Critically Reflect on the Importance of Capital Budgeting

Capital budgeting is the process of identifying, analyzing and selecting investment projects and assets on which cash flows are intended for long-term business development and growth. Capital budgeting considers what investment projects will be accepted based on the investment rate of return that such an investment initiative will produce. Businesses exist in order to make profit and capital budgeting is a useful measure of determining the effectiveness of its investment decisions.
Capital budgeting is important for the following reasons (Horngren, Datar & Foster, 2006):

  1. It enables a company to develop and prepare long-term strategic goals. Capital budgeting enables the appraisal of investment options for businesses to determine future long-term direction.
  2. It helps companies plan their financing. Capital budgeting carefully identifies necessary expenditures, which can be huge and affect a firm’s financial performance. Also, poor forecasting may result in over or under investment of resources.
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