Capital budget

A capital budget covers spending on assets that will produce benefits over multiple periods — machinery, buildings, vehicles, major software systems, and expansion projects. It is distinct from the operating budget, which plans the revenues and expenses of a single year's normal business activity. Because capital projects commit cash for years and are difficult to reverse, they are budgeted separately and reviewed at a higher level of the organization.

Building a capital budget starts with proposals from operating units, which are then screened using capital budgeting techniques: net present value, internal rate of return, payback period, and discounted payback. Projects that clear the company's required rate of return are ranked, and management funds them until the available capital is exhausted — a process known as capital rationing. The resulting schedule feeds the cash budget and the pro forma financial statements, because approved outlays become cash requirements and future depreciation expense.

Time horizon is what sets the capital budget apart in a company's planning cycle. Operating budgets are typically annual and are broken into months or quarters; capital budgets commonly span three to ten years and are updated as projects advance through approval, commitment, and completion. Senior management and the board are usually the participants for capital decisions, while operating budgets are prepared much closer to the front line.

The CMA Part 1 exam tests capital budgets within planning, budgeting, and forecasting. Know how the capital budget connects to the master budget, which participants and time frames apply to each budget type, and how approved capital spending flows through to the cash budget and pro forma statements.