CAPITAL BUDGETING

Capital Budgeting and Investment Decision Making



Capital Budgeting and Investment Decision Making

Introduction

Agricultural co-operatives, like all agribusinesses, operate in an increasingly competitive and sometimes hostile economic environment. Co-operatives must continuously invest in resources to serve their members more effectively if they hope to survive and grow. Their efforts should focus on obtaining lower cost inputs used in agricultural production and/or more effectively and efficiently marketing their members' agricultural outputs. Unfortunately, agricultural co-operatives, and agribusinesses in general, have sometimes been less than willing to adopt more sophisticated management practices of manufacturing and financial sector corporations.

One management practice which has been widely adopted by corporations is capital budgeting. Capital budgeting is the rational allocation of financial resources among competing multi-period projects. Brigham suggests that capital budgeting is the process of analysing “planned expenditures on fixed assets”. Schwarz suggests that capital budgeting is an integral component of the organization's “strategy/plans/budgets” process.

Capital budgeting has been widely utilized as a management and strategic planning tool by corporations. Chandra suggests that the budgeting process often has many behavioural outcomes in the organizational planning process, such as enhanced goal congruence and more universal participation. Currently, a majority of major corporations make use of some type of capital budgeting technique in their strategic planning process.

Agricultural co-operatives are created and managed for the benefit of their members. Co-operatives, like other not-for-profit oriented organizations, have traditionally made limited use of capital budgeting techniques when making long-term commitment of resources to various projects or facilities. Co-operatives may not have adopted capital budgeting for a variety of reasons:

* lack of financial sophistication by co-operative management;

* difficulty in determining the economic objective functions of a co-operative; and

* difficulty in estimating an appropriate cost of capital to the co-operative.

Paige, in a study of the management accounting practices of not-for-profit organizations, found that the “area reflecting the greatest deficiency was the use of capital budgeting techniques”. Unfortunately, there is a distinct paucity of research on the adoption of capital budgeting practices by agricultural co-operatives.

The adoption of capital budgeting models tends to be crucial for the success of both traditional and not-for-profit organizations in today's dynamic and outcome-oriented environment. Researchers in not-for-profit management suggest that sponsors, donors, members, regulators and other stakeholders of non-profits are demanding more accountability and better performance from management.

Appropriate capital investment decisions will increase the co-operative's long-term effectiveness and efficiency, while incorrect decisions will erode the co-operative's ability to achieve its mission and meet the needs of members. The adoption of the appropriate capital budgeting tools provides co-operative managers with both the processes and techniques required to make decisions that will enhance the organization's resource base while improving its ability to serve its members and evaluate effectiveness of its investments. Table I provides a summary of recent studies of the adoption of capital budgeting practices by not-for-profit organizations.

Purpose

The purpose of the present study is to explore the utilization of capital budgeting techniques by agricultural co-operatives in strategic planning.

Capital budgeting for agricultural co-operatives

Capital budgeting is the technical component of an ...