Archive for the ‘Financial Budgeting’ Category
A number of factors combine to make capital budgeting decisions perhaps the most important ones financial managers and their staff must make. There are a huge number of variables that must be considered although many can be defined as legible due to their probability of occurrence. However the cost of failure is great with companies facing bankruptcy if their market judgment is vastly incorrect. This report then focuses on evaluating the major risks that effect capital budgeting decisions and how that information can aid the techniques used to analyze fixed asset investments.
First, since the result of capital budgeting decisions have an impact for many years, the firm will lose some of its flexibility. For example, the purchase of an asset with an economic life of ten years locks the firm in for a ten year period. Further because asset expansion is fundamentally related to expect future sales a decision to buy an asset that is expected to last ten years requires a ten year sales forecast. If the firm invests too much in assets, it will incur unnecessarily high depreciation and other expenses. On the other hand, if it does not spend enough on fixed assets, two problems may arise. ‘First, its equipment may not be efficient enough for least-cost production and second, if it has inadequate capacity it may lose a portion of its market share to rival firms, and regaining lost customers will involve heavy selling expenses and price reductions, both of which are costly’. If a firm forecasts its needs for capital assets in advance, it will have an opportunity to purchase and install the assets before they are needed. Unfortunately, many firms do not order capital goods until existing assets are approaching full-capacity usage. If sales grow because of an increase in general market demand, all firms in the industry will tend to order capital goods at about the same time. This results in ‘backlogs, long waiting times for machinery, and an increase in their prices’. The firm which foresees its needs and purchases capital assets during slack periods can avoid these problems. Capital budgeting typically involves substantial expenditures, and before a firm can spend a large amount of money, it must have the funds available – large amounts of money are not available automatically. Therefore, a firm contemplating a major capital expenditure program should plan its financing far enough in advance to be sure funds are available.
A key area concerned with the capital budgeting decisions made by firm’s lies within the capital structure policy as this sets the tone for all future financial decisions.
Incorporating the tax deductibility of interest but not dividends and bankruptcy costs leads to the trade-off theory of capital structure. Some debt is desirable because of the tax shield arising from interest deductibility but the costs of bankruptcy and financial distress limit the amount that should be used. This is because when companies are highly levered the threat of default risks is great. Therefore an optimal range of debt finance needs to be incorporated into capital structure policy.
This is an extremely important concept for companies to consider when undertaking in capital budget decisions as their capital structure will have a large influence in determining which investment options to pursue. For example if the company decides to follow an investment proposal where the discounted payback period is great during the later stages of the project although the initial cash outlays are large. If the company is heavily financed through debt then the risk placed on that project will be high due to the probable default risk occurring if the short term future produces an uncertain event that throws the investment into doubt. A recent example of this case is described below:
The recent crisis in the football industry has demonstrated the importance of keeping a tight control of a company’s finances. As the industry became increasingly profitable throughout the 1990′s many clubs operated under the trade off theory principles. To incorporate increased spending in parallel with exponential transfer and wage increases clubs borrowed excessively to a point where the industry could not sustain itself any longer. This reached a head during May 2002 when the sudden collapse of ITV Digital resulted in the threat of bankruptcy for many smaller clubs. This situation was due to fact that smaller clubs had gambled their future on the excessive amounts of capital they were receiving from ITV Digital. Capital budget decisions had been based around spending for short term gains thus allowing football clubs to neglect their long term survival and as a result over six hundred footballers were made redundant during the summer in order to cut costs.
For example the highly profitable semi-conductor companies of the mid 1990′s like Samsung, did not shift their capital budgeting decisions policy towards higher levels of debt as the trade off theory suggests. This can be explained through the fact that in high-tech growth industries current assets are best described as risky and intangible. Therefore borrowing heavily would appear foolish as in times of crisis the company’s current assets would be rendered worthless resulting in nothing tangible to safeguard against spiraling default payments. This does appear slightly pessimistic considering during times of prosperity one would expect expansion and growth however there are many other risk factors that need to be taken into account when forming capital budgeting decisions.
Sales Stability: Companies with a stable source of income can feel more comfortable about supporting higher levels of debt because they are able to service the debt.
Asset Structure: When fixed assets are at a higher percentage relative to current assets, higher levels of debt can be supported due to the security factor. The lender is aware that if the interest can not be paid, fixed assets can be sold off.
Operating Leverage: The relationship between fixed and variable costs suggests that a high level of operating leverage will result in a high level of fixed costs. Therefore a company that is highly levered in operating leverage should have low levels of financial leverage to prevent the increase of costs.
Management Attitudes: These attitudes change regarding the current financial climate and whether personal styles tend to be more conservative or aggressive.
Lender and Rating Agency Attitudes: The credit rating of a firm has implications regarding the entire capital structure policy of a firm.
It is essential that top management is aware of the information gained from producing the capital budgeting decisions and it is not just limited to the financial management department. Often within companies there is a capping of the capital budget made by top management which can extinguish any investments projects no matter how profitable they might be. Therefore there needs to be a good two way communication process between senior management and financial management to prevent conflict occurring.
One way of achieving this is through SWOT analysis. Before developing strategies to accomplish the firm’s objectives, a manager needs to access the internal strengths and weaknesses of the firm. This evaluation should include the firm’s financial health, physical capital, human resources, production efficiency, and product demand. External threats and opportunities that impact the firm’s ability to accomplish its objectives also need to be considered. An external threat and opportunity analysis might include evaluating the behavior of close competitors or assessing the impacts of the business cycle on clientele incomes and the resulting product demand. The SWOT analysis helps the firm understand the current constraints placed on it by both internal and external forces and enables the firm to take corrective action, when possible to better position itself to accomplish its objectives.
Through implementing SWOT analysis correctly a greater amount of information is available to make informed capital budgeting decisions. The technique can then be implemented with in standard investment appraisal techniques such as NPV, discounted payback period and IRR. By providing SWOT analysis to aid capital budgeting decisions the threat of failure deceases. However reviewing or post-auditing is a final step to review the performance of investment projects after they have been implemented. While projected cash flows are uncertain and one should not expect actual values to agree with predicted values, the analysis should attempt to find systematic biases or errors by individuals, departments, or divisions and attempt to identify reasons for these errors. Another reason to audit project performance is to decide whether to abandon or continue projects that have done poorly. Therefore in order to eliminate poor performance the various risks associated with capital budgeting decisions need to be applied as strictly in the auditing process to aid in the decision making process for future capital budgeting decisions.
You are tired to hear from adults that you must learn, learn and learn. But alas – adults are often right when it comes to teaching, studying and learning and getting some useful skills in the everyday fields.
Some of us have budgeting as our second nature but the rest of us have regular difficulties with budgeting and managing our money. It is very important to know how to conserve money and how to spend it in a proper way. As a child you have to learn how to crawl before you learn how to walk and run.
How to teach you to manage your money? There are several important aspects you should know about financial management.
Ask your parents or teachers to help in constructing a simple budget. You need it to track your income and expenses and to see how much you can save.
If you are dreaming of computer games and clothes, or want to save for your college education, it means you have goals. Determine your short- and long-term goals and find points in your budget where you can tighten your expenses if it is a problem for you to save.
Inflation eats up our money and your today’s savings may be not so serious tomorrow and that is the important reason for investing. Just to have a piggy bank is not the best method of saving and saving accounts are better.
Having significant long-term goals think about ways to increase your income. Even being a child you can earn some money and many teens and especially older teens have full or part-time job.
Usually kids know little about credit cards and they never discuss credit cards responsibility with their parents. Find out everything about cards with the lowest interest rate and how to pay the balance to avoid late fees and interest.
Surf the Internet and find more free information about financial planning for kids.
Budget software reviews save you the time to search, compare, and try to figure out what’s the personal finance software available. With today’s programs you easily learn how to make a budget, reduce your debt and keep track of your personal financial planning. Keeping your finances organized saves you time, improves your financial future and gives you peace of mind.
These are what we consider the best personal budgeting programs:
Mvelopes – is quite different from its competitors. It incorporates an improved envelope system where you divide your income into “envelopes” assigned for particular bills and expenses. Their website is user-friendly and includes many features to match your personal needs. Their personal finance software allows you to enter all of your bank accounts and keeps track of your net worth.
With Mvelopes you can link to thousands of financial institutions making it easier to keep your balances up to date without the need to balance each account. You don’t need to download and install personal finance software, this way you can have access to your personal budgeting from any part of the world. With the money you’ll save each month, Mvelopes will pay for itself in a few weeks. The program includes their famous “Top 10 Tips for Getting out of Debt”.
Note: We found out that Mvelopes is more advanced therefore; it will take you a little longer to learn. Their plan has repeating fees based on 2 year, 1 year, and quarterly subscription plans, but you’ll really learn how to make a budget.
YNAB – is like a basic “envelope” system and provides plenty of features. With this program you only spend money you already earned instead of money you will earn in the future. This is very useful especially if you don’t have a steady income. Their personal finance software comes with 3 worksheets with instructions and explanations.
With this system you’ll know how to make a budget easily in a few minutes. After you install the software, you’ll need to update and review your personal budgeting only a few minutes each week based on their four principles.
Note: You Need A Budget is more user-friendly than Mvelopes, however it’s not compatible with Apple (yet). With your purchase you’ll get FREE: 5 spreadsheet bonuses, training support and the “The YNAB Way eBook”. YNAB doesn’t do an automatic upload of your financial transactions and category assignment, and has no bill pay functionality. On the other hand it has a one-time only payment.
Quicken Deluxe – here you’ll find a solid personal finance software whether you’re a novice or an experienced user of budget planner software. Manage your investments, savings, and classify your expenses efficiently. If you’re part of a starting family and are trying to save money for a new home, college fund, or other costly items, Quicken Deluxe is perfect for you.
“My Savings Plan” is a new upgrade very useful if you have problems setting money aside each month. Their new Bill Minder Gadget (Windows Vista) is a Desktop window to remind you of any overdue bills, and other money transactions. Their system links to more than 5,300 financial institutions, including PayPal.
Note: Quicken Deluxe does not offer import/ export for data of investment accounts, and it’s also a more complicated tool than YNAB. However, Quicken Deluxe is a better personal finance software for tracking your net worth and investments.
Budgeting and accounting are both very boring subjects when it comes to exercising them in real life to plan your finances. But budgeting and accounting for the domestic consumption is directly related to achieving your financial goals.
Tabulating and charting your monthly and annual expenses in each and every category helps to control your expenses. This also reduces the probability of allocating too many dollars to those products and services that are not really important.
If you want to become financially free and wealthy then you must budget your expenses like governments and business all around the world. You must keep track of each and every dollar you earn.
If you can manage to reduce unnecessary expenses then you can divert that money towards buying some appreciating assets (Stocks, bonds, gold, mutual funds, real estate, online properties, etc) which appreciate in its price over time and make you rich and financially free.
Budgeting and accounting are the subjects that are not taught well in our schools and colleges. And that’s why most of the people struggle financially. Both of these skills are important skills to achieve your financial goals.
People who are wealthy today are typically doing both of these exercises for their Business and home every month, for years and till this day to maintain their wealthy state. And they teach their children these 2 basic subjects of money management as well. You should begin to practice these habits early; it does get easier each time because you’ll begin to notice your expenses.
And that’s why their children are more financially independent than the children of high income but low net worth group of people (Upper Middle Class).
What are your Financial Goals?
If you ask a typical upper middle class person (I am talking about High Income, low net worth group of people) about their financial goals, most of the people will tell you the following.
- Minimize the Tax burden by taking large mortgage loans
This is the prime financial goal of people living in USA and worldwide. They think that taking larger mortgage loans is a smart idea. Because it will reduce your tax liabilities and thus, you will save on the tax.
One of my friends has recently taken a large mortgage loan to save on taxes. But according to me, if he would just budget his household’s monthly finances then he will easily save more money rather than saving on taxes every year.
Most of the people focus on larger things. But they don’t focus on the smaller expenses. If you deduct few of your small expenses every year then you will save much more money than your interest payment on your home mortgage (Only Interest payments on mortgage loans are Tax free).
What I advise people do every month, is to sit down with your spouse or family and write down each and every category’s expenses on a paper. Make category for each and every expense and write down expected spending in front of each category and compare that with actual expenses.
I know that this is very boring. And I personally find this exercise very boring myself. I suggest you find some alternative methods of budgeting your expenses like “Pay Yourself First” method or “Budgeting on Excel spread sheet or *UPDATE* – Quicken
But in any case, budget your finances.
How Much Money Do You Spend?
Do You know How Much you and your family spend each year on Food, Clothing and Housing?
Most of the people in this world will answer this question with a -”No”. But most of the millionaires and wealthy people will answer the above question with a – “Yes”. Remember that I am not talking about Mortgage payments or car loan payments you make every month.
Most High income and low net worth (Upper Middle Class) people will say that they remember each and every important transaction that they make every month, so why worry about small expenses such as food, clothes, and mobile bills?
And these people will also argue that “I am saving on taxes by taking higher mortgage loan so I don’t need to budget because after all I am saving on taxes at the end of the year.”
Well, these are just excuses. Did you know that according to the survey on Millionaire households in USA, almost two-thirds of households know exactly where each dollar that they earn goes every month?
I want to stress the importance of budgeting. It is a very important exercise. Most of the people really don’t know what they really spend their money on every month.
This is very bad in the long run. If you want to be rich, financially free, and wealthy, then you have to plan your every expense. You should take note where that dollar of yours goes every time.
Budgeting: The Long term benefits
Long term Benefits of Budgeting
When it comes to budgeting, all the financial planners and advisors will tell you How important budgeting is and why everyone should do it. Now, all of us know that budgeting is a very important financial exercise but how many of us seriously do budget?
Not even 1% of people get involved with budgeting. In fact, let me tell you my own example. I myself, run a personal finance blog and advising people to budget their own finances. But Honestly speaking, I personally hate this exercise. Because it’s so boring and nothing is glamorous in it.
So What I do is, I create the environment of economic scarcity for me. I use “Pay Yourself First” Formula. It means that every month I invest 10-15% of my Income for long term investing. And I live with the rest of the money.
I advise you to find some less boring ways to budget your finance like “Pay Yourself First”. Spread sheets, Quicken, or something else. Because there are long term advantages of budgeting and it’s much easier to budget if you visualize the long-term benefits of this work.
There are long term benefits of Budgeting. So You have to find alternate ways to budget your finances if you find it boring. If you have other methods to budget finances, then please share them with the readers.
Have you realized your fiscal targets up to this point? Do you even understand what your financial objectives are? A significant aspect of effective financial planning actually starts with where you are first. Think about it, if you wanted to get to Las Vegas and you wanted to make use of MapQuest what’s the initial thing you’ll need to input? That’s right, you’d need to enter where you currently are. Plenty of people stumble at this point in life. They start out at the finish line. It looks so easy, but becoming successful financially will start with understanding your financial goals.
And listed below are 3 quick tips on budgeting to help establish your financial goals:
Why did I purchase this? If you find yourself reading through yet another financial book or looking through a video tutorial series, stop and ask yourself the reason you ordered the program in the first place. Do you need to raise your earnings? Do you have specific debts you would like to clean up? Do you only wish to be able to build an emergency account? The answer to this could come as a surprise to you. Determine your goals. What did you dream about? When you were a young child what did you dream about? Kids have the skills to dream with out thinking themselves out of it. Someplace along the road we, as adults listen closely to our inner voice more than our dreams. Go back to being a kid. Discover some of the best desires you had as a child and see if you are able to fit a financial goal around this dream. What do you want? It sounds so simple but determining what you want first is a big element to obtaining it. People say that if you ask a question enough to your subconscious you are going to at some point get a solution. So ask it. “What do I want?” Then listen for the answer. It appears so easy but you could be amazed by what comes about. This might get you started on sticking with tips on budgeting.
If you intend to become successful financially then defining your goals to begin with is essential. Don’t be like a lot of people and start off at the end. You need to first work out what it is that you need. Only then will you be able to claim that you have laid a stable foundation for success with finances. For more info on tips on budgeting read more of our posts.
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Good financial practice means that household budgeting should be something you already have under control. You should know exactly where your household money comes from, where it goes, and that all of your financial priorities and goals are being met. The question is however, when did you create the budget that you’re currently living within?
Although you might think that your finances are working at the best they can, if you haven’t taken a look at your household budgeting for the past year, the chances are that your budget could use a spring clean. Interest rates go up and down. Income usually changes over the course of a year whether because of salary increases, or income tax changes. Supermarket prices certainly fluctuate making your housekeeping bills higher now than they were when you set your budget in place. So unless your budget was made in the last six months, it’s probably time to dust it off and take another look at it.
Use the same format as you did for the original budget. Take a look at the figures that are current in respect of outstanding balances, interest rates, minimum payments, etc and make any necessary changes. Once you have your new total expenditure, check your income to see if this has changed. Your housekeeping money is probably higher now than it was originally so if you haven’t any additional money coming in, you may need to look at where your housekeeping money is going and consider making cuts or changes to what you buy – paying closer attention to special offers and bulk buying can help you make additional savings if you need to stretch your income a little bit further.
Spring cleaning your household budgeting isn’t just about ensuring that your finances are up-to-date however. If you are on a tight budget it’s also a great way to motivate yourself into sticking within the financial boundaries you’ve set. Seeing the outstanding balances on your debts decrease is a surefire way of re-igniting your passion for your budget!
So don’t let your budget stagnate. Make sure you schedule a time at least once a year for a financial spring clean just to make sure that your finances are working for you, and that your household budgeting plan is on track for a good financial future.