How can a company make smart investment decisions?
“Rule number 1 never loses money; rule number 2 never forget rule number 1”
For your company to gain or even lose money you clearly need to invest first, and investment is the only way to increase your earnings. If you are a person who was not initially comfortable with investment and the terms associated with it this blog is for you. In business language, the idea of investment by a company is called capital budgeting. Capital budgeting refers to making decisions about long term investment of the capital owned by the company, into operations of the company or into new investments. It’s basically a method of investment appraisal.
The whole process tries to determine the long term viability of the investment decisions. The general decisions taken are about investment on purchase of a new plant, property or technology. What all of this tedious process results in is increase of the value of the company, which in turn benefits the shareholders of your company. Every financial advisory company has proprietary capital budgeting software and capital budgeting systems in place to give maximum return on investments.
Capital budgeting is done by financial advisers or analysts and is done using techniques like (INSERT INFO GRAPHICS ABOUT THE BELOW GIVEN TECHNIQUES)
• Payback Period • Discounted Payback Period • Net Present Value • Accounting Rate of Return • Internal Rate of Return • Profitability Index The above given techniques work on comparison made between the cash inflow, which will be the income from the project and outflow, which will be the expenditure made to run/acquire the project.
It measures the rate (time) in which the initial cash flow or the money invested is returned by the project. In easier terms it’s the time period in which you will get your invested money back. And as you would have guessed investors prefer a shorter payback period. It can easily be called the break even time for an investment.
Net Present Value
Abbreviated as NPV is a mathematical process where in we subtract the discounted cash flow from the initial cash flow. A higher Net Present Value is preferred and your investment makes sense only of the NPV is positive.
Accounting Rate Of Return
Abbreviated as ARR is a method of calculating the profitability of the project. Its calculated as projected total net income divided by the initial investment made.
Internal Rate of Return
Abbreviated as IRR is the discount rate at which the net present value of the project taken becomes zero. We advise that a higher IRR should be preferred .
Abbreviated as PI is the ratio of the present value of the future cash flow of a project to initial investment made on the project. It actually is a modification of the net present value. Over the years we have given the best stellar advice in terms of Capital Budgeting and have given a ROI of ______
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