This report is about how should the financial management and the capital budgeting decision process interwork effectively in order to create shareholders wealth. The capital budgeting process is a significant effect of the shareholders wealth. Specially, a company success or fair is rests with a key stage of the decision process - Financial appraisal of project phase. Moreover management does not only consider about the quantitative analysis but also take into account of qualitative factors. Therefore management will better able to make sensible decisions that will critical effect of shareholders value over the long term.
Introduction
Nowadays "the words "maximizing shareholder value" have become a battle cry for managers and directors". [1] However how should a company achieve this objective and actually created shareholders value? Therefore not only a role of a financial management should be within a company but also the capital budgeting decision process. While the financial management and the capital budgeting decision process could be interwork effectively. It could be a critical effect of created shareholders value.
Financial management and capital budgeting decision process
The financial management is concerned with a company's long term investments, which including take into account of acquiring, financing and managing assets, to achieve the goal of maximum shareholder wealth. Due to the shareholder have entrusted their money to the company and expected the company can spend their money to invest advisably. Moreover shareholders prefer lower level risk rather than high level of risk, in order to gain more returns. Thus financial management "is responsible for handing external financial matters, such as managing cash and credit, capital budgeting, raising funds, and financial analysis and planning." [2] In addition if management made a investing in the wrong decision, it is a dangerous problem. For instance shareholders will not invest to the company again or lead to a company suffers losses. Hence management's decision is a significant effect of the shareholders wealth and the company's success or failure. Thereby how should a company solving this problem? The Capital budgeting system should interwork with the financial management.
A capital budgeting process can get forward to achieve the company's goals and act as a planning which allows a manager in making smart long- term investment decisions. Since a Capital budgeting is mainly take into consider investments in a long-term assets, which involve tangible items, for example plant, equipment and property. These investments not only crucial effect on the future cash flow of a company but also the risk associated with those cash flows. [3] Thereby management can base on the capital budgeting process in deciding "whether expanding the business strategies, re-deploying assets, or downsizing." 3 In this way, management can facilitate that shareholder's value can be created effectively while a capital budgeting system and the financial management can interwork appropriately.
Figure 1: The capital budgeting process
The capital budgeting process
The capital budgeting is a process that the financial manager will basis on it in deciding whether to invest in specific projects. Owing to the capital budgeting outcome will effect of shareholder wealth, thus a capital budging decisions is indispensability. The capital budgeting process is depicted, in the form of a highly simplified flow chart, in Figure 1
Strategic Business Plan
At strategic business plan, a company identify that the objective should be "maximum shareholder wealth."While that objective is "clearly identifies the business the firm is in and where it intends to position itself in the future." 3 Thus managers can base on that to pursuit of company objectives with an effort as a result achieve create shareholders value.
Preliminary screening
At this stage, many investment ideas will be generated. It is not worthy to analysis or evaluate all the investment ideas across-the-aboard. Therefore management can through preliminary screening to filter out the poor or unsound proposal.
Financial appraisal of projects
The financial appraisal phase, it is an important phase and it allows management in decision whether to investment. If the management takes a wrong decision this critical effect shareholder wealth. Thus it is indispensability.
Authorization
At this stage, the authorization is act as a motivational and quality control function. Due to the major capital projects have been met on all previously process, hence very few capital projects will be reject by the senior management. If the senior management rejected of the capital project, it will serious injure motivation.
"The degree of commitment, enthusiasm and driving of the management team implementing the project is a major factor in determining the success or failure or marginal projects." [4]
Project implementation and monitoring
The implementation phase, which is a capital expenditure control, its help to ensure capital is readily available to start up the project. Once the project has been implementing, ceaseless monitoring progress will be add on to observe the deviation and taking rectified actions when needed, such as training personnel and so on.
Post-implementation audit
Post-implementation auditing is similar to control phase, it is a basis for rectified actions, which identify problems and error in existing project, provides valuable information and improve the quality of existing decisions and future decisions.
Key stage of the decision process
In order to create shareholder value, company should not overlook a key stage of financial appraisal of project, since there are seriously impacts on shareholder wealth by using traditional techniques. It is universally acknowledged that traditional techniques such as NPV, Payback value are most popular method to appraisal projects. However those techniques usually lead to incorrect capital budgeting decision, as a result how should a company solving these problems? A new appraisal technique Real Options, risk and uncertainty should involve to facilitate that shareholder's value can be created effectively.
Sometimes while proposals shown as a negative NPV, management only choose to reject those proposals immediately, in fact there are some implied opportunities of those proposals. Those implied opportunity may not be capture by traditional techniques thus management are usually overlook it and lead to impact on the firm loss the chance.
Moreover it is not worth for management to base on conventional techniques in deciding whether to take an investment. Due to the project will be successful is rests with selecting a high or low discount rate and it will result in inaccurate cash-flow prediction. However both of these weaknesses may be addressed by a new appraisal technique of Real Options, risk and uncertainty as an improvement to the traditional approach to project planning. [5] Real options allow management to bring the rigors of financial analysis to corporate strategic analysis, [6] therefore it allows a growth opportunity for a company to expand into a new market such as developing countries and gain cash flow.
"Now is a time to ensure that projects are not rejected as a result of error or excessive caution, and for management to encourage companies to invest for the upturn" [7] to ensure that shareholder's value can be creating and maximization effectively.
Figure 2: A best practice decision process
An optimal capital budgeting decision process
An optimal capital budgeting decision process should be chiefly comprise of strategic business plan, screening, financial appraisal, project implementation and monitoring phase. Why these decision processes should be retains? Since both of them are critical effect shareholders value, however some decision phase are overlaps or overlooks, so some phase should be add on or filter out appropriately, as a result a best practice decision process can be generated. The best practice decision process is depicted in Figure 2.
First of all, while management has a clear objective to achieve the goal, management should communicate from inside and outside the firm such as employees and advisors by investment suggestion. Therefore a identification of investment opportunities phase that should be involve to ensure that the best investments proposal are evaluated, selected and implemented.
Furthermore, the management does not only consider about the quantitative analysis test, it is because quantitative analysis test have been become formulize. Therefore management should take into account of whole-company perspective and a phase of qualitative factors in project evaluation should be include, which allows a management to facilitate investment project's generation, selection and implementation closer to become more science, as a result management's decision can be result in more comprehensive.
Perhaps some company are still adopt post- audit phase to identify problems and error in existing project, however this phase is overlap of the monitoring phase and this phase is otiose. For instance, while an investment project had been already implemented, it imply those project have been passed through previous process, hence it is unnecessary to identify problems and error in existing project again. Thus this phase should be filtering out appropriately.
Conclusion
A shareholder's value creation rests with financial management's decision and an optimal capital budgeting decision process. Since financial management's decision is significant effect shareholder's wealth. Therefore the financial management and the capital budgeting decision process should be interwork effectively. However, by understanding the quantitative analysis test such as NPV, management should also consider qualitative factors, Thereby shareholder's value can be created effectively.
In a decision making, many investment ideas will be generated, however in a firm of limited resources it may not be implement all proposals. Besides quantitative analysis test, management should also consider qualitative factors. Since it will stifle the entrepreneurial spirit and those factors are seriously impacts on a company success or fair. While in a decision making phase, many investment ideas are not only deciding by management but also at divisional level, hence management should considering at divisional level's enthusiasm and commitment. However management do not only take into consider at divisional level, a management should consider the whole-company benefit. Therefore management will better able to make sensible decisions that will critical effect of shareholder value over the long term.
