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Capital expenditure budgeting is the process of establishing a financial plan for purchases of long-term business assets. Businesses create separate budgets for the acquisition of current assets and long-term assets. Purchases of current assets only affect a single operating year, while purchases of long-term assets affect multiple years. Keeping the two types separate makes it easier for businesses to analyze tax implications and to report on only those items that have an impact on the current financial situation.
Budgeting is an important part of business management. A budget is a plan for the future that details expected income and expenses. Operationally, budgets are tied to the most important business cycle: the fiscal year. Every fiscal year, a business must report on its operations to pay taxes and to make required disclosures to regulators and investors. Although a business can create a budget to reflect any length of time, it is the fiscal year budget that is its basic tool for operations.
A fiscal year budget concerns only those assets and liabilities that impact the current year. Including items that affect more than one year makes it difficult to assess the financial success or failure of current operations. To maintain the relevancy of the fiscal year budget, long-term assets and liabilities are carried on separate specialty budgets. One of the most important specialty budgets is the capital budget.
Capital expenses are purchases of or investments in long-term assets, such as facilities, equipment, and research and development. The financing of these items occurs over more than one year. Capital expenditure budgeting is the process of maintaining a separate budget for these assets and, often, a separate approval process.
Typically, the process of capital expenditure budgeting includes drafting a master budget for approval by management or the board. This budget can span ten or more years, depending upon the assets involved; it reflects long-term assets that the company owns, is in the process of financing, and expects to purchase in the future. Capital expenditure budgeting often involves large amounts of money and decisions that will have a significant effect on future operations.
The length of time involved and the size of the investment in long-term assets often means that capital expenditure budgeting has two approval phases. A master budget is approved at some point as a general game plan. As it gets closer in time to the point when actual funds will be allocated to make a budgeted purchase, the individual allocation of funds must often be approved again. Sometimes, this can result in the cancellation of an expected capital expenditure. Governments often find themselves in the position of having approved a capital expenditure in a past year and having the decision reversed in a later year when the actual allocation is voted down by a different administration.