Capital Budgeting

Let’s discuss the capital budgeting process from the Corporate Finance section of the CFA exam.

The capital budgeting process is the process of identifying and evaluating projects that bring in cash flow to a firm over a long period of time such as over a year.

The four main steps include:

1. Idea Generation: This comprises of brainstorming of profit generating ideas. It can be carried out by employees, senior management and can also come from outside the organization.

2. Analyzing Project Proposals: A cash flow forecast must be made to analyze all project ideas to further determine which one is the most profitable one for the firm.

3. Create the firm-wide capital budget:Firms must prioritize projects in relation to the timeline of cash flows, resources and the strategic plan. A project idea may make complete sense individually but may not be in line with the strategic plan of the firm which would make the project not a high priority.

4. Monitoring decisions and conducting a post-audit: In this stage the actual results are compared to the forecasted results. This helps in identifying key issues and making better future judgments.

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