Posted by Anjali Kaur on Oct 15, 2021
Capital Budgeting

Factors affecting capital budgeting decisions

Why Capital Budgeting decisions so important to success of a firm? - QS  Study

Capital budgeting decisions involve decisions on the fixed or working capital requirements for the business. In this post, we will focus on factors affecting capital budgeting decisions involving fixed capital.

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Types of Assets:

1. Fixed Assets

Fixed assets are those which remain in the business for more than 1 year, usually for a much longer period. For example, plant and machinery, furniture, etc. Decisions to invest in fixed assets must be taken very carefully as this investment is quite large, such decisions are also called capital budgeting decisions.

2. Current Assets

Current assets are those assets that are involved in the normal routine of the business and can be converted into cash and cash equivalents within a year.

Factors determining the requirement of fixed capital

1. Nature of the business

The type of business that is, the nature of a business helps in deciding the requirement of fixed capital. For example, a manufacturing company needs more fixed capital as compared to a trading company.

2. Scale of operation

The company which is operating at a large scale requires more fixed capital as they need more machinery and other assets whereas small-scale enterprises need less amount of fixed capital.

3. Technique of production

Companies using capital-intensive techniques require more fixed capital whereas companies using labor-intensive techniques require less capital because capital intensive techniques make use of plant and machinery and companies need more fixed capital to buy plant and machinery.

4. Growth prospects

Companies which are expanding and have higher growth plan requires more fixed capital as to expand they need to expand their production capacity for that they need more plant and machinery, so more fixed capital is required.

5. Diversification

Companies that have plans to diversify their activities by including more range of products require more fixed capital.

6. Technology Upgradation

Industries in which technology up-gradation is fast need more amount of fixed capital as when new technology is invented, old machines become obsolete and need replacement.

7. Financing Alternatives

If companies can arrange finance facilities easily. then they require less fixed capital as they can acquire assets on easy installment instead of paying huge amounts at one time.

8. Level of collaboration/ Joint Venture

If companies are preferring collaboration, joint ventures then companies will need less fixed capital as they can share plants and machinery with their collaborations but if companies prefer to operate as an independent unit then there is more requirement of fixed capital.

Thank You!

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