Capital investment decisions and how to implement them
Capital investment is the money used by a company to purchase fixed assets, like machinery, buildings, or land. The money can be in the form of assets, loans, or cash. The aim of capital investment decisions, also called ‘capital budgeting’, is to allot the capital investment funds of the company in the most effective manner and ensure the best possible returns.
Effective capital investment decisions can help grow your business, enable it to be more agile, and maybe even reduce its expenses in the long run. A poor investment decision, on the other hand, can result in wasted time, money, and resources, potentially threatening the cash flow or even the business’s viability.
For these reasons, it’s very important to get off to the right start with capital investment decisions, making sure you have a solid strategy and you follow a decision-making process. The process for capital decision-making and implementation involves several steps:
Image source: Pexels
1. Exploring investment opportunities
When making a capital investment decision, the first step is to identify investment opportunities. For this purpose, the company needs a capital investment committee, whose task is to determine expected future sales, set sales targets, and identify investment opportunities accordingly.
Other points that also need to be taken into consideration before you begin exploring favorable investment opportunities include determining the organization’s strategic plan, keeping an eye on the external environment, as well as discussing the objectives and strategies with the company employees and asking for their suggestions.
2. Gather investment proposals
Once you’ve explored and identified the best investment opportunities, the next step in capital investment is to collect investment proposals.
The investment proposals are checked by different persons in the company before they reach the capital investment committee, in order to confirm if they meet the requirements. Then, the investment is classified based on various categories, including welfare investment, expansion, replacement, etc. This is necessary in order to make the process faster and more comfortable.
3. Making the decision
Making the actual capital investment decision is the third step. In this stage, the executives will make one final review of the available investment opportunities and decide which investment is most necessary.
The final decision will be reached based on several factors, such as opportunities that are created by technological changes, cash flow budget, the outlook of the management, competitor strategies, market forecast, fiscal incentives, etc. This is because the investment to be made should not simply help substitute old equipment with new, but it should also aim at the expansion of operation levels and, as a result, increase the company’s productions and profits.
4. Implementation
Once the previous three steps have been completed, the selected investment proposal is implemented. Implementing the projects can be quite challenging and time-consuming, but there are certain things the management personnel can take in order to make sure it’s done expeditiously and at a reasonable cost:
- Formulate the project properly. Make sure that all the details are taken care of by the assigned employee in advance and that proper analysis has been done in order to avoid any delays in the implementation.
- Rely on the principles of responsibility accounting. Responsibility accounting means that specific responsibilities will be assigned to specific persons in order to ensure that the project is completed in time and remains within the specified expense limits.
- Use network techniques for project planning and control such as PERT (Program evaluation and review technique) and CPM (Critical Path Method) to help you monitor the projects efficiently.
4. Reviewing the Performance
Image source: Pexels
The last step in capital investment is reviewing the performance. Once the operations get stabilized, the management will compare the actual results with the projected results. NPV (net present value) is the best ROI metric to measure a project’s absolute return, while PI (profitability index) is used to measure its relative return.
Final thoughts
Companies make capital investment decisions on a frequent basis, which is why it’s important to determine your organization’s project needs. Making these decisions isn’t easy as there’s a lot at stake with a large capital outlay.
In addition, the long-term impact might be unknown due to the outlay of capital increasing or decreasing over time. The above-listed steps will help you choose the best opportunity for your company and reduce the risks involved in capital investment.
