Capital budgeting is a process used by companies for evaluating and ranking potential expenditures or investments that are significant in amount. The large expenditures could include the purchase of new equipment, rebuilding existing equipment, purchasing delivery vehicles, constructing additions to buildings, etc. The large amounts spent for these types of projects are known as capital expenditures.
Capital budgeting usually involves the calculation of each project's future accounting profit by period, the cash flow by period, the present value of the cash flows after considering the time value of money, the number of years it takes for a project's cash flow to pay back the initial cash investment, an assessment of risk, and other factors.
Capital budgeting is a tool for maximizing a company's future profits since most companies are able to manage only a limited number of large projects at any one time.
