success of the project.

Capital budgeting decisions are also vital to a business because it creates a structured step by step
process that enables a company to:

3. Develop and formulate long-term strategic goals – the ability to set long-term goals is
essential to the growth and prosperity of any business. The ability to appraise/value
investment projects via capital budgeting creates a framework for businesses to plan out
future long-term direction.

4. Seek out new investment projects – knowing how to evaluate investment projects gives
a business the model to seek and evaluate new projects, an important function for all
businesses as they seek to compete and profit in their industry.

5. Estimate and forecast future cash flows – future cash flows are what create value for
businesses overtime. Capital budgeting enables executives to take a potential project and
estimate its future cash flows, which then helps determine if such a project should be
accepted.

6. Facilitate the transfer of information – from the time that a project starts off as an idea
to the time it is accepted or rejected, numerous decisions have to be made at various
levels of authority. The capital budgeting process facilitates the transfer of information to
the appropriate decision makers within a company.
 7. Monitoring and Control of Expenditures – by definition a budget carefully identifies
the necessary expenditures and R&D required for an investment project. Since a good
project can turn bad if expenditures aren't carefully controlled or monitored, this step is a
crucial benefit of the capital budgeting process.

8. Creation of Decision – when a capital budgeting process is in place, a company is then

able to create a set of decision rules that can categorize which projects are acceptable and
which projects are unacceptable. The result is a more efficiently run business that is
better equipped to quickly ascertain whether or not to proceed further with a project or
shut it down early in the process, thereby saving a company both time and money.

1. Long-term Implications of Capital Budgeting: A capital budgeting decision has its effect

over a long time span and inevitably affects the company’s future cost structure and growth. A

wrong decision can prove disastrous for the long-term survival of firm. On the other hand, lack

of investment in asset would influence the competitive position of the firm. So the capital

budgeting decisions determine the future destiny of the company.

2. Involvement of large amount of funds in Capital Budgeting: Capital budgeting decisions

need substantial amount of capital outlay. This underlines the need for thoughtful, wise and

correct decisions as an incorrect decision would not only result in losses but also prevent the firm

from earning profit from other investments which could not be undertaken.

3. Irreversible decisions in Capital Budgeting: Capital budgeting decisions in most of the

cases are irreversible because it is difficult to find a market for such assets. The only way out

will be scrap the capital assets so acquired and incur heavy losses.
4. Risk and uncertainty in Capital budgeting: Capital budgeting decision is surrounded by

great number of uncertainties. Investment is present and investment is future. The future is

uncertain and full of risks. Longer the period of project, greater may be the risk and uncertainty.

The estimates about cost, revenues and profits may not come true.

5. Difficult to make decision in Capital budgeting: Capital budgeting decision making is a

difficult and complicated exercise for the management. These decisions require an over all

assessment of future events which are uncertain. It is really a marathon job to estimate the future

benefits and cost correctly in quantitative terms subject to the uncertainties caused by economic-

political social and technological factors.

6. Large and Heavy Investment: The proper planning of investments is necessary since all the

proposals are requiring large and heavy investment. Most of the companies are taking decisions

with great care because of finance as key factor.

7. Permanent Commitments of Funds: The investment made in the project results in the

permanent commitment of funds. The greater risk is also involved because of permanent

commitment of funds.

8. Long term Effect on Profitability: Capital expenditures have great impact on business

profitability in the long run. If the expenditures are incurred only after preparing capital budget

properly, there is a possibility of increasing profitability of the firm.

9. Complicacies of Investment Decisions: Generally, the long term investment proposals have

more complicated in nature. Moreover, purchase of fixed assets is a continuous process. Hence,

the management should understand the complexities connected with each projects.

10. Maximize the worth of Equity Shareholders: The value of equity shareholders is increased

by the acquisition of fixed assets through capital budgeting. A proper capital budget results in the

optimum investment instead of over investment and under investment in fixed assets. The
management chooses only most profitable capital project which can have much value. In this

way, the capital budgeting maximize the worth of equity shareholders.

11. Difficulties of Investment Decisions: The long term investments are difficult to be taken

because decision extends several years beyond the current account period, uncertainties of future

and higher degree of risk.

12. Irreversible Nature: Whenever a project is selected and made investments as in the form of

fixed assets, such investments is irreversible in nature. If the management wants to dispose of

these assets, there is a heavy monetary loss.

13. National Importance: The selection of any project results in the employment opportunity,

economic growth and increase per capita income. These are the ordinary positive impact of any

project selection made by any company.

Importance of Capital Budgeting—

(a)Capital budgeting decisions impact the firm for several years, they must be carefully planned.
A bad decision can have a significant effect on the firm’s future operations. In addition, the
timing of the decisions is important. Many capital budgeting projects take years to implement. If
firms do not plan accordingly, they might find that the timing of the capital budgeting decision is
too late, thus costly with respect to competition. Decisions that are made too early can also be
problematic because capital budgeting projects generally are very large investments, thus early
decisions might generate unnecessary costs for the firm.

(b) Capital budgeting has long-term implications:

The most significant reason for which capital budgeting decisions are taken is that it has long-

term implications, i.e. its effects will extend into the future, and will have to be endured for a

longer period than the consequences of current operating expenditure. Because, a proper

investment decision can yield spectacular returns, whereas a wrong investment decision can

endanger the very survival of the firm.

That is why, it may be stated that the capital budgeting decisions determine the future destiny of

the firm. Moreover, it also changes the risk complexion of the enterprise. When the average

benefits of the firm increase as a result of an investment proposal which may cause frequent

fluctuations in its earnings that will become a risky situation.

(c) Capital budgeting requires large amount of funds:

Capital investment decisions require large amount of funds which the majority of the firms

cannot provide since they have scarce capital resources. As a result, the investment decisions

must be thoughtful, wise and correct. Because, a wrong/incorrect decision would result in losses

and the same prevents the firm from earning profits from other investments as well due to

scarcity of resources.

(d) Capital budgeting is not reversible:

Once the capital budgeting decisions are taken, they are not easily reversible. The reason is that

there may neither be any market for such second-hand capital goods nor there is any possibility

of conversion of such capital assets into other usable assets, i.e., the only remedy is to dispose-

off the same sustaining a heavy loss to the firm.

(e) They are actually the most difficult decisions:

Capital investment decisions are, no doubt, the most significant since they are very difficult to

make. It is because of the fact that their assessment depends on the future uncertain events and

activities of the firm. Similarly, it is practically a difficult task to estimate the accurate future

benefits and costs in terms of money as there are economical, political and technological forces

which affect the said benefits and costs.

Importance

Identify Opportunities
As a business owner or entrepreneur, you are often presented with many different potential
opportunities. You could go in a number of different directions as a company. The first step in
the capital budgeting process is identifying which opportunities are available to you at the time.
Before you can make a decision he have to know what is available first.
Assess Opportunities
Once you have identified the possible opportunities for your business, the next step in the
process is to assess each opportunity individually. You to compare each opportunity against your
vision for the company and the mission statement. Look at the values of each opportunity and
see if they match with your own values. Many of the potential opportunities can be eliminated in
the step before you can get into the financial information. You want only pursue opportunities
that match your business plan.
Cash Flow Assessment
Another vital part of the capital budgeting process is cash flow assessment. When looking at a
new project, you to come up with a cash flow plan for it. You need to estimate the amount of
cash that will take to complete the project and how much cash it will require going forward. This
often requires the consultation of several different experts. For example, if you are considering
starting a new plant for your business, you will need to consult with an architect and possibly a
builder to determine how much it would cost. If building is not your expertise, do not rely on
guesstimates for your information.
The second part of the cash flow assessment process helps you determine how much money are
project could bring in. When calculating these numbers do not ever use the best case scenario.
Use numbers that are more realistic for your assessment. This part of the process helps you
determine whether the project is viable or not.
Making Decisions
Ultimately, the objective of capital budgeting is to help you make decisions that are smart for
your business. Taking the necessary steps to evaluate each opportunity can help you avoid
disastrous consequences for your business. If these steps are not taken, you can take on a project
that does not bring any value to your company. Ultimately, it could prove to be the last mistake
your company remakes. Therefore, the capital budgeting process is crucial to consider before
making any big decisions for any type of project.

The significance of capital budgeting is explained in the following points:

(a) Long-term Applications:

Implies that capital budgeting decisions are helpful for an organization in the long run as these

decisions have a direct impact on the cost structure and future prospects of the organization. In

addition, these decisions affect the organization’s growth rate.

Therefore, an organization needs to be careful while making capital decisions as any wrong

decision can prove to be fatal for the organization. For example, over-investment in various

assets can cause shortage of capital to the organization, whereas insufficient investments may

hamper the growth of the organization.

(b) Competitive Position of an Organization:

Refers to the fact that an organization can plan its investment in various fixed assets through

capital budgeting. In addition, capital investment decisions help the organization to determine its

profits in future. All these decisions of the organization have a major impact on the competitive

position of an organization.

(c) Cash Forecasting:

Implies that an organization needs a large amount of funds for its investment decisions. With the

help of capital budgeting, an organization is aware of the required amount of cash, thus, ensures

the availability of cash at the right time. This further helps the organization to achieve its long-

term goals without any difficulty.

(d) Maximization of Wealth:

Refers to the fact that the long-term investment decisions of an organization helps in

safeguarding the interest of shareholders in the organization. If an organization has invested in a

planned manner, shareholders would also be keen to invest in the organization. This helps in

maximizing the wealth of the organization. Capital budgeting helps an organization in many

ways. Thus, an organization needs to take into consideration various aspects.

Q.2.

IMPORTANCE OF WORKING CAPITAL

Working capital is a vital part of a business and can provide the following advantages to a
business:

HIGHER RETURN ON CAPITAL

Firms with lower working capital will post a higher return on capital so shareholders will benefit
from a higher return for every dollar invested in the business.
IMPROVED CREDIT PROFILE AND SOLVENCY

The ability to meet short-term obligations is a pre-requisite to long-term solvency and often a
good indication of counterparty’s credit risk. Adequate working capital management will allow a
business to pay on time its short-term obligations which could include raw materials, salaries,
and other operating expenses.
HIGHER PROFITABILITY

According to a research conducted by Tauringana and Adjapong Afrifa, the management of

account payables and receivables is an important driver of small businesses’ profitability.

HIGHER LIQUIDITY

A large amount of cash can be tied up in working capital, so a company managing it efficiently
could benefit from additional liquidity and be less dependent on external financing. This is
especially important for smaller businesses as they typically have a limited access to external
funding sources. Also, small businesses often pay their bills in cash from earnings so an efficient
working capital management will allow a business to better allocate its resources and improve its
cash management.

INCREASED BUSINESS VALUE

Firms with more efficient working capital management will generate more free cash flows which
will result in a higher business valuation and enterprise value.

FAVORABLE FINANCING CONDITIONS

A firm with a good relationship with its trade partners and paying its suppliers on time will
benefit from favorable financing terms such as discount payments from its suppliers and banking
partners.
UNINTERRUPTED PRODUCTION

A firm paying its suppliers on time will also benefit from a regular flow of raw materials,
ensuring that the production remains uninterrupted and clients receive their goods on time.

ABILITY TO FACE SHOCKS AND PEAK DEMAND

An efficient working capital management will help a firm to survive through a crisis or ramp up
production in case of an unexpectedly large order.

COMPETITIVE ADVANTAGE

Firms with an efficient supply chain will often be able to sell their products at a discount versus
similar firms with inefficient sourcing.
Top 10 Advantages of Adequate Working Capital | Financial Analysis

The following points highlight the top ten advantages of adequate working capital.
Adequate Working Capital Advantage # 1. Solvency of the Business:

Adequate working capital helps in maintaining solvency of the business by providing

uninterrupted flow of production.

Adequate Working Capital Advantage # 2. Goodwill:

Sufficient working capital enables a business concern to make prompt payments and hence helps

in creating and maintaining goodwill.

Adequate Working Capital Advantage # 3. Easy Loans:

A concern having adequate working capital, high solvency and good credit standing can arrange

loans from banks and others on easy and favourable terms.

Adequate Working Capital Advantage # 4. Cash Discounts:

Adequate working capital also enables a concern to avail cash discounts on the purchases and

hence it reduces costs.

Adequate Working Capital Advantage # 5. Regular Supply of Raw Materials:

Sufficient working capital ensures regular supply of raw materials and continuous production.
Adequate Working Capital Advantage # 6. Regular Payment of Salaries, Wages and Other
Day-to-day Commitments:

A company which has ample working capital can make regular payment of salaries, wages and

other day-to-day commitments which raises the morale of its employees, increases their

efficiency, reduces wastages and costs and enhances production and profits.

Adequate Working Capital Advantage # 7. Exploitation of Favourable Market Conditions:

Only concerns with adequate working capital can exploit favourable market conditions such as

purchasing its requirements in bulk when the prices are lower and by holding its inventories for

higher prices.

Adequate Working Capital Advantage # 8. Ability to Face Crisis:

Adequate working capital enables a concern to face business crisis in emergencies such as

depression because during such periods, generally, there is much pressure on working capital.

Adequate Working Capital Advantage # 9. Quick and Regular Return on Investments:

Every Investor wants a quick and regular return on his investments. Sufficiency of working

capital enables a concern to pay quick and regular dividends to its investors as there may not be

much pressure to plough back profits. This gains the confidence of its investors and creates a

favourable market to raise additional funds in the future.

Adequate Working Capital Advantage # 10. High Morale:

Adequacy of working capital creates an environment of security, confidence, high morale and

creates overall efficiency in a business.

2.12.1 Advantage of maintaining working capital at optimal level

Some of the major advantages of keeping working capital at optimal level are as under:-

Solvency of the company: Satisfactory working capital helps in keeping solvency of the
company by supplying continuous flow of production.

Reputation: Adequate working capital enables a company to disburse timely payments

and therefore, helps in creating and keeping reputation.

Unproblematic Loans: A company having sufficient working capital, high solvency and
excellent credit position is able to get loans from banks and other sources on friendly and
constructive terms.

Cash discounts: Adequate working capital furthermore enables a company to get benefit of cash
discounts on the procurements and therefore, it reduces costs.

Uninterrupted delivery of raw material: Adequate working capital assures uninterrupted

receipt of raw material for the nonstop production.

Uninterrupted disbursement of salaries wages and other day-to-day obligations: A company

which has sufficient working capital will be able to make usual disbursement of salaries, wages
and other day-to-day obligations which raise the spirits of its employees, increase their
effectiveness, decrease wastages, save costs and increase profits.

Utilization of positive market conditions: Simply a company which has sufficient working
capital can utilize positive market situation such as procuring its necessities of material in bulk
when the prices are low and by holding its inventory for privileged prices.

Capability to face crisis: Sufficient working capital makes a company able to face business
crisis in emergencies such as depression for the reason that during such periods, generally, there
is much burden on working capital.

Rapid and interrupted return on investment: Every saver desires a rapid and interrupted
return on his savings. Adequacy of working capital makes a company able to disburse dividends
rapidly to its investors as there possibly will not be much force to plough back earnings. This
increases the self-confidence of its investors and creates an encouraging market to acquire
further funds.
Sky-scraping morale: Sufficiency of working capital makes an atmosphere of safety,
confidence, high morale and creates effectiveness in a company, on the whole.