A consultant commented that too often the numbers look good

A consultant commented that \"too often the numbers look good but feel bad.\" This comment often stems from estimation error common to capital budgeting proposals that relate to future cash flows. There are several reasons management and consultants may feel this way. Research & discuss some of those reasons (findings), and provide an example to support your post.

Solution

Capital budgeting revolves around capital expenditures which include large inflow and outflow of money to finance investment projects. It is a process by which a company decides whether it should invest in a project or not. We have tried to explains advantages and disadvantages of capital budgeting.

Capital budgeting is largely used for long term investment opportunities whose tenure is more than a year and fetches returns over several subsequent years. These investment opportunities could be for new plant & machinery, factory facility, construction of a building etc. The decision regarding capital expenditures have far reaching effects on the success or failure of the enterprise. Once acquired, capital assets cannot be disposed off except at a substantial loss. The capital budgeting decisions pertain to fixed assets or long term assets and yield a return, over a period of time, usually exceeding one year.

Drawbacks of capital budgeting are as follows:

1 All the techniques of capital budgeting presume that various investment proposals under consideration are naturally exclusive which may not practically be true in some particular circumstances.

2. The technique of capital budgeting requires estimation of future cash flows and outflows. The future is always uncertain and the data collected for future may not be exact. Obviously, the results based upon wrong data can be good.

3. There are certain factors like morale of the employees, good-will of the firm etc.’ which cannot be correctly quantified but which otherwise substantially influence the capital decision.

5. A wrong capital budgeting decision taken can affect the long term durability of the company and hence it needs to be done judiciously by professionals who understands the project well.

4. Urgency is another limitation in the evaluation of capital investment decisions.

5. Uncertainty and risk pose the biggest limitations to the techniques of capital budgeting.