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You are the chief financial officer for an organization and need to discuss with fellow C-suite executives that cost cutting is not the only answer to profitability. Prepare for the next manager's meeting by responding to the following prompts:
Question 1: Explain how a capital budget and a return on investment contribute to sustainable growth.
Answer
Capital budgeting is a critical procedure that is undertaken by organisations to ensure that a potential project is judged on the basis of its merits through potential inflows and outflows over the life of the project. It plays a significant role in helping organisations undertake financially and economically sound business decisions. Hence, it can be concluded that capital budgeting adds to the economic value of the organisation through its ability to pick up viable projects from various alternatives available. It ensures that the business remains useful, developed, competitive and sustainable towards the environment as well. It increases the working productivity through the accruing benefits associated with the potential project. Capital budgeting is hence an extensive process that ensures better examination of long term promises for the organisation.
Return on investment is the net profit left after all the payments are made in due course. Investors of an organisation are interested about the future cash flows of its organisation through its business operations. Hence, return on investment is an effective accounting tool that optimises decision making process for any financial entity. Their longevity is determined by the long-term sustainability of the cash flows. Hence it can be said that return on investment significantly contributes to sustainable growth of the organisation. They are directly related to each other and move in the same direction. If the return on investment increases, it is likely that sustainability shall augment too.
Thus, capital budget and return on investment can play a critical role in assessing the economic potential of the organisation and the national economy at large. They are the key drivers that can make an organisation grow high on development and sustainable grounds. For instance, healthcare organisations need several equipments for taking care of their patients on a daily basis. These costs are to be compared.
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Question 2: Clarify the role that risk analysis plays during capital investment decision making.
Answer
Knowing how critical capital budgeting procedure is to the success of the organisation, it becomes imperative for all organisations to undertake an effective risk measuring analysis to ensure that the potential threats and vulnerabilities are known to the organisation well in advance for them to mitigate these risks and hence avoid further disruption. Capital investment require huge amount of liquid funds.
Hence, it is essential for the organisation to know what are the risks associated with the capital investment before they plan to undertake the proposal. It becomes a significant pre-requisite for ensuring better financial stability to the organisation. Having a complete knowledge of the associated risks, an organisation is in a better position to determine its long term worth and the potential proposal.
Though there exist an inseparable relationship between risks and rewards, a well planned action towards assessment of potential risks can increase the ability of the organisation to either prevent it completely or detect and correct the business situation as quickly as possible. This speeds up the recovery time. Hence, it can be concluded that an efficient risk examination process is useful while undergoing any capital investment decision.
It allows the organisation to exploit new opportunities for its long term growth and financial feasibility. Not only does this process help in validating the long-term perspective of the projects, it also helps in making the organisation cope up with the several uncertainties cropping up in the market. It provides a deep insight through the expert's eye in safeguarding the financial entity against the risky aspects of the project.
There are several tools and methods like calculation of net present value and profitability index that can help an organisation succeed in making a correct choice for long term investment of their funds.
There are several risks that facilitate any project towards its failure, but a proper risk analysis not only creates awareness the organisation of its potential existence but also allows them to undertake necessary security actions for the same. Hence, it can be easily said that a risk analysis process is a combination of exploiting new opportunities, making capital investments and gaining there from.
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