When it comes to capital budgeting it can be done in various ways. There are various tools that are used to make better decisions. But not all investors might look at each investment prospective in the same perspective. The actual steps that lead to the capital budgeting decision being taken might differ. But here are some basic steps that are always part of every capital budgeting decision:
Investment opportunities do not come seeking an investor. Every potential investment would have to be searched for and shortlisted. And the perfect timing is also important. Investing in an outdated piece of technology, for example, would not be a good decision. So the investor should be well aware of the market scenario and the trends to look out for. This would help the investor or the business to find the best available investment opportunities.
Analysis of the available choices
Once a list of the most relevant opportunities is picked there are various factors to be studied to find the ones that actually meet the requirements. Businesses often look for investments that are in line with their financial goals. For example, consider the capital investment on a new piece of machinery, a business would look for machines that help improve their production in the long run. If a business is investing in a new project it would be a project that would, in some way or the other, increase the value of the business as well.
The price quoted for the investment might not always be the same as the actual value of the investment. The investor would thus perform a cost analysis, a detailed one. Operation costs and overhead costs if involved would also be taken into account. This would help understand whether the capital being invested is justified.
Cash flow calculation
For the invested amount, the actual cash flow predicted would then be studied. Here is where the factors like payback period would be taken into account. Will the investment give quick profits and then saturate or will the investment grow slowly and steadily? Each of these situations might be favorable for different investors.
Every investment, no matter how carefully it is executed, comes with a little risk adhered to it. Risk analysis report might not always be available readily for the investor to study. So the investor would also perform a detailed analysis of the risks involved and the countermeasures and contingency plans to tackle such risks.