How to Prepare a Capital Budget

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Preparing a budget is crucial to any business or organization.
Preparing a budget is crucial to any business or organization. (Image: Deklofenak/iStock/Getty Images)

Creating and implementing a budget is crucial to any business or organization for many reasons. Preparing a capital budget is necessary in order to increase profits and minimize costs. Most businesses and organizations typically plan a budget for a 12-month period, which allows management to take a look at the bigger picture. A capital budget differs from a short-term budget in that it takes a look at long-term investments, examining the purchase or upgrade of fixed assets such as buildings, machinery and equipment.

Identify financial objectives, clearly defining the organization's capital development goals. Include the time frame for achieving those objectives. Prioritize needs, and then determine how financing those needs will affect the budget. Before drafting a final budget, managers should consider what actions can be taken to improve performance in certain areas, particularly when the unexpected happens.

Solicit support for specific funding priorities. Take into consideration that there will not be enough money to fund every capital project on your organization's wish list. Work with other members on the Finance Committee in establishing evaluation criteria for assigning priorities. For example, need might be measured by the current condition or uses of physical assets such as buildings and equipment. On the other hand, consideration of certain projects might be based on health and safety factors, or overall benefit to the community.

Collect the data necessary to estimate funding for capital expenditure needs. Analyze financial statements including the income statement, balance sheet, and statement of cash flow to get a better idea of the organization's long-term financial health. Financing a capital expenditure means paying additional money in interest. While it is not usually a wise decision for an organization to finance all of its debt, paying cash can affect cash flow by significantly reducing operating capital.

Consider the feasibility of any capital expenditures such as new construction, major renovations or new equipment first by looking at how long it will take to recover the cost of any major investments. Examine other alternatives, and consider whether the costs of the project are justified, or if there are ways to cut those costs. Finally, determine whether investing in a specific capital project will increase the value of the organization as a whole. Keep in mind that you may have to defend budget decisions to others in the organizational hierarchy.

Draft a proposed budget that allocates resources by assessing the outcomes of previous projects in any long-term planning efforts. Since most capital projects take years to develop, year-to-year comparisons are often used to evaluate performance. The decision to invest in new projects or assets depends on not only the long-term cost to finance the project, but also relies on the cash flow a project is expected to generate over the coming years. The budget should outline in detail how individual capital expenses will be financed. A solid spending plan needs to show how money will be appropriated for any improvements, which are recommended.

Measure progress by overseeing operations on a regular basis throughout the fiscal year. Capital project planning is as much about measuring outcomes as it is about evaluating and selecting capital projects. Projects must be completed within the time frame, and according to the steps outlined in the budget.

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