Capital budgeting is that aspect of planning that involves the decision to invest in capital expenditure. Capital budgeting is an important aspect of financial planning to any organisation. It has been employed by both the corporate and the public entities.
We will write a custom Essay on Pay-offs and Risks of Capital Investments specifically for you
301 certified writers online
One of the advantages of capital budgeting is that the budgeting entity is able to plan the on the risk and return of investing in a capital projects while assessing the cash flow, both outlay and cash inflow from the investment. This paper discusses how proper capital finance and budgeting could heighten the success of a government organisation.
The Importance of capital budgeting to a public organisation
Like any other finance field, it must be noted that the modern day organisations operate under scarce resources. This means that there are unlimited cash needs that compete for the limited finances. A public organisation therefore ought to plan and budget for its capital expenditure so as to ensure maximum benefits are derived from the chosen capital expense.
Most of the governmental organisations work not with a profit motive but to increase the social wealth of the citizens. As such, there is a need to ensure that the capital project chosen is one that derives maximum benefits to the stakeholders, most of who are the public.
The different capital expenditures carried by governmental organisations are usually implemented at the expense of recurrent expenditure. This is because any governmental organisation usually has two main types of expenditures: capital and re-current.
A proper budgeting of a capital expenditure by a governmental organisation helps to balance between capital projects and also reserve some funds that are to be used to as the projects operating costs.
This is the main advantage of capital expenditure budgeting. An organisation should not commit all its funds in a capital project and lack the funds to run the operation of the project. These operation costs include such expenses as services, repairs, and maintenance.
Rift Valley Railways capital investment decisions
Rift Valley Railways is an arm of a government that took over the management of Railway transport in the country. Recently, the authority decided to invest in a train that will travel at a speed of up to 80 miles per hour.
This decision was reached due to the increased cost of road transport and the need to de-congest the road transport. The authority had evaluated several options that would have been used to address the situation and came up with the final decision to invest in a train.
The decision was reached after the executive council formed a committee of financial experts to evaluate the various options available and advice on the most suitable of all. Among the other available options were construction of an additional road that serves the city, and extension of the available road through construction of over-asses and by-passes etc.
The committee used one capital investment appraisal tool to carry out the evaluation. The used tool is referred to as the Net Present Value (NPV). This is capital investment appraisal method that uses the present value of the anticipated cash inflows and compares them to the other present values of the competing projects.
After carrying out this appraisal, the committee recommended that the authority adopt the purchase of an additional train that will be used to decongest the public roads. Several reasons were offered some which were of quantitative and others qualitative in nature. It was agreed that purchasing a train would be the most financially viable option as compared to the rest and therefore, the train was purchased.