Accounting for Planning and Control Essay

Submitted By ruihappy190054
Words: 912
Pages: 4

Name: Ruixuan Cao
Professor’s name: Dr. Wright
Course: AF 211
Accounting for Planning and Control Managers in making investment decisions are faced with the problem of limited resources. This, therefore, necessitates an understanding of the topic of capital budgeting. Capital budgeting is the process of determining and pursuing investments which cash flows are expected in the future period usually more than a year. It entails the decision on the acquisition of new assets or equipment that is to be utilized by the business to increase its future cash flows and profitability. Managers are, therefore, faced with the challenge of determining which project to invest in order to avert the adverse effect on the financial performance. In making investment decisions, various factors must be considered. Managers have to know that the success of the business entirely depends on how best the investments are analyzed before they are undertaken. First, capital budgeting requires large capital outlay (Dugdale 16). Most of the capital budgeting decisions require a large proportion of business funds. It, thus, implies that failure to make proper investment decisions will lead to losses for the organization. Secondly, investment decisions are irreversible. After deciding on what projects to invest in, managers will lack the ability to reverse their decisions, i.e., equipment once acquired cannot be easily disposed of. The managers must therefore be careful before settling on a particular investment projects because of this nature. Moreover, in analyzing investment, the future cash flows are of importance. The cash flows likely to arise to the organization after determining which projects to invest will be realized in the future. The cash flows cannot be determined with certainty and therefore depend on forecasts and future changes in conditions (Szpiro 53). Managers will use their skills in forecasting future cash flows and in evaluating the worth of the investments. Capital budgeting needs long time decisions and commitments. Various models are used in evaluating the investments to pursue by the organization. These can be largely categorized into two: non-discounted methods and discounted methods of capital budgeting. The non-discounted method include payback period in which the period required to recoup the capital invested is used. Projects with a short payback period are preferred. The return on investment is the second non-discounted method of project evaluation. In this method, projects with the highest returns are chosen for investment purposes. This method is pegged on the historical accounting estimates. The discounted models of investments analysis have gained popularity and preference. This model considers the time value of money in deciding on what projects to pursue. It therefore takes into account inflation effect and considers all the cash flows (Szpiro 55). The methods include net present value, internal rate of return, profitability index, and discounted cash flows. For NPV, the project with the highest NPV should be pursued since it maximizes shareholders wealth (Heilbroner and Bernstein 23). Managers, by using IRR model, select projects with the highest rate of return. The discounted methods provide a basis for ranking the projects making them be preferred by managers in allocating the scarce business resources. Discounted methods of evaluating projects are also useful because they provide a clear forecast of all future cash flows and therefore consider wealth maximization goal. Capital budgeting impacts both the business and society. For the business, capital budgeting determines the going concern and the performance of the business. A business that fails to identify which projects are worth investing in will incur colossal losses that might interfere with the going concern of the business. Secondly, shareholders depend on the…