Capital budgeting processes include the analysis of short-term and long-term financing. Short-term financing is affected by cash and cash equivalents in cash budgeting. Generally, loans can be considered one long-term financing option, but they can also be taken out for the short term. Both options have advantages and disadvantages. It is important to look at the different financing processes of capital and cash budgeting. The two main financing options are issuing new equity and selling debt. Capital budgeting analysis helps inform business decisions and plays a part in determining how much money a project will need to generate in order to realize a profit.
At A Glance
Cash and cash equivalents are the most liquid assets.
- Cash and cash equivalents are used in cash budgeting, and they are used in capital budgeting if they are being transferred into another type of asset.
- Effective business managers create cash and capital budgets to determine when there will be available money or shortfalls that need to be managed.
- Financial organizations have created many financial instruments, such as factoring and trade credit, to meet the short-term financing needs of companies.
Short-term loans can be secured and paid back more quickly than traditional loans, but they come with higher rates and fees.
Simple and compound interest paid on a short-term loan can be easily calculated.
Long-term financing generally requires that an asset such as real estate be used as collateral to be seized if the debt is not paid on time.
- Long-term financing provides more financial stability and less frequent loan negotiation than short-term financing and stock offerings do, but long-term financing also lacks flexibility because of its fixed rates, which can affect future financing opportunities.
- The costs of raising capital for a business include the cost of debt and the cost of equity.
- The cost of capital can be calculated for each component of capital, such as the cost of equity and the cost of debt.
- The WACC formula can be used to calculate the cost of capital and guide management decision-making.