In modern-day business, capital budgeting is rather crucial for a number of reasons. Various methods of that tool may be helpful for businesses and their managers in making the right decisions. Moreover, certain projects can be followed by various concerning risks. This is why every manager should take them into consideration when making the right decision. The following text will review the necessity of this tool and the use of one of the methods known as the payback method.
Capital budgeting is valuable, for it allows assessing and calculating a project’s value throughout its expectancy. It may help managers rate said value, considering they require a large sum of money (Indeed Editorial Team, 2021). That way, they may approximately predict the ways in which the project may be profitable (if it is). Moreover, it gives them a perspective on whether the expenses in case of a failure will outnumber the financial benefit received from it.
Nowadays, many diverse methods are used to identify the value and importance of a certain project. It would have been perfect if it was possible to receive the same conclusion from each method (Indeed Editorial Team, 2021). Unfortunately, that usually does not occur, as each one of them gives different results. Currently, capital budgeting methods are divided into traditional and discounted cash flow. Within the latter, there is a number of methods that may be used.
One of the methods of the traditional type is the payback period. It is identified as the easiest way to provide finances for a new project. It helps businesses assess the time required for a sufficient amount of cash flows from the said project (Indeed Editorial Team, 2021). The latter is required to cover the expenses that may have followed as a result of the decision. Thus, businesses may decide whether the calculated time is suitable for them or not.
This method advises businesses to choose projects with a shorter payback period. This is explained by the fact that they will be able to cover the expenses from the investment significantly faster (Indeed Editorial Team, 2021). It helps people who not only have a limited sum of money for investing in projects but also need to recover this sum prior to promoting and starting a new project. That way, businesses are less likely to waste money on the one that has a longer financial recovery period.
Reference
Indeed Editorial Team. (2020). Capital budgeting: Definition, importance and different methods. Indeed Career Guide.