Capital Budgeting Techniques

A business owner faces make many important decisions from the very start of establishing a business. They must determine what kind of business they want to be, whether to be a solo proprietorship, limited liability corporation (LLC) or a corporation. Once this decision has been made there are many different aspects that must be taken into consideration for the company to become successful and stay successful. One very important aspect is cash flow and how funds must be utilized within the company. For instance, money must always be on hand for the day to day expenses like buying supplies and paying employees. These are considered short term expenditures and then there are long term expenditures that must be carefully planned out. Long term expenditures are building and equipment maintenance day the road and new projects that can help expand the company or help bring in more cash flow. The money that is spent on these long term expenditures is generally referred to as capital and the planning and evaluating on the projects that will utilize the capital is called capital budgeting. This process, capital budgeting, can help a company’s financial managers determine if the project is even beneficial to the company, how much money should be put into the project, assess the risk and develop ways to overcome those risk. To help with this process, financial managers can use capital budgeting techniques which have groups of calculations and sets of decision rules. The techniques that are used are called payback period, net present value (NPV), internal rate of return (IRR), and profitability index (PI) (Lasher, 2011, p. 456-458). The payback period is generally the easiest budgeting technique out of the group and provides an financial manger an estimation on how long the original cost of their investment back and this timeframe will also let them know how long the capital will be at risk. This process is mainly effective if the company only has one cash