Investment Decisions
The investment decision relates to the decision made by the investors or the top level management with respect to the amount of funds to be deployed in the investment opportunities. In simple sense, selecting the type of assets in which the funds will be invested by the firm is termed as the investment decision.
Investment decision can be long term or short term decision. Long term investment decision is concerned with commitment of funds for long period and the benefits of which are expected to be realised over a period of time. The long term investment decisions are otherwise called capital budgeting.
Significance/Importance of Investment Decisions (Capital Budgeting)
In a business organisation long term investment decisions are inevitable for maximising the value and wealth of the shareholders. An unsound investment decision may cause several bitter experiences to the business organisations. Hence, long term investment decisions are to be taken with care and concern. The need, importance and significance of capital budgeting arise mainly because of the following reasons.
1. Large investment of funds: Long-term investment decisions involve huge investment. Since the demand for funds far exceeds the availability, the firm should make a judicious plan of investment.
2. Long-term commitment of funds: Capital expenditure is more or less permanent in nature and the element of risk involved is comparatively greater. Therefore, there should be careful planning for capital expenditure.
3. Irreversible in nature: Capital expenditure decisions are irreversible in nature, Once the decisions are taken for the acquisition of long term assets, it become very difficult to dispose of such assets without incurring huge loss.
4. Long-term effect on profitability: Capital budgeting decisions have long term and significant effect on profitability of a concern. Apart from its impact on present earnings, long-term investment decisions affect the future growth and profitability of the enterprise. Capital budgeting is essential one to avoid over-investment as well as under-investment, both of which are extremely risky..
5. Risk of obsolescence: There is risk of fixed assets becoming obsolete before the expiry of normal life of the asset. There is also the possibility of the products manufactured with the help of such assets going out of fashion. Hence, capital budgeting is inevitable one for avoiding such a state of affair.
6. Difficulties of investment decisions: The long term investment decisions are very difficult to take as these decisions extend to a number of years, and have higher degree of risk.
7. National importance: The investment decisions taken by individual firms will have their impact on the level of employment and economic growth of the nation.
Capital Budgeting
Meaning and Definition
Capital budgeting is the process of making decisions to invest the available funds most efficiently in long term activities against an anticipated flow of future benefits over a number of years. It is an expenditure incurred in a particular period, the benefit from which is expected to be realised over a period of time, normally exceeding one year. It includes raising of long term funds as well as their utilisation in long term assets. It is also known as investment decision making or investment appraisal. Capital budgeting is nothing but planning for capital assets.
According to Charles T. Horngren Capital budgeting is "long-term planning for making and financing proposed capital outlay".