Capital Budgeting Process, Accountancy and Financial management Video Lecture | Accountancy and Financial Management - B Com

in this chapter we're going to learn
about capital investment decisions and
the time value of money capital
budgeting is the process of making
capital investment decisions capital
aggress Prince Avenue we buy assets that
we use for a long period of time and
which require large sums of money
examples of capital investments are
buying new equipment building new plant
automating production developing major
commercial websites also things like
investing in a new fleet of vehicles all
those are considered capital investments
those are typically the ones that are
shown as long-term assets in your
balance sheet whenever we make applebutt
to decisions we use four methods of
analyzing those decisions the ones we
picked out our capital investments we
will use these four methods to analyze
them and figure out which one's best we
use payback period in accounting rate of
return these two are quick and needs to
calculate and typically we use them for
the shorter lifespan investments and
then we can also use net present value
an internal rate of return these are a
little bit more difficult to calculate
and typically use for longer span
investments the last two consider time
value of money which we'll talk about
later let's say a quick look at cash
basis versus accrual basis if you think
of accounting one in accounting one we
said GAAP requires us to prepare
financial statement based on accrual
accounting GAAP requires accrual
accounting
however when we're doing capital
investment decisions we will be looking
at cash flows instead so we're not going
to look at accounting income we're gonna
look at cash flows except for one method
for accounting rate of return we will
use accrual-based accounting income how
would you remember which one to use
accounting income
it's a RR which stands for accounting
rate of return that's one that uses
accounting income whenever we are
looking at cash flows from our
investment they would include
future cash revenue however any future
savings on cash costs will also be
considered a cash inflow so if we don't
have to pay for costs going forward so
any cost savings would also be
considered a cash inflow to the company
also don't forget when you are looking
at assets if there's a residual value of
an asset we would also take that into
consideration and that would be
considered a cash inflow so let's go
through the capital budgeting process
the first step is to identify potential
investments in a typical company there
will be a number of capital investment
projects that the company wants to do
but they cannot get into everything
because they're limited by constraints
at this stage they will identify all the
potential investments that they would
like to do so different managers of
different areas will list all the
potential investments once the
investments are identified then managers
how to come up with the projected cash
inflows for each of the investments this
is a very hard time consuming process
however managers have to make the best
possible projections given the
information they have once we have the
projected cash inflows we go ahead and
analyze the investments using the four
methods that we talked about four
methods of investment analysis you would
use one or more of the four methods that
we listed before the four methods if you
remembered where payback period
accounting rate of return net present
value and internal rate of return once
we analyze the investments some of the
potential investments that we identified
in step one would get rejected right
away after analyzing the investments we
go through the next steps with whatever
passed through our analysis once let's
say for example that we had a lot of
potential investments and there are only
three investments that pass the added
analysis let's say that the three that
passed analysis were building in
addition to our building
upgrading the computer system and
replacing our existing fleet of vehicle
now that we have identified these three
investments we come across a problem we
don't have enough money to invest in all
these three projects so what do we do in
this type situation companies do what
they call capital rationing capital
rationing is a term used when companies
have to choose among alternative capital
investments these decisions are
typically done based on the availability
of funds and how soon managers need this
particular particular investment so
going back to our example let's assume
that this company only had money to do
one particular investment and they
decided to go with replacing their
existing fleet of vehicles what happens
to the other two investments that passed
tests upgrading the bill are building in
addition and upgrading the computer
system those will get kept for future
fundings or those will stay in the list
of in restaurants for the future they
will continue to reassess those three
investment so if factors change and they
don't need one of those in restaurants
they will scrap it from the list of
investments finally companies will
perform a post edit of their capital
investment a post audit is basically
where they will go after the investment
it's done and compare the actual net
cash flows from the project to the cash
inflows they anticipated during step 2
of the capital budgeting process the
Polestar it helps companies figure out
whether the investments are going as
planned and if they're not going as
planned whether they should abandon the
project and sell and recover whatever
they can for the rest of the chapter
we're going to focus on the four methods
of analyzing investments we're going to
learn how to calculate them and learn
about the pros and cons of each of them