Every enterprise, however big or small, has to incur huge expenditure for the establishment of the production unit.
Such expenditure is necessary for the installation of plant and equipment and purchase of other fixed assets in order to commence the production.
This expenditure is known as ‘capital expenditure’ and may be incurred before or after the commercial production is begun.
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ADVERTISEMENTS:
The amount of capital expenditure to be incurred may vary from company to company depending upon its nature of work.
Decisions regarding investments in fixed assets (capital expenditure) should be taken judiciously so as to get the desired results at the minimum cost and to avoid the unnecessary blockade of capital which may have far-reaching effects on the economy of the enterprise.
A capital asset, once acquired, cannot be disposed off without any substantial loss. It, therefore, requires a long-term planning and designing a systematic investment programme.
ADVERTISEMENTS:
There may be a number of problems before the management while taking decision for investment of funds in one of several proposals before it at the time of expansion, replacement of old plant and equipment, choice of equipment and making buy or lease decisions.
The management is always interested in selecting a proposal which allocates the resources in the most efficient manner.
Thus, in order to design and carry out a systematic investment programme, capital budgeting is required.
The capital budget is, thus an estimate of cost of each project along with the justification for its approval and disapproval and thus selecting out what the management thinks out to be a worthwhile project of several alternatives available. It considers several factors before finalizing the worthiness of the project.