Last updated on Jan 26, 2024
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- Capital Budgeting
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Define your strategic goals and vision
3
Evaluate and rank projects
4
Select and allocate capital
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5
Implement and monitor projects
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6
Evaluate and adjust projects
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Here’s what else to consider
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Capital budgeting is the process of evaluating and selecting long-term investments that align with the strategic goals and vision of your organization. It involves estimating the expected cash flows, risks, and returns of various projects and choosing the ones that maximize the value of your firm. However, capital budgeting is not a one-time exercise. It requires constant monitoring, evaluation, and adjustment to ensure that your capital allocation decisions are consistent with your changing environment, objectives, and opportunities. In this article, you will learn how to align your capital budgeting decisions with the strategic goals and vision of your organization in six steps.
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- Amal S. 3
- Akira Mizoguchi, CPA Fractional CFO | Corporate Development | eCommerce | Infrastructure | Rotman MBA '24 1
1 Define your strategic goals and vision
The first step is to clearly define your strategic goals and vision for your organization. What are your core values, mission, and purpose? What are your long-term aspirations and competitive advantages? What are the key performance indicators (KPIs) that measure your success and progress? Having a clear and shared understanding of your strategic goals and vision will help you identify and prioritize the projects that support them.
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- Amal S.
Capital budgeting should be viewed from multiple perspective, no just return on investment, cash flow, etc. It can also be looked at from Risk perspective, in whatever categories established and classified by the organization, i.e, safety, security, cost reduction, hazard, lost of assets, resource retention, prevailing rules and regulations - invest in projects which are necessary to keep the organization in operations and avoid law suits.
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2 Identify potential projects
The next step is to identify potential projects that can help you achieve your strategic goals and vision. You can use various sources of information, such as market research, customer feedback, industry trends, internal analysis, and innovation initiatives, to generate ideas and opportunities. You can also solicit suggestions from your employees, stakeholders, and partners. You should aim to create a diverse and comprehensive list of projects that cover different aspects of your business, such as growth, efficiency, quality, sustainability, and differentiation.
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- Ravi Agarwal Professor of Finance and Accounting. Editorial Advisor - Emerging Market Case Studies Journal
The hardest part in life of a corporate manager is to find and choose beneficial projects. This even becomes more difficult when they have to do it consistently.In a competitive market, it is impossible to remain at the top position just because of some advantageous projects all the time. That too, such projects are to be in line with your strategic goals.A firm can remain at an advantageous position for some of the time because it would be threatened by the competition and me-too players. Therefore, the task of getting profitable projects is very difficult in real life.That is the reason firms in real life adopt a comprehensive 'articles of association' so that they don't hesitate to grab an unrelated project but profitable project.
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3 Evaluate and rank projects
The third step is to evaluate and rank the projects based on their expected cash flows, risks, and returns. You can use various capital budgeting techniques, such as net present value (NPV), internal rate of return (IRR), payback period, profitability index, and sensitivity analysis, to estimate the value and feasibility of each project. You should also consider the qualitative factors, such as strategic fit, competitive impact, social responsibility, and stakeholder interests, that may affect your decision. You should rank the projects according to their value creation potential and alignment with your strategic goals and vision.
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- Akira Mizoguchi, CPA Fractional CFO | Corporate Development | eCommerce | Infrastructure | Rotman MBA '24
Strategy is about differentiating your company from competitors. Differentiation is based on activities that generate competitive advantages. When reviewing a financial model for capital budgeting, assumptions such as sales prices or margins should be assessed to determine if your company's activities and competitive advantages are reflected in them. This allows you to check a project's strategic fit with your company
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4 Select and allocate capital
The fourth step is to select and allocate capital to the projects that rank the highest. You should consider your available budget, financing options, and opportunity cost when making your capital allocation decisions. You should also balance your portfolio of projects to ensure that you have a mix of short-term and long-term, low-risk and high-risk, and core and non-core projects. You should allocate capital to the projects that offer the highest return on investment (ROI) and support your strategic goals and vision.
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5 Implement and monitor projects
The fifth step is to implement and monitor the projects that you have selected and allocated capital to. You should assign clear roles and responsibilities, set realistic timelines and milestones, and establish effective communication and coordination mechanisms. You should also track the performance and progress of each project using the KPIs that you have defined. You should compare the actual results with the expected results and identify any deviations or issues that may arise.
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6 Evaluate and adjust projects
The sixth step is to evaluate and adjust the projects based on the feedback and outcomes that you have obtained from the previous step. You should assess the success and failure of each project and determine the causes and implications. You should also review your capital budgeting process and identify any areas for improvement or learning. You should make any necessary changes or corrections to your projects or capital allocation decisions to ensure that they are aligned with your strategic goals and vision.
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7 Here’s what else to consider
This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?
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