Capital Budgeting Techniques
Capital budgeting is a significant part of a project, and the corresponding techniques allow business owners to improve the wealth of investors and stockholders. The primary purpose of capital budgeting techniques (CBT) is to recover the invested capital and further increase the overall profit of all parties involved in the project (Senthilnathan, 2020). All CBT have different functions that can be divided into two major categories: traditional, such as payback period and accounting rate of return, and non-traditional, such as net present value, internal rate of return, and profitability index (Senthilnathan, 2020). For instance, the payback period (PBP) is the amount of time required to recover the investments made in the project, while the accounting rate of return (ARR) is the total profit the project can create over the investments made (Senthilnathan, 2020). Applying these two techniques in combination allows the company and its owners to evaluate the financial efficiency of a specific project.
Furthermore, the techniques mentioned above are helpful for the company as they can give some insight regarding the potential outcomes of a particular project, which is necessary for building the corresponding strategy. For example, a finance manager for a major utility company can apply PBP to collect vital information on the potential risks related to the project and facilitate working capital management throughout its implementation (Senthilnathan, 2020). The opportunity to evaluate the risks is crucial for a major utility company as it operates in broad scope, and the risky elements of the project can deal severe damage to the business if left unattended. Additionally, the manager can apply ARR while deciding to accept or reject a particular project, calculating the necessary data based on the accounting process (Senthilnathan, 2020). The major utility company under discussion can significantly benefit from the use of this CBT as it can help avoid spending resources on non-profitable projects.
Financial Performance Evaluation
Many key performance indicators are used to evaluate the company’s commercial effectiveness and business success at large, including return on assets (ROA) and price-to-earnings (PE) ratio. ROA represents the ratio between net income and total assets, while PE is the ratio between net income and outstanding shares (Khodavandloo et al., 2017). These parameters are associated with the company’s capital structure, which can significantly impact the firm’s general performance (Khodavandloo et al., 2017). Overall, capital structure is the combination of total equity and total debt of the organization, meaning that the key performance indicators mentioned earlier can provide much insight regarding the company’s financial performance (Khodavandloo et al., 2017). However, these metrics do not strictly depend on the company itself as some market conditions can influence them, such as a rapid decrease in the number of outstanding shares caused by severe alterations in the market or an environmental crisis (Khodavandloo et al., 2017). For instance, people may massively sell their stock in case of critical inflation.
In addition, ROA and PE ratios can be used to analyze the financial health of a company. For instance, current data on Apple shows that its PE ratio is around 29, and its ROA is more than 19% (Yahoo Finance, 2021). Although these digits may appear insignificant for such a large enterprise as Apple Incorporated, the key performance indicators under discussion still demonstrate that the company’s business activity is successful and profitable in terms of financial performance.
References
Khodavandloo, M., Zakaria, Z., & Nassir, A. M. (2017). Capital structure and firm performance during global financial crisis. International Journal of Economics and Financial Issues, 7(4), 498-506.
Senthilnathan, S. (2020). Capital budgeting – The tools for project evaluation. Social Science Research Network.
Yahoo Finance. (2021). Apple Inc.