Last updated on April 2nd, 2024 at 07:35 am
A chief financial officer (CFO) is one of the highest-ranking finance practitioners in a company. Any business stands upon its financial plans and strategies, which in turn fall on the shoulders of a CFO. In addition to being the financial supervisor, they actively advise the CEO and other directorial board members on business functioning and strategies.
Steering the wheels of financial leadership in any business, a Chief Financial Officer takes care of the financial health of a business. Their responsibilities are expansive, including but not limited to cash flow management, merger or acquisition planning, capital analysis and capital budgeting.
In this article, we will understand the role of the CFO in the capital budgeting of a business.
Assessing, planning and deciding: What is capital budgeting?
Simply put, capital budgeting involves identifying and evaluating different potential investments and choosing the ones with the highest returns. A project is assessed based on the cash outflow it demands and the cash inflow it generates.
In general, a business invests in projects with a profit scope. However, when there is a limitation in the budget, it has to assess different ventures and choose the one which scores highest on return benefits.
An example of a decision based on capital budgeting would be to invest in guest posting on high DA websites to reach the company's SEO goals instead of hiring an in-house marketing team.
To explain this in lay terms, let us consider another example. Your laptop has stopped working. Given your budget, you can buy or rent a new laptop or repair the old laptop.
You realise that your laptop is just one year old and repairing it will give you the best ROI on the investment you already made on your old laptop. So, the best option would be to repair your old laptop instead of the other options that negate the ROI of your old laptop.
To invest or not to invest, that is the question: Significance of capital budgeting
A bad investment is as bad as running into debt, if not worse. Prudent investment decisions are necessary for a company to stay on top of its profit-making game. To make sure every investment is worth it, capital budgeting is indispensable. Here are some of the functional significances of capital budgeting:
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Profit above all
As discussed earlier, the primary purpose of capital budgeting is selecting the most profitable projects amongst a pool of potential investments.
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Capital outflow management
Capital budgeting puts a rein on investments by planning the outflow required and the period for which it will be necessary. Many projects might need investments over a shorter tenure, which may be selected over long-term expenditure projects.
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Evaluating fund sources
The funding for a project is often outsourced. Evaluating the right source of financing that is most appropriate and profitable for the business is a part of the capital budgeting process.
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Preventing debts
When the funds are outsourced, a wrong investment that cannot gain minimum revenue to cover the investment amount might drag a business into debt. Every investment is irreversible, and thus, analysing it minutely before giving the green light to it is crucial to prevent any potential debts.
Judgements and decisions: Role of CFO in capital budgeting
Shouldering all financial responsibilities, a CFO supervises the entire capital budgeting process involving a series of decision-making situations. It has many functions beyond the simple selection of projects because each project has a holistic impact on a business. Therefore, a CFO supervises the process and makes big decisions.
- Setting the investment budget and profit benchmark: A CFO has the final say in forecasting the capital required for an initial and overall investment in a project. This ensures that the entire amount is sourced and ready and a workable target is selected for the income profit from that particular project.
- Increasing company ranking: A CFO churns out the highest profit possible and this gain helps the company go up the ladder of corporate competition.
- Supervising each step: There are five main steps in the capital budgeting process - identifying projects, assessing their profitability potential, finalising the project and its budget, setting a target return and reviewing the financial performance. A CFO takes care of everything involved in each of these steps.
As a financial supervisor, a good CFO excels at financial leadership and ensures the smooth functioning of all financial operations and the fulfilment of targets.
Conclusion
Capital budgeting is a prominent part of finance and budget management. With careful consideration of the right investment opportunities, the finance of a business will stay intact.
As a strategic financial counsellor, a CFO has to be on top of the economic functioning of the company. Sound financial decisions made by a CFO builds a company’s success story.
If you are trying to get a grounding in all the skills that a prudent CFO needs to run the financial management of a business, then check out Imarticus’ Postgraduate Certificate Programme for Emerging CFOs. The 12-month course incorporates live online classes and campus immersion to train emerging CFOs with the required professional skill set to ace their job profile requirements.
