Analysis Of Capital Budgeting Practices In Australia And Canada

Advantages of Budgeting

Budgeting or simply budget is the process of deciding the maximum amount that we plan to spend for a project. Be it a company or household budget is the most common term that is necessary for any project. It is a plan that decides the total sum of money that the company would spend within a given period and the total amount the company can save during the same period. If the company does not have a proper plan of its expenses it will not be able to save any amount from a project, rather it may incur losses due to nonexistence of a well-planned budget. Thus, a budget prevents unnecessary spending by people. Budgeting involves different tools for preparation of budget such as determination of incomes and expenses, establishment of cost constraints and enabling the existing business operation against the determination. For uninterrupted performance of any business a proper plan is most significant without which the organization must face various financial problems (Bromwich & Scapens, 2016). Different types of organizations use different types of budgets such as cash budget, sales budget, capital budget, production budget, marketing budget, revenue budget, performance budget, expenditure budget, project budget, flexibility budget, zero based budget and appropriation budget. Although we will discuss all the above-mentioned budget but we will use only capital budget for the analysis of the journals. Cash budget involves the total cash inflows and outflows for the company during the given period. This budget helps in determining the total cash revenues and expenditure for a period. Sales budget estimates the total sales that the company would be able to make in the given period and thus sets sales targets for the company (Belton, 2017). Capital Budget relates to the cost incurred by the company on long term investments which also includes fixed assets. The NPV of these assets is calculated to know their true value on today’s date. Production budget determines the total units that the company needs to produce to meet the requirements of the sales budget. Marketing budget estimates the total amount of expenditure that the company plans to spend on the promotion and marketing of a product. Revenue budget predicts the expenditure related to the revenues of the government after netting off with the same. Performance budget analyses the performance of the company (Visinescu, et al., 2017). Expenditure budget deals with all the expenses that the company has incurred during the period. Project budget estimates the total cost of a project. Flexibility budget determines the variable cost with the help of variable rate of each activity and the fixed cost associated with the company. Zero based budget is prepared for careful apportionment of cost due to scarcity of resources. Finally, Appropriation budget is prepared for determination of total amount that the management allots for a specific expenditure. Along with these budgets the advantages and disadvantages associated with budgeting is also discussed in this report (Truong, et al., 2008).

Budgeting is very important for any type of organization. It is also very useful for the one using it. The advantages of budgeting are listed as follows:

1. It focuses on achieving the financial objective of the company by reducing those expenses which are not necessary for the business. It is very useful for companies having limited resources as it is directed towards money related objectives(Naci & Hasan, 2012).
2. With the help of budget, the company can estimate the total expenses which prevent lack of funds in the organization. Through this it calculates the total sum to be saved and thus helps in controlling money.
3. By using the budgeting techniques, the company is sure about the areas where money is spent, thus keeping the track of its money. It shows us the total inflows and outflows of the organization which makes it easy for the management to take decisions on planning with respect to raising of debts and investment opportunities.
4. It makes it easy for the organization to estimate the future money requirement through which it decides how much amount should be invested in each area.
5. With budgeting the company divides its total expenditure and savings into different categories which enable them to organize its expenses and savings properly. Thus, making it easier for them to analyses each category based on proportion of savings and expenditure and make any adjustments accordingly(Linden & Freeman, 2017).

Disadvantages of Budgeting

The major disadvantages of budgeting faced by the organization are as follows:

1. Budgeting involves employment of extra manpower for collection and evaluation of data making the process more expensive and time consuming for the organization. So, it increases the cost of the company and workload of the managers as its reliability must be checked when it is complete.
2. It is the responsibility of the management to allocate expenses among various departments which may lead to strife among the departments due to the methods used for this purpose. Many controversies are created between the departments because it is practically impossible for the management to consider the suggestions from each department(Heminway, 2017).
3. It is prepared on assumption basis which raises the possibility of inaccuracy. The budget is prepared based on the current market trends and scenario through which the company estimates its future expenditure and income. The cost of preparing the budget is affected significantly due to changes in economic behavior of the bases on which it is prepared.
4. Some managers believe in spending the entire amount of funds allocated to their department with the fear of reduction in next year’s budget by the unspent amount of the current year. Due to this the managers leads to spend more than they require to spend. Thus, we see that budgeting can cause rifts between the department where they will want their specific budget to be passed and given that the resources are limited it is not possible for the companies to act in this regard(Bennouna, et al., 2010).
5. Budgeting is also based on the concept that there is a lot of cost involved in case of budgeting and timely updating of the same is regard with respect to the company, thus we see that budgeting is a complex process and requires lot of cost and effort on part of the management and thus we see that it is a major disadvantage for the company(Heminway, 2017).

For this assignment two articles on budgeting has been selected that highlights the different aspects that are related to it in some way or the other. Both are the articles have been written by professionals and are scholarly reviewed. The first article that has been selected is, “Cost of Capital Estimation and Capital Budgeting Practice in Australia” by Gang Truong, Graham Partington and Maurice Peat (Truong, et al., 2008); secondly, “Improved Capital Budgeting Decision Making: Evidence from Canada” by Karim Benoni, Geoffrey G. Meredith and Teresa Marchant (Bennouna, et al., 2010).

In the first journal the author has stated the overall importance that is related to capital budgeting and have highlighted the evaluation of the same in case of corporate finance in Australia. The various aspects that have stated in the article are use of real option analysis instead of the discounted value of cash flow technique, the various discount rates that the companies can use, the inputs that the management uses while applying the principles of CAPM. It also analyses the difference between the regulatory practices and the Australian corporate policies that the companies follow (Fay & Negangard, 2017). The authors have also stated the various tables and charts that highlights the estimation of the cost of capital as per the policy of the CAPM. The author has also done various surveys that includes large organization and how are they applying the policies of CAPM when it comes to capital budgeting. It was found that evaluation of the techniques used by the Australian Companies, and it was seen that net present value method was used by 82 companies out of which it was found that 94 percent of the total responses and 13% of the total responses were included by 11 companies (Alexander, 2016). The following research questions that can be stated –

• How the policies with relation to Australian Accounting Standards and other regulatory policies, have improved over the years and how companies are benefiting from the same?
• How many companies are using the policy of NPV and cash flow methods for practical application when it comes to their business?

The second article talks about the policies of capital budgeting with contest to the regulatory policies that are being practiced in Canada when it comes to capital budgeting decision making. The various trends in the process of capital budgeting has also been discussed. There has been a gap of around 50 years in the analysis that has been done by the companies in this contest. The authors have stated that companies are not using the cash flow method for the analysis of their investments and neither they are doing proper utilization of the DCF technique. The overall determination of the cash flow was not proper for the company, moreover the basis for the DCF technique should be cash flow method and not the accounting income method. The companies want that inflation should be recognized as an important factor when it comes to capital budgeting process (Knechel & Salterio, 2016). It is important that while taking such decisions weighted cost of capital should be considered and no single cost should form the basis for the companies. In case of Canada the concept of taking weights for analysis is still not relevant. Many companies must face difficulty when it comes to analysis of the cost based on the divisional distinction between the companies. For effective analysis it is important that risk element should be considered by the companies, also they should highlight any issues they face when comes to practical adoption of the theoretical data. 88 firm were surveyed in Canada and out of that it was found that 17 firms did not use the technique of sensitivity analysis and DCF. The survey had a lot of limitations as it was restricted to only few large firms and not many companies were involved in that so it cannot be said that results are very much reflective of the practices that are carried out in general (Knechel & Salterio, 2016). Most of the managers are still considering IRR as the key element that can help them in decision making which is having its share of disadvantages. The following research questions can be set –

1. What are the ways in which the Canadian firms are adopting the capital budgeting methods and what are the various techniques that they are following and how much it has been effective since the past years?
2. What are the overall improvements that have happened in case of Canadian Regulatory Practices and how companies are applying the same for evaluation of their techniques of capital budgeting?

Purpose of the two articles

Thus, we see that both the research articles are talking about how the regulatory policies have affected the overall methods of capital budgeting and how they can be changed. Few similarities and dissimilarities between the research articles have been stated below:

The following similarities between the 2 studies were observed during the study:

1. DCF technique is the most widely used capital budgeting technique as said under both the journals. This is because the said technique is based on cash flows and not accounting income. The technique is directed towards calculation of present value of estimated future cash flows which helps in determining the real future income as per the present date. Both the authors emphasize on recognizing the above technique and rely on discounting rates as used under weighted average cost of capital method(Choy, 2018). As per both the authors effective capital budgeting starts with proper utilization and adoption of the DCF technique.
2. The main emphasis by both the authors was on the capital budgeting technique and different methods of applying it. They focused mainly on the techniques used under corporate finance such as the CAPM model, DCF technique using both the cash flows and cost of capital as the basis of calculation, the net present value method, the internal rate of return method, the payback period method, dividend imputation technique, the weighted average cost of capital, etc. Both the authors described about the different methods used by the companies for capital budgeting and the advantages and advantages of each of these methods in details. The main aim of both the authors is to bring out the effectiveness of the methods used by the company and how far the company is successful in implementing the same. They also discussed about the challenges faced by the companies while using the above-mentioned techniques and the disadvantages for the company attached with each method they use. Both discussed about the different types of risks that the company bears while using the above techniques and suggested the tools for the measurement and control of each type of risk.

The dissimilarities between both the journals were as follows:

1. Decision making on capital budgeting by the Australian companies is discussed in the first journal in comparison to discussion relating to Canadian capital budgeting technique and its improvements as discussed in the second. In the first journal the author focused only on the decision-making technique using the CAPM model and discussed about the other methods considering the same. Whereas in case of second journal the author focused mainly on the DCF technique using cash flows and the cost of funds as the key parameter(Goldmann, 2016).
2. The first journal emphasizes on estimation of cost of capital whereas the other focuses on improvement in decision making under capital budgeting.

The outcomes derived from the first journal are as follows:

1. For the estimation of cost of capital CAPM model is the most widely used method as the asset pricing model throughout the continent. For discounting rates, the most common weighted average cost of capital method is widely used by most of the companies operating within the national boundaries of the island continent. The most common techniques used by the companies as their risk evaluation technique is the fixed discount rate. Although it was observed from the study that the risk varies with respect to time and the companies agrees to the same. 

2. The companies use many other alternative techniques such as the payback method or the internal rate of return(IRR) method along with the commonly used net present value(NPV) method for project evaluation. Thus, the use of alternative techniques for the same work instead of single capital budgeting technique is very common between the companies of this territory. Another option for the evaluation of the projects that came up as a popular technique is the real options technique. This method is considered as unimportant as mostly the users of this type of technique are substantially minor(Alexander, 2016).

Many points were found in the second journal that needs special attention and required to be discussed accordingly. Following are the outcomes derived from the journal and the learnings from the same:

1. There were many sectors that were ignored and which requires more attention for improvement in the process of decision making on investments. The discounting cash flow (DCF) technique which is the most commonly used techniques also needs much improvement but the same has been restrained.
2. For the investment decision making process the most commonly used technique is the discounting cash flow technique (DCF) which also has the highest recommendations for the said process. This method has become a standard technique due to which the use of non DCF techniques has reduced considerably although it is still adopted by some firms(Bennouna, et al., 2010). 

Conclusion 

Based on the overall analysis capital budgeting is a complex process and it is important that organizations need to have proper knowledge so that they can make better application of that so that they can reap in benefits from them. From the above analysis companies have failed to adopt to the changes that have occurred in the capital budgeting methods and policies and still there are companies that are not able to apply these principles. Out of the surveys conducted only large firms have been using capital budgeting as a technique for their organizations but rest smaller organizations are still left to adopt these for mainstream accounting and disclosure. Hence, we can say that still there needs to be changes made so that such huge benefits that are associated with capital budgeting can be reaped.

References

Alexander, F., 2016. The Changing Face of Accountability. The Journal of Higher Education, 71(4), pp. 411-431.

Belton, P., 2017. Competitive Strategy: Creating and Sustaining Superior Performance. London: Macat International ltd.

Bennouna, K., Meredith, G. & Marchant, T., 2010. Improved capital budgeting decision making: evidence from Canada. Journal of Mnagement Decisions, 48(2), pp. 225-247.

Bromwich, M. & Scapens, R., 2016. Management Accounting Research: 25 years on. Management Accounting Research, Volume 31, pp. 1-9.

Choy, Y. K., 2018. Cost-benefit Analysis, Values, Wellbeing and Ethics: An Indigenous Worldview Analysis. Ecological Economics, p. 145.

Fay, R. & Negangard, E., 2017. Manual journal entry testing : Data analytics and the risk of fraud. Journal of Accounting Education, Volume 38, pp. 37-49.

Goldmann, K., 2016. Financial Liquidity and Profitability Management in Practice of Polish Business. Financial Environment and Business Development, Volume 4, pp. 103-112.

Heminway, J., 2017. Shareholder Wealth Maximization as a Function of Statutes, Decisional Law, and Organic Documents. SSRN, pp. 1-35.

Knechel, W. & Salterio, S., 2016. Auditing:Assurance and Risk. fourth ed. New York: Routledge.

Linden, B. & Freeman, R., 2017. Profit and Other Values: Thick Evaluation in Decision Making. Business Ethics Quarterly, 27(3), pp. 353-379.

Naci, T. & Hasan, O., 2012. The Measurement and Management of Unused Capacity in a Time Driven Activity Based Costing System. Journal of Applied Management Accounting Research, 10(2), pp. 43-55.

Truong, G., Partington, G. & Peat, M., 2008. Cost-of-Capital Estimation and Capital-Budgeting Practice in Australia. Australian Journal of Management, 33(1), pp. 95-121.

Visinescu, L., Jones, M. & Sidorova, A., 2017. Improving Decision Quality: The Role of Business Intelligence. Journal of Computer Information Systems, 57(1), pp. 58-66.