We have finally hit it: the mother of all corporate finance. Capital budgeting. Here is where our hard work has pointed us. How do we use our analytical tools to make good, sound and solid decisions?
It was not too long ago that someone here in Washington, DC counseled that we should not let a good crisis go to waste. We can debate the wisdom of the media message and the context in which that advice was given. However, as your professor, I proffer that as business people coming of age now, you will be all the better for the wear.
It is relatively easy to make capital decisions in times where resources are plentiful. However, it takes a different discipline and rigor to conduct capital budgeting when resources are constrained. Charles Alsdorf offers insight into this dynamic.
Reflect a moment on the "food fight" that Alsdorf references. What does this mean? Discuss the notion of balancing financial and strategic benefits in the capital budgeting process. What can our holistic approach to financial management offer in this process?
I appreciated some of the advice given from this video, such as: When originally designing a project, we want to build in growth options and ways to expand, and, we want to develop a more scrutinizing risk analysis. It seems like we would want to do these things anyway, so it is good that the crisis has at least been pruning business practices. I like these tips: “What can you do more with less?” “Focusing on immediate payback, and those projects that are going to use more internal resources”, “What will happen if I defer the project or not do it at all?”. These seem like common sense. Therefore, it is good that the economic collapse has at least some benefits such as getting us focused on the basics, that when followed correctly, can have fruitful results.
ReplyDeleteAlsdorf makes reference to the debating that takes place when project managers are evaluating projects to fund. He calls this a “food fight.” Capital budgeting, according to Alsdorf, is incredibly complex. There are a multitude of attributes to consider when making a budgeting decision and when numerous people are involved, debating about best practices is common. A challenge is that no two projects are alike, which makes comparing projects difficult. “Food fights” take place when companies don’t have the right tools to properly compare projects and evaluate them based on their benefits.
ReplyDeleteAs Renee mentioned in her post, I too liked Alsdorf’s suggestion of considering how much of the project could be completed with 80% or 50% of the budget. Not assuming that a project plan will pan out exactly as planned with the most amounts of funds will help to ensure the project is running on the lowest possible budget. By doing that, along with a risk analysis, project managers can be confident that their projects will be executed correctly and efficiently.
Project managers try to optimize the project value- get more bang for the buck - so they need to focus on getting a greater return for every dollar spent. Alsdorf outlines the importance of capital budgeting and efficiency for business(es) especially because the economy is struggling to come out of the recession. Alsdorf emphasized that when project managers are evaluating how to fund projects, it’s more than just go or no-go decisions. Like Meredith said, no too projects are the same so obviously evaluation of capital budgeting doesn’t always work the same way, and the decisions are not always as simple as “go” or “no-go”. But, like Renee said, isn’t this common sense? I think so, but we have to keep in mind that projects, technology, strategy, and business are continuously getting more and more complex. If Aldorf’s suggestions are successfully implemented, practical and real gains are more likely to result.
ReplyDeleteThe notion of balancing financial and strategic benefits in the capital budgeting process is actually a practical approach on whether or not to accept the investment in a project. Our holistic approach to financial management is helpful in terms of perspective. The fact that we have diverse backgrounds as opposed to soley economic or financially-based backgrounds allows us to pick a part a project in to all of its elemenets and then build on that in terms of how each element effects the desired outcome of the project. I feel that a lot of times people who have business backgrounds may get stuck on the mind-set of the "rational consumer" when it is important to note that the world is not always rational... so maybe a project that would be financially viable is not necessarily practical in terms of specific elements entailed in the project.
ReplyDeleteI find it funny (or sad) that we had to have a financial crisis before some companies thought to implement these standard common sense applications. Of course, you should always ask what you can do for less! For example, when budgeting a trip to Disney World (which my fiancé is currently doing), he has to ask what am I giving up by getting the more expensive hotel? Should I get the more expensive hotel or should I get a cheaper one but be able to eat at nicer restaurants during my trip? I also think you should always ask if a project can be deferred, not done, or done and what the results of doing so will be. For example by not going to Disney World this summer, my fiancé can save over $2,500 that can go towards our wedding. This example can also be used when talking about prioritizing. Alsdorf comments that it’s difficult when comparing apples (trip to Disney World) to oranges (wedding) because there isn’t a good method of evaluation. So how do you evaluate these differences? Alsdorf doesn’t hit on this answer but I wish he would have because this too befuddles me. Overall I liked his advice except I wish he gave us some real world application.
ReplyDeleteCan capital budgeting really be that difficult? It seems to me to only be a problem of proper planning and research. Millions of people make such decisions frequently while deciding how to budget their household. It's all about being thrifty. I do not think the problem is in the planning and research, the problem is dealing with a change in budget and becoming accustomed to how to properly implement this change. It is hard to deal with a loss in money for projects (ex. if a family of four is used to spending $150/week on groceries, a pay cut that leaves them with only $100/week would be a drastic change to deal with. My personal budgeting tip is to have extra money because usually more money is needed than planned. This is probably better explained with an example. The family of four has $100/week to spend. They should PLAN to spend only $75 leaving the rest of the money for unplanned items.
ReplyDeleteSo, according to Charles Alsdorf, when companies are not well-equipped to prioririze captital budgeting projects, debating ensues, which he calls refer to as a food fight. I think that these "food fights" happen all the time, on all levels of our economy.
ReplyDeleteI think that we are a society of "now." There is some knee-jerk negative reaction to planning and prioritizing budget aimed at the future. I almost think it's ingrained in our minds, that we would rather use the money on today, not tomorrow. Alsdorf makes that analogy/reference to the difficulty of comparing "apples" and "oranges" - precisely the problem that we just don't like thinking about saving money for too long. There is almost always an instant attraction to the "now" - especially when you have been backlogging your "now" for a while now. The problem is that people are just short-sided: they almost never think to look too deep into tomorrow. Of course, when you have a financial crisis, our biggest fears are realized and we are forced to think (and spend) in a different way. Hopefully the scars of turbulent times can help us collectively put value in budgeting. And the same with companies and captial budgetting.
It seems to me that pretty much every problem that we have been presented with in this class have stemmed from a lack of good judgment and prudence. I know I’m starting to sound like a broken record player (for those of you who know what that is) but these things are starting to get just as repetitive. For every failure or crises that we are faced with, almost always it was something that was totally avoidable.
ReplyDeleteFinancial meltdown? Avoidable
NFL Lockout? Avoidable
Inflation, deflation, poverty? Avoidable
These are things that are wholly within our means. Except for an act of God (like a tsunami or an earthquake) most of mans suffering is of his own making. Why?
Because of a lack of good judgment and prudence. This reminds me of an article I read that spoke of the importance of the virtue of prudence:
“It is defined as the intellectual virtue which rightly directs particular human acts, through rectitude of the appetite, toward a good end. Emotional well-being, we will argue, comes about through a certain structuring of the entire network of human emotions, one that results from a proper disposing of the emotions by the virtues. For it is prudence that determines the mean of reason in all human actions and situations.
A moral virtue is a habit that makes its possessor good. One may be brilliant and learned without being morally good, but it is not possible to be prudent and not morally good. The prudent man is one who does the good, as opposed to one who merely knows the good. There are many moral philosophers and theologians around, but prudent persons are probably not as common. It is much easier to talk about virtue — including prudence — than it is to actually be virtuous. And one who does not behave well cannot be said to be prudent, even though he happens to be very learned. We will understand this better as we take a closer look at just what prudence is. “
The video was an interesting view on a subject that is taking on increasing precedence in industry across the country. I think Charles Alsdorf hit it on the head perfectly when he discussed the importance of planning the capital budgeting process. I think the idea of planning fractional funding or completion to determine importance and impact of various funding levels on performance and output. This is not only an area to help calculate impact, but also an opportunity to achieve better value on investment and determine the best avenue for funding. I think that by taking Alsdorf's suggestion and providing people with the tools and structure to methodically approach and process the capital budget. The process, so augmented and supported, would provide a more constructive forum which would hopefully lead to a better atmosphere than that described as a 'food fight'. It will be interesting to see how various regulatory impingement's and increased corporate focus change and shape the capital budgeting process in the years to come.
ReplyDeleteI like to start off by saying Nicole, have a FANTASTIC time in Disney World. Second, capital budgeting is employed when determining whether or not to invest financially into a project. In most cases, capital budgeting allows companies to determine “who, what, when, where and why” to spend the big bucks.
ReplyDeleteAlthough, capital budgeting is a complex process it should also be a holistic process. To me it sounds as though capital budgeting is experiencing similar problems to those of the federal government; I say this due to Team Microsoft’s most recent analysis of the GAO document. Poor planning, poor execution and poor management skills. With these necessary and essential fundamentals, capital budgeting should not be that hard like Sara said.
The video provided interesting insight into when a company should invest into a project. However, investing in project wouldn’t be so difficult if companies would start with the basics.
After watching the video and reading the comments of my peers I would like to state that I agree with most of what has been said. In my mind it would only makes sense to create a detailed analysis for every project before deciding to sign off on it and deciding to go ahead with a project based on importance to the overall success and performance of the whole (Firm/Company). I find it wildly surprising that this is something is not standard practice across every industry. This video gives great information on a topic that need to be addressed. I look forward to watching the much needed changes in the business world.
ReplyDeleteI agree with Tommie and everyone else's insightful comments. I feel as if capital budgeting and the planning process is key in the implementation of any project, especially business ventures. Although capital budgeting is extremely complex I believe the basic fundamentals are simple don't spend the money if you cannot afford it and don't overspend on unnecessary overhead costs. Although the planning process is often avoided because it takes the longest, it is the most important aspect of planning. We have learned through our consulting studies the importance of framing an issue, and if the framework is incorrect if effects the success of the entire process. This concept applies to capital budgeting as well. Framing the budget is key and will pay dividends in the future.
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