Why is Capital Budgeting Important for Your Business?

What Is Capital Budgeting?

Capital budgeting is a process of evaluating the costs and benefits of large-scale projects you are considering for
your business. It is a long-term investment that improves your capital assets such as an office building, a piece of
equipment, building maintenance, and renovation purchases. In order to get a loan, you need to prove that the
investments you want to make in your business will increase your gains.

Capital budgeting helps financial decision makers make informed financial decisions that require a large capital
investment. Projects include:

 Investing in new equipment, technology, and buildings

 Upgrading existing equipment and technology
 Renovation projects
 Expanding the workforce
 Developing new products
 Expanding into new markets

Capital Budgeting Methods

The following capital budgeting examples need to be reviewed so that your business makes solid investment
decisions.

 Internal rate of return

 Net present value
 Payback period
 Discounted cash flow

Internal rate of return

This method measures the return percentage to expect from a specific project. Many companies pursue projects
with a rate of return that is higher than the cost of capital.

Net present value

This method measures how profitable you can expect a project to be. Any project that has a net present value that is
positive is acceptable. If it is negative, then it is not acceptable. The net present value method is a popular capital
budgeting method because it helps you choose the projects that are expected to be the most profitable for your
business.

Payback period
This is the simplest capital budgeting method, but it is the least accurate. It is quick and can give managers a vague
sense of how well a project is going to perform. The payback period measures the amount of time it takes for you to
earn cash inflows from your project to recover the cash outflows that you invested in the project.

This method is popular for people who have limited funds to invest in a project and need to recover the investment
costs before the continue with another project.

Discounted Cash Flow

Discounted cash is money adjusted for its time value it is based on the idea that money can earn interest. This
method tries to discover how much the project is worth today based on how much money it will make in the future.

Steps to Take

The key to capital budgeting is broken down into a few steps.

 Explore opportunities: seek the most cost-effective methods including timing, location, potential costs and
more.
 Estimate the total cost of the project: gauge the total cost of the project and have multiple scenarios.
 Calculate your return on investment: a cash flow estimate will help you see a potential return on
investment.

The Bottom Line

Capital budgeting is an extremely useful financial tool that can help any company plan big expenditures on long-
term assets. It is important to know what you are getting to before you begin. A capital budget can help you take
your company in the right direction. If you do not have capital budgeting in place, you are setting yourself up for
more risk and less funds.

Reference: Merino, M. (2021, October 15). Why is capital budgeting important for your business?. Crestmont
Capital. https://www.crestmontcapital.com/blog/why-is-capital-budgeting-important-for-your-business

Do We Need to Think More About Small Business Capital Budgeting?

1. Introduction
Capital budgeting is one of the most important areas of finance literature. The decision of capital
budgeting, or the allocation of fund in assets for a long term, is obvious for both the large and small
business. Existing theory of capital budgeting explains the investment decision-making pattern of large
businesses very well. This paper discusses whether the capital budgeting theory of large business is well
applicable for the small ones or not. If it is not, further development of theory becomes necessary.
Followed by the analysis of some theoretical and empirical studies, this paper suggests specific factors to
consider in future researches on capital budgeting theory for small businesses.
Understanding the pattern of capital budgeting in small businesses is important. Small business is a
significant portion of total businesses in an economy. Also, small business constitutes the starting point for
the entrepreneurs. According to Deek (1973), small business is an important asset within an advanced
industrial economy. But they cannot make possible contribution for the economy if they are held back by
managerial and entrepreneurial limitations. According to FitzRoy (1989), evidences are there to support
that small firms are more innovative. Furthermore, it is observed that the overall demand for customized
goods and services increase than the increase of mass-produced goods (Carlsson, 1989). Thus, worldwide
experience shows that equitable development from economic and social context is enhanced by the
contribution of small businesses (Jeppesen, 2005). All these studies ndicate that successful small business
is important for an economy. And, the success of small business depends on optimal capital budgeting
decision. This is why small business capital budgeting demands special attention for complete theoretical
development.
This paper is organized in six sections. Fixing up the definition of small business is important and the
analysis on it is in the second section. The third section analyzes the theoretical evidence to show how the
small business capital budgeting has a different decision-making environment. Empirical evidences are
discussed in section four. Section five and six describes the findings, and conclusion plus research
implications respectively.

2. Definition of small business

Small is a relative term. Whether the size of a business is small or large, is a very difficult question. The
purpose of the definition can play role in determining the borderline. Most of the studies on small business
capital budgeting used either number of employees or amount of sales revenues as the attribute to create
a line between large firms and small firms. Grablowsky and Burns (1980) and Graham and Harvey (2001)
defined small business based on revenue, which is less than $5 million and $1 billion respectively.
Danielson and Scott (2006) used number of employee as the differentiating factor. They used the
benchmark of 250 employees to define small business. Stanley (1997) used both the number of employee
and sales revenue, which are fewer than 1000 employees and less than $5 million revenue. Pattillo’s
(1981) was exceptional where the small and large are differentiated based on their size of capital
investment. However, the differences in the definitions of small business indicate the necessity of
developing an appropriate definition that would be useful for this kind of research. Here, Deek’s (1973)
statement may help as a guideline to determine an acceptable borderline between small and the large:
“Small firms are owner-managed. In the small firm the work of the owner is concerned primarily with
management or superintendence.”

3. Capital budgeting in small and large business

The theory of capital budgeting supports Net Present Value (NPV) method most, which involves
discounting all relevant cash flows at a market determined discount rate such as the cost of capital.
Determination of cost of capital requires the separation principle that requires that the investment
decision can be made independent of shareholders’ (owners’) tastes and preferences. Since the ownership
is not readily marketable, separation principle, and thus the market-determined discount rate are
inappropriate for closely held and small businesses (McInish and Kudla 1981). Therefore, there is some
degree of complexity and inappropriateness employing existing capital budgeting theory for small business
investment decisions.
In case of small businesses, the owner will have to make decisions concerning production, sales, finance
and administration without any specialist management support or advice (Deek 1973), which is not the
same at all for large incorporated firms. Danielson and Scott (2007) have worked on the agency problem in
small firm investments. Their result shows that agency conflicts affect a firm’s investment decisions in
different ways before and after the separation of ownership and control.
Therefore, there is a need to address the problem of decision-making in small business, and some scholars
have been working in this field. For example, McMahon and Stanger (1995) suggest that small business
financial objective function is sympathetic to existing financial thought, but capture complexities arising in
small business. They also argue that the small business financial objective function should reflect the kinds
of enterprise-specific risk that typically exist in small businesses arising from liquidity, diversification,
transferability, flexibility, control, and accountability considerations.
In other words, the capital budgeting process of small business is likely to be different from that of a large
business. The size and availability of capital, investment opportunities, and the nature of the decision
makers being different for small businesses may partially explain this difference.

4. Some evidences
Several researchers have conducted the study of capital budgeting decision-making pattern of small
businesses but the number is lower than what is for large incorporated businesses. For example, all of
Grablowsky and Burns (1980), Pattillo (1981), Block (1997), Graham and Harvey (2001), and Danielson and
Scott (2006) have conducted studies to find the pattern of capital budgeting decisions of small businesses.
Although, their sample size was much different from one study to another, their location of research, data,
and methodology were almost same.

All of these studies used survey methodology. Sample size varied from 65 to 792. Pattillo’s (1981) study
was unique among these in terms of sample size and data. This study also compared national and
multinational firms in USA. In addition to survey data, this study used substantial amount of other data
from the operation manuals and specific case studies of the firms in the small sample. Additionally, the
chief financial officer of each firms were interviewed very deeply. Therefore, the small number of firms in
the sample is justified by in depth analysis of their decision-making process.
In Grablowsky and Burns (1980) study, lack of understanding as well as expertise of the concepts of capital
budgeting are the reason behind small businesses less use of modern capital budgeting techniques.
Observing that the smaller firms used single techniques, such as, inspection, ‘need’, or payback for
evaluating capital investment proposals, Pattillo (1981) states “Findings of variances from the theory by
the sample firms could be useful in determining theoretical gaps and could indicate the most useful future
orientation of new techniques or refinements in theory or technique.” The findings of these studies are
given in the following table. Graham and Harvey (2001) and Block (1997) found more use of payback
period method than discounted cash flow methods in small firms. Danielson and Scott (2006) found that
investment decision of small and large firms differ and many small businesses do not use sophisticated
capital budgeting techniques or do not involve discounted cash flow methods. They rely on gut feel or easy
techniques like payback period. They showed that the lack of financial sophistication, assumptions of
capital budgeting theory being not true for small firms, size, short operating history, lack of education of
the top decision maker, lack of discretion in investment decision, credit constraints, difficulties in
quantifying future cash flow are the possible reason why small firms decide differently in capital
budgeting. These results are given in table 2.
5. Findings
We have found that there is no well accepted standard definition of small business in the literature that
can be used to create the basis of applying the theory of capital budgeting. Still, it is possible to say that
the theory of capital budgeting, which is constructed under assumptions related to large incorporated
businesses, is not fully applicable for small businesses. NPV is the ultimately suggested method of capital
budgeting that involves estimation of cash flows, and the market determined discount rate. Both of these
two tasks require expertise and relevant knowledge. Decision-makers in small businesses may lack this
knowledge or may find it cost ineffective to hire that kind of expertise. Moreover, market determined
discount rate is not possible to find since the market for small business’s capital is not liquid, which does
not allow thinking about separation of investment and financing decision. Also, the effect of agency
conflict, when it is present, on the investment decision, is different for small businesses because of lack of
separating ownership and control. Size and availability of capital as well as investment opportunities are
also among some other factors contributing to this conclusion.
Some empirical studies done so far have found results demonstrating the inapplicability of modern capital
budgeting theory for small businesses. In addition to above, some other reasons found from these
empirical studies are, lack of knowledge, cost of hiring outside consultant, low priority of planning, size and
availability of capital, size and availability of investment opportunities, tendency of high reliance on gut
feel or easy techniques like payback period, short operating history, credit constraints, difficulties in
quantifying future cash flow, and limited discretionary alternatives for investments.

Reference: Uddin, M. M., & Rasel Chowdhury, A. Z. Md. (2009, February 8). Do we need to think more
about small business capital budgeting?. SSRN. https://papers.ssrn.com/sol3/papers.cfm?
abstract_id=1339427

The Use of Capital Budgeting Techniques in Businesses: A Perspective from the Western
Cape
Capital budgeting is one of the most important areas of financial management. There are several
techniques commonly used to evaluate capital budgeting projects namely the payback period, accounting
rate of return, present value and internal rate of return and profitability index. Recent studies highlight
that financial managers worldwide favor methods such as the internal rate of return (IRR) or non-
discounted payback period (PP) models over the net present value (NPV), which is the model academics
consider superior.In particular this research focused on small, medium and large businesses and
investigated a number of variables and associations relating to capital budgeting practices in businesses in
the Western Cape province of South Africa.
The results revealed that payback period, followed by net present value, appears to be the most used
method across the different sizes and sectors of business. It was also found that 64% of businesses
surveyed used only one technique, while 32% of the respondents used between two to three different
types of techniques to evaluate capital budgeting decisions. The findings show that the more complicated
methods such as IRR and NPV are most favored by the large businesses as compared to the small
businesses. The majority of the respondents believed that project definition was the most important stage
in the capital budgeting process. Implementation stage appeared to be the most difficult stage for the
manufacturing sector whereas Project definition, Analysis and selection and Implementation were
generally rated as being the difficult stages by the retail sector. Project definition and Analysis and
selection were found to be the most difficult stages by the service sector. Most businesses used the cost of
bank loan as a basis in capital budgeting and more than two thirds of respondents used non-quantitative
techniques to consider risk when making a decision on investing in fixed assets.

Reference: Brijlal, P. (2008, August 27). The use of capital budgeting techniques in businesses: A
perspective from the Western Cape. SSRN. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1259636

How planning and capital budgeting improve SME performance

Abstract

This paper focuses on the use of strategic planning among small and medium sized enterprises (SMEs) in
the UK manufacturing sector. It analyses the relationship between the intensity of strategic planning,
business objectives, perceived performance, changes in the business environment and the use of capital
budgeting techniques. Capital budgeting is of particular interest as an area of investigation, and is one
which has seldom featured in previous studies of strategic planning behaviour. These issues were
investigated via a survey of UK manufacturing SMEs carried out in the winter of 1996/97.

The key results suggest that SMEs incorporate a range of objectives into their strategic planning process,
with profit improvement perceived to be the most important objective, followed by sales growth. SMEs
engaged in detailed strategic planning are more likely to use formal capital budgeting techniques,
including the net present value method, which is consistent with maximising the companys' value.
Perceived profitability and success in achieving organisational objectives were positively associated with
planning detail, suggesting that strategic planning is a key component improving performance. Planning
detail was also associated with a significantly higher level of perceived change in the business
environment.

Reference: Peel, M. J., & Bridge, J. (2002, July 24). How planning and capital budgeting improve SME
performance. Long Range Planning.
https://www.sciencedirect.com/science/article/abs/pii/S0024630198800216

Bounded rationality, capital budgeting decisions and small business

Abstract

Purpose

The purpose of this paper is to provide insight into the capital budgeting decision-making of Canadian and
Mexican entrepreneurs in small businesses in the food sector. The objective is to understand the capital
budgeting decisions through the lens of bounded rationality and how these decisions are affected by
different (national) contexts.

Design/methodology/approach

This is a comparative study in which the use of constructivist grounded theory allowed deep conversations
about capital budgeting decisions. Data was collected from forty semi-structured interviews with
entrepreneurs/managers in two regions, Mexico and Canada.

Findings

Insights from this study suggest that entrepreneurs’ capital budgeting decisions are not only taken under
conditions of bounded rationality but also suggest a prominent role of context in how bounded rationality
is applied differently towards investment decisions.

Research limitations/implications

While the findings cannot simply be generalized, exploring how capital budgeting decisions are made
differently across two regional contexts adds to the understanding of the nexus of context, bounded
rationality and capital budgeting decision-making.

Practical implications

Using a bounded rationality lens, this study contrasts and explains similarities and differences in the
entrepreneur’s capital budgeting decision-making within small businesses. The insights add to the body of
knowledge and help entrepreneurs to reflect on their approach to decision-making.

Originality/value

The paper uses a less commonly applied approach to understand two under-researched regional contexts.
We use constructivist grounded theory to explore entrepreneurs’ capital budgeting decision-making in
small businesses in two regions, Canada and Mexico. The comparative approach and the findings add to
the understanding of decision-making, highlight the prominent role of context and also challenge some
insights from previous research.

Reference: Burgos, J. A. M., Kittler, M., & Walsh, M. (2020, February 7). Bounded rationality, capital
budgeting decisions and small business. Qualitative Research in Accounting & Management.
https://www.emerald.com/insight/content/doi/10.1108/QRAM-01-2019-0020/full/html

Improved capital budgeting decision making: evidence from Canada

Abstract

Purpose

The purpose of this article is to evaluate current techniques in capital budget decision making in Canada,
including real options, and to integrate the results with similar previous studies.
Design/methodology/approach

A mail survey was conducted, which included 88 large firms in Canada.

Findings

Trends towards sophisticated techniques have continued; however, even in large firms, 17 percent did not
use discounted cash flow (DCF). Of those which did, the majority favoured net present value (NPV) and
internal rate of return (IRR). Overall between one in ten to one in three were not correctly applying certain
aspects of DCF. Only 8 percent used real options.

Research limitations/implications

One limitation is that the survey does not indicate why managers continue using less advanced capital
budgeting decision techniques. A second is that choice of population may bias results to large firms in
Canada.

Practical implications

The main area for management focus is real options. Other areas for improvement are administrative
procedures, using the weighted average cost of capital (WACC), adjusting the WACC for different projects
or divisions, employing target or market values for weights, and not including interest expenses in project
cash flows. A small proportion of managers also need to start using DCF.

Originality/value

The evaluation shows there still remains a theory‐practice gap in the detailed elements of DCF capital
budgeting decision techniques, and in real options. Further, it is valuable to take stock of a concept that
has been developed over a number of years. What this paper offers is a fine‐grained analysis of investment
decision making, a synthesis and integration of several studies on DCF where new comparisons are made,
advice to managers and thus opportunities to improve investment decision making.

Reference: Bennouna, K., Meredith, G. G., & Marchant, T. (2010, March 9). Improved Capital
Budgeting Decision Making: Evidence from Canada. Management Decision.
https://www.emerald.com/insight/content/doi/10.1108/00251741011022590/full/html

INVESTMENT APPRAISAL OF SELECTED CLIMATE SMART AGRICULTURAL (CSA) PRACTICES

AMONG SMALL SCALE COCONUT FARMERS IN LEYTE

Coconut farming is a very important source of economic activity among small scale farmers in Leyte,
Philippines. Climate change can affect coconut production significantly. Among the hazards brought by
climate variability and change, the typhoon is the most damaging to coconut production. When super
typhoon Haiyan hit Leyte in November 2013, the coconut farms were severely damaged causing reduction
in income among small scale farmers. Farmers are facing unprecedented challenges in improving coconut
productivity. One of the feasible ways to respond to changing climate and extreme weather events is to
adopt climate smart agricultural practices (CSA). CSA is a sustainable development strategy anchored on
three pillars such as productivity, mitigation and adaptation to climate change. Investigation of CSA
practices and its potential for scaling up was the focus of our study, particularly in Leyte province. Results
showed that adapting and mitigating climate variability and change in coconut production requires
adoption of typhoon resilient coconut variety coupled with diversified cropping practices. For Leyte,
Philippines, the adoption of either coconut banana intercropping or improve coconut variety are feasible
options that the farmers can explore. They can maintain or increase productivity and also mitigate the
adverse effect of extreme weather events and changing climatic conditions.

Intercropping coconut with banana is an efficient solution to increase farm productivity. With the
continuous conversion of agricultural land into commercial and housing purposes, areas of cultivated lands
for food production are on the decline which endangers the food security of Filipinos. Thus, coconut
farmers must adopt diversified and efficient cropping technologies. Through intercropping banana in areas
planted with coconut, farm productivity will increase significantly. On average, farm income of farmers
adopting the CSA is higher by 50%. Similarly, the adoption of Tacunan green dwarf coconut variety
provides a continued stream of benefits in comparison to the traditional variety when a damaging typhoon
will hit the area. Leyte province is likely to experience more frequent and damaging typhoons; thus, the
use of improved variety can mitigate this climate hazard.

Small scale coconut farmers face different barriers in adapting these CSA practices. These challenges
include financial and technical resources. Hence, support from various institutions, either government or
private sector, should prioritize technical and financial support for potential scaling up of these practices.
This will enhance the adoption of these prioritized CSA practices and help coconut farmers become more
resilient. Various agencies and stakeholders should conduct capacity building activities and trainings
related to the adoption of these climate smart agricultural practices but should also consider providing
access to technology and markets.

Investment appraisal practices: A comparative study of conventional and Islamic financial

institutions

Introduction
Investment decisions are vital for the long term survival of firms. In addition, these decisions are expected
to contribute to maximizing a firm's value. Capital budgeting decisions are among the most important
decisions the financial manager of a company has to deal with. Capital budgeting refers to the process of
determining which investment projects will maximize shareholder value. Therefore, firms are expected to
evaluate investment alternatives using suitable techniques that are able to measure the impact of
acceptance or rejection on a firm's value. To this end, finance theory suggests that firms should use
discounted cash flow methods (DCF) to analyze capital budgeting alternatives. Among DCF techniques,
academics overwhelmingly prefer the use of net present value (NPV). Empirical studies in the area
concentrate on studying the possible gaps between theory and practice. A large number of studies
conducted with the aim of identifying the capital budgeting practices of firms in many countries report
that companies adopt capital budgeting techniques other than DCF methods, either instead of or as well as
DCF methods. One non-DCF method, payback period (PB), although seriously flawed, is found to be used
extensively by firms in developed markets (Graham & Harvey, 2001). Brounen, de Jong, and Koedijk (2004)
report that the PB method is the most frequently used method among firms in the UK, Germany, and
France, and it is also very common in the Netherlands, where it is the second most popular method after
NPV. Published studies report conflicting results, however. As a result, researchers continue investigating
this area, despite the volumes of published papers, with the aims of identifying trends in capital budgeting
practice, determining the extent of inclusion of new developments by firms, and studying new economies
or industries.

The purpose of this paper is to investigate the current capital budget and risk practices of conventional and
Islamic financial institutions. To our knowledge, this is first published attempt to study the capital
budgeting practices of Islamic financial institutions. We carry out this analysis using standard difference-of-
means tests to see whether there is an “Islamic Sharia'a effect”. This means that we investigate whether
capital budgeting practices differ significantly between the two types of institution and whether these
differences can be explained by the adherence of Islamic financial institutions to the principles of Islamic
Sharia'a.

The additional contribution of this study to the existing empirical literature on capital budgeting and risk
practices is threefold. First, while a large number of studies on the use of capital budgeting techniques are
conducted, published papers on emerging markets are limited. Therefore this study aims to bridge that
gap. Second, it also provides evidence of the capital budgeting techniques and risk methods adopted by
financial institutions, an economic sector which has largely been ignored by previous studies. Third, it
identifies the capital budgeting techniques adopted by Islamic financial institutions that adhere to the
requirements of Islamic Sharia'a. Among the most important requirements is the prohibition of riba
(interest), as Islam prohibits paying or receiving interest.1 The use of DCF methods, despite their
superiority to other techniques, is not fully compliant with the requirements of Islamic Sharia'a (El-Abji,
1985).

Survey of capital budgeting practices

The literature on capital budgeting practices is voluminous. However, the aim of this section is not to
provide an extensive survey of the literature, but to review a small selection of recent studies necessary to
develop the hypothesis of the study. Limiting the brief review to some recent studies is a response to the
findings of a number studies that practices change over time. In the absence of studies conducted in
Bahrain, the review use studies conducted elsewhere. Chazi, Terra, and

Research design and sample characteristics

A structured survey approach was used which enabled us to collect information about firms' capital
investment decision making in a systematic manner. The questionnaire had two parts. The first part
contained ten questions requesting data on the size of the institution, the contribution of foreign
operations, industry membership, listing status, the size of government ownership, the respondent's
position, education, background, age and the length of service with the company. The second part of

Capital budgeting practices

The first objective of this study is to identify the capital budgeting techniques used by financial institutions.
Similar to large number of studies, including Graham and Harvey, 2001, Brounen et al., 2004, Hermes et
al., 2007, we asked firms to rate different capital budgeting techniques on a 4-point scale in terms of the
frequency with which they are used (where 0 = never and 4 = always). This provides information about the
methods that are being used, as well as about the relative importance

Summary and conclusions

This paper reports a study on the capital budgeting evaluation techniques and risk estimation methods
used by financial institutions in Bahrain. The purpose of this study was to determine the present
application of quantitative capital budgeting methods, cost of capital and cash flow estimation, and risk
analysis. The results of the paper are based on a survey of 66 conventional institutions and 39 institutions
that follow Islamic Sharia'a principles in Bahrain. We carried out the analysis

Reference: Al-Ajmi, J., & Al-Saleh, N. (n.d.). Investment appraisal practices: A comparative study of
conventional and Islamic financial institutions. https://www.semanticscholar.org/paper/Investment-
appraisal-of-selected-climate-smart-in-Ruales-Seri%C3%B1o/
d1f446fdc6f723a955962776e7483e486d7749bf

Capital budgeting: a systematic review of the literature

Abstract

Paper aims

The purpose of this article is to identify the research opportunities in capital budgeting.

Originality

This research contributes to the literature by providing a methodology where researchers can potentially
identify gaps from budgeting according to the existing scientific literature and contributes to the
engineering management practice by to identifying the difficulties found by engineering managers that
interfere in the capital budgeting process.

Research method

It was used the Knowledge Development Process-Constructivist (Proknow-C) tool that can researchers
potentially identify gaps from budgeting according to the existing scientific literature. It then explicitly
define the frontiers of knowledge and possible opportunities to follow when investigating the field.

Main findings

Capital budgeting is not shown as a macro research area for the researchers. Few authors have developed
research with the same scopes or few of them still research on the theme.

Implications for theory and practice

The academy advocates that capital budgeting has a key role in business management and, therefore,
managers have to use more sophisticated analysis practices. Organizations should seek professionals with
experience in capital projects appraisal and who are familiar with and knowledgeable in the use of
adequate practices for decision-making.

Reference: Michelon, P. de S., Lunkes, R. J., & Bornia, A. C. (2020a, March 13). Capital budgeting: a
systematic review of the literature. Production. https://doi.org/10.1590/0103-6513.20190020

An assessment of management skills on capital budgeting planning and practices:

evidence from the small and medium enterprise sector
1. Introduction

Small and medium-sized businesses (SMEs) play a crucial role in fostering innovation, creating jobs, and
reducing poverty and income inequality (Dzomonda & Fatoki, Citation2019). A contributing factor in many
modernised countries’ low unemployment rates and progressive economic growth is the participation of
SMEs (Awad-Warrad, Citation2018). Small and medium-sized enterprises in South Africa account for
approximately 42% of the country’s Gross Domestic Product (GDP) and 47% of the labour force (Moise et
al., Citation2020).

The South African Minister of Small Business Development expressed concerns that SMEs have a 37%
probability of surviving in their first four years, with further emphasis that “Business failure is often
attributed to the lack of entrepreneurial knowledge, poor business skills, education, training, innovation
and risk-taking factors” (Gumede, Citation2019).

Capital budgeting has remained one of the most significant financial decision areas of most business
enterprises, including SMEs (Nguyen, Citation2019). Despite this, researchers are still trying to figure out
the best strategy for implementing this fundamental idea, and South Africa is no different. As a result, it is
necessary to identify the planning and procedures that are currently in place within these organisations,
with a focus on capital budgeting planning and procedures. Planning is essential for businesses to be
successful and long-lasting in this modern day.

SMEs must discover ways to increase their competitiveness, notably in terms of their capital investment,
product cost, and pricing, given the limited resources available for implementing new progressive working
methods and the ever evolving market pressure (Khurana et al., Citation2019). Due to poor capital
budgeting decisions, many SMEs in South Africa find it difficult to compete with larger businesses (Imran et
al., Citation2019).

Few studies have focused on analysing financial decision-making, derived from capital budgeting planning
and practices, and its impact on small businesses.

Alles et al. (Citation2021) investigated the usage of capital budgeting strategies in SMEs and the impact of
non-financial factors on the approaches that SMEs choose to use. The authors concluded by stating that
the type of ownership, age, and experience of the decision-maker are important determinants of the
capital budgeting procedures utilised by SMEs.
Siziba and Hall (Citation2021), on the other hand, evaluated the application of capital budgeting
techniques over a period of time. Thus, this study aims specifically at the management level who are the
key principle in utilising and implementing capital budgeting planning and practices.

As a result, it is necessary to determine what planning and practices exist within these businesses, with a
focus primarily on capital budgeting planning and practice. One of the most commonly recognized capital
budgeting planning (CBP) practice are owners’ and managers’ influence on capital budgeting planning and
practice. Companies today require unique skills and dedication on the part of its personnel in order to
thrive in the modern world of tough competition, coupled with the difficulties of globalisation and
borderless marketplaces made possible by technology (especially social media). These are typically found
in big businesses that have the financial resources to give their staff the appropriate training and
education. Unfortunately, SMEs lack these abilities, hence the need to consider the aspects that are
disregarded in capital budgeting planning and practices in order to fill this gap in SMEs. Therefore, the aim
of the study was to assess the influence of management skills and owners on current capital budgeting
planning and practice within the eThekwini Springfield Industrial Park.

2. Literature review

2.1. Capital budgeting theory

This study focuses on the capital budget function. The Capital Budget Theory (CBT) is grounded on the idea
“that companies make investment decisions based on wealth maximization and increasing the value of the
organization” (Basch, Citation2017). Capital budgeting is the process by which organisations determine
which investments will generate long-term returns. Furthermore, maximizing shareholder wealth should
not be the sole goal of businesses, as owners should have significant autonomy to pursue multiple
objectives (Warren & Jack, Citation2018).

Capital investment decisions in small firms differ from those of large firms in several ways. Firstly, small
business owners are concerned not only with wealth maximization but also with maintaining their
independence, which may affect their investment selections. Secondly, access to capital may pose an issue
for small business owners, which may influence decisions regarding liquidity and maintaining cash
reserves. Thirdly, personnel constraints and a lack of investment expertise may limit small business
owners’ ability to adequately analyse investment options (Li et al., Citation2020).

To attain greater survival, sustainability, profitability and cost-effectiveness, companies use capital
budgeting. This brings critical responsibilities for the managers or owners of the SMEs as their decisions
regarding capital budgeting marks the future of their companies in terms of their productivity and growth
(Oyelaran-Oyeyinka, Citation2020).

It has been recorded that only 10–20% of SMEs undertake the capital budgeting process, and these are
mostly public limited companies, which have sufficient funds to invest in long-term projects.
Approximately 20% of the automotive industry’s SMEs have adopted capital budgeting for taking
investment decisions and dealing with the tough competition which requires investment in advanced
technologies (Burgos et al., Citation2020). The SMEs for electronics also adopt capital budgeting for the
same reason (Zainuddin et al., Citation2021).

2.2. Importance of SMEs to eThekwini Municipality and South Africa

Small and medium enterprises (SMEs) are also commonly known in South Africa as small, medium, and
micro enterprises (SMMEs). The SMEs within eThekwini include firms with a diverse range of operations or
product lines. They include businesses run by the traditional families employing more than one hundred
people and categorized under “medium sized enterprises” along with individuals who are self-employed,
and mostly come from the lower strata of the society categorized under “micro enterprises which are
informal in nature” (Durban Government, Citation2018). These SMEs are heterogeneous and operate in
sectors of a diverse nature. They face several challenges in the administration of their business
enterprises. The SMEs in eThekwini are operating in both the informal and formal economies. At the
current stage, the region encompasses 11769 permit holders who are operating in the informal economy
(Kibangou, Citation2019). The informal circle of operation is mostly in the central business district of
Durban, encompassing a population of middle-aged black women.

Currently, there are more than 2 600 SMEs operating in the eThekwini Municipality receiving support from
the government at various stages, including the establishment of the business, legal matters, and
registration of their taxes (Blankespoor et al., Citation2020). However, SMEs still lack guidance in many
areas, such as financial management, business management, human resources, and marketing (Ellitan,
Citation2021).

2.2.1. The eThekwini Springfield industrial park

The Springfield Industrial Park is located within the city of Durban in the eThekwini Municipality, which is
one of the busiest cities in the KwaZulu-Natal province of South Africa. Durban is the third biggest
economic hub within South Africa, with around 3.5 million residents (Durban Government, Citation2018)
that spread over an area of 2 297 sq. km. It is classified as a Category A municipality. A category “A’
municipality means a municipality that has exclusive municipal executive and legislative authority in its
area. This not only makes the Springfield Industrial Park a highly and efficiently managed South African
business location, but also a destination for the attraction of all kinds of business activities (eThekwini
Municipality, Citation2018). The municipality works with a vision of becoming the most live able,
sustainable, and caring city of South Africa where there is harmony and prosperity within the citizenry,
thus putting the Industrial Park at the heart for business attraction (Durban Government, Citation2018).

The local economy of the eThekwini Municipality is considered as the province’s economic powerhouse
and makes a significant contribution towards the overall economy of the country. The growth within the
municipality is being continuously supported by the infrastructure of high quality and world-class industrial
activities (eThekwini Municipality, Citation2018). The ensuing development of various industries, including
the Springfield Industrial Park, has resulted in the modernization and establishment of infrastructural
facilities to achieve the overall aims of government development of South Africa.

The GDP performance of eThekwini Municipality has been a significant contributor towards the GDP of
South Africa. The municipality is posed as an economic center of the country ranking second and
contributing to the GDP through industrial growth of a significant amount in the region. The GDP of the
eThekwini Municipality was R 302.3 billion in 2016 and recorded an annual growth of 1% in comparison to
2015 GDP (Durban Government, Citation2018). Therefore, industries, such as those located within the
Springfield Industrial Park, are important role players for the government of the country. There has not
been enough research conducted within SMEs in the Springfield area with regard to capital budgeting and
sustainability in the longer run which this study aims to serve the locality as a first.

2.3. Skills and influence of managers/owners

The key decision-makers of capital budgeting in the SMEs are the owners of the business and not the
managers. It has been observed that either the owners carry out the capital budgeting process or they
work in consultation with external experts on capital budgeting (Asgary et al., Citation2020). Most of the
SME owners are unskilled and are not highly educated to carry out the process of capital budgeting. The
SME owners operating in Springfield Industrial Park are from the local communities and lack both
education and funding, which results in not carrying out the capital budgeting processes in more than 50%
of the cases (Egbide et al., Citation2019). In their study, Essel et al. (Citation2019), found that a
relationship existed between the education level of entrepreneurs and their success in business. The
relationship of was that the more qualified the entrepreneur was the greater success there was in
business. According to Asgary et al. (Citation2020), reflected results were in their intuition, good marketing
strategies, good access to capital and customer needs. These are the essential factors required to answer
the second research objective of this study, which is the influence of management skills of the CBP.

The capital budgeting planning process requires a lot of information from managers or owners in SMEs
(Awinja & Fatoki, Citation2021). Therefore, one of the positive influences that management or owners can
bring into the capital budgeting and planning process is efficient sharing of information (Edvardsson et al.,
Citation2019). Managers and owners can provide useful information about the net output from the capital
budgets and the potential risks (Sacks et al., Citation2018).

A consequence of information-sharing for instance, is that the superior is able to improve the quality of
decisions and design of capital budgeting planning (Baah et al., Citation2021). Managers and owners
coordinate and propose a more efficient and goal-specific incentive contract, which increases the
subordinates’ motivation to achieve the budget. This will, in turn, lead to improved financial performance
within an SME (Orobia et al., Citation2020). Are these essential factors play that much of a huge role and
contribute to having adequate and sound capital budgeting planning and practices within SMEs?

2.3.1. Decision-making of management

A larger percentage of SMEs have the ownership of the businesses as sole proprietorship and close
corporations. Therefore, they are the sole decision makers of budgeting practices. The owners mostly opt
for cash flow budgeting rather than capital budgeting in the SMEs (Orobia et al., Citation2020). In most
situations, capital budgeting was not even implemented by the owners due to their stand on financial
viability; not having capital to invest in new projects; and a lack of knowledge regarding the entire process
of capital budgeting (Egbide et al., Citation2019). Bergeron and Gaboury (Citation2020) mention that the
rest of the SMEs, which applied the capital budgeting process for their investment in new projects, did so
through the assistance of external expert consultants. Does management’s decision-making play a key role
in capital budgeting practices and financial viability of SMEs?

2.3.2. Financial considerations

The business environment of South Africa is such that the first obstacle, faced by SMEs, is the non-
availability of finances, not only for establishing the company, but also for any future investments (Asah et
al., Citation2020). Access to finance is considered to be a hurdle for many start-up businesses including
established SMEs (Adegboye & Iweriebor, Citation2018). The second consideration is disturbing, since it is
highly likely that limited access to financing opportunities may have a direct influence on the sustainability
of South African SMEs (Mbumbo et al., Citation2019).
According to (Pilar et al., Citation2018), a firm’s socio-economic factors, its size, its type ownership, age
and their accessibility to finance has an adverse impact. Additionally, any failure to declare assets, deliver
accounting records, or ensure creditworthiness and financial performance will adversely influence financial
institutions’ promptness to pledge to medium- or long-term investments (Owusu-Anane, Citation2020).

This scarcity to gain credit worthiness is a major limitation for manufacturing SMEs that wish to expand
their activities (Horváth & Szabó, Citation2019). It is clear that SMEs present a high risk to the lender.
Moreover, many SMEs have inadequate assets that can be used as collateral and will suffer from poor
mechanism (Godke Veiga & McCahery, Citation2019). Furthermore, Appiah et al. (Citation2018) asserts
that the absence of financial support is also due to the owner’s flaws in drafting a well-prepared and
explored credit proposal for the financial institutions.

Different financial institutions, especially private firms, provide loans to SMEs at a very high rate of
interest, which deters SMEs from investing in long-term bigger projects or capital budgeting (Page &
Okeke, Citation2019). Although the lending rates of government agencies are very low, SMEs are largely
not aware of the various policies, rules, and programmes pertaining to lending and are thereby not able to
access the benefits.

2.3.3. Government policies

The Department of Trade and Industry (DTI) provides financial support to qualifying companies in various
sectors of the economy. Financial support is offered for various economic activities, including
manufacturing, business competitiveness, export development and market access, as well as foreign direct
investment.

The taxation policies for SMEs by the eThekwini Municipality are very supportive towards the SMEs,
especially those operating in the Special Economic Zones which are exempted from taxation for a long
period of time, usually for 10–15 years on average (Pilar et al., Citation2018). Since the Springfield
Industrial Park comes under SEZ 63 in the eThekwini Municipality, the SMEs operating in this zone have
been exempted from taxation for now. Thus, this exemption impacts the capital budgeting of the SMEs
positively (Jeganathan, Citation2021).

2.3.4. Lack of networking ability

Although the SMEs are operating in the same park or municipality, they were not connected with each
other at any level. This non-connection hampers any type of exchange of business knowledge or
experiences between the different entities. Thus, even this internal resource is being under-utilized by the
SMEs (Orobia et al., Citation2020).

Mutual production-distribution planning, among the supply network players, is considered a proper
mechanism to support enterprises in dealing with the uncertainties and dynamism linked to the current
markets (Andres et al., Citation2018). Enterprises, especially SMEs, should be able to overcome the
incessant changes of the market by enhancing their agility. Carrying out shared planning allows enterprises
to develop their readiness and agility for facing market volatility (Osei et al., Citation2018).

2.3.5. Business knowledge regarding the financial management skills

Most managerial skills, especially financial management skills, are lacking in the owners along with the
knowledge that these skills must be acquired. The major cause of this problem was observed to be the
background from which these owners hail; their education level and the lack of guidance or training
institutes for providing such assistance to them (Orobia et al., Citation2020).

Consequently, most of the owners request the assistance of external consultants in capital budgeting for
the lack of internal financial knowledge (Kirton & Greene, Citation2019). Due to the outsourced party not
being accountable for the performance of the business, it is not within their contracted scope to do
number crunching to provide analytical data and the party is not obligated to highlight concerns and issues
(Abdel-Khalik, Citation2018). Do outsourced and third-party funds and borrowings play a significant role in
the financial sustainability of SMEs?

2.3.6. Knowledge to identify and resolve business challenges

The knowledge and capabilities of the owner are crucial for business performance and growth because the
management structures and independence of small businesses cause owners to have a key role in business
operations (Guritno et al., Citation2019). Entrepreneurship education plays a crucial and important role in
providing the crucial skills for an owner to operate their daily business requirements, as well as how to
face obstacles and challenges that they will face during their business life (Almahry et al., Citation2018).

Several researchers give entrepreneurship a significant focus in their studies (Almahry et al., Citation2018).
In addition, Rae and Melton (Citation2017) suggest entrepreneurship education should include skill–
building and leadership programmes, new product development, creative thinking and technology
innovation

According to (Nabi et al., Citation2018), individuals, who have work experience and educational
background, have a set of various skills. These individuals are more likely to become entrepreneurs and
make better business progress than others. This study assesses whether theoretical financial knowhow has
an influence on the practical side of the sustainability of SMEs.

2.3.7. Ability to control, lead, manage, direct, and monitor the manpower

All SMEs’ staff are essential to their operations. This includes acquiring new people for the business and
ensuring that they are productive additions to the SME (Martínez-Costa et al., Citation2019). Effective
human resource management matches and then develops the abilities of job candidates and staff with
that of the needs of the firm. An effective personnel system will contribute to the key ingredients for
survival, sustainability, and growth (Chams & García-Blandón, Citation2019).

Human resource management is a complementary deed. At one end, one employs qualified people who
are well suited to the firm’s needs. At the other end, one trains and develops staff to meet the firm’s
needs. Most expanding small businesses fall between the two levels (Bornay-Barrachina et al.,
Citation2017). In this context, the study also assesses if having advanced and modern technology and
accounting software influences positively on capital budgeting planning and practices

2.3.8. Resource management for capital budgeting and planning

Managers in SMEs can use resource management to ensure the longevity of their financial operations,
while others can use it to cultivate a competitive edge in the long- term (Qosasi et al., Citation2019).
Resource management is designed to set a firm’s financial course of action, identifying the financial
strategies it will use to compete in the marketplace and how it will organise its internal financial activities
Ramasobana et al. (Citation2017) asserts that managing resources is, in effect, management’s game plan
for strengthening the organisation’s financial position, pleasing shareholders, and achieving financial
performance targets. Thus, according to Opoku (Citation2016), an SME whose management has poor
resource management appears to be directionless and wasteful. There is a great link between resource
management and capital budgeting and planning (Al Breiki & Nobanee, Citation2019). Whilst capital
budgeting and planning are of such importance to the operation of an SME, Amer et al. (Citation2020)
emphasises that in too many cases, the participation of employees in planning and even decision-making is
instrumental to improved financial performance.

The researchers sought to determine the nature of resource management required for CBP which ensures
longevity of financial operations and can cultivate a competitive edge. The study seeks to determine
whether managing resources forms an integral part of management’s key responsibilities in achieving
financial performance targets.

2.4. Theoretical review

2.4.1. Contingency theory adopted

The theoretical framework on which this study is based on is the Contingency theory that is extensively
used to explain the characteristics of Management Accounting Systems (MAS) as financial and strategic
tools in organisations (Macy & Arunachalam, Citation1995).

Bouwens (Citation2017) argues that the adoption and success of the capital budgeting system depends
upon specific contingent factors, such as product diversity, cost structure information, firm size,
competition, business culture and evaluation tools. Bouwens (Citation2017) also suggests that the
effectiveness of a MAS depends on the extent to which the MAS’s distinctiveness meets the requirements
of the various contingencies faced by the organisation.

This study seeks to ascertain the influence of management skills on current capital budgeting planning and
practice within SMEs. An example is the contingency relationship between the need to invest in a more
enhanced financial management system, such as capital budgeting techniques and the organisational
factors in increasing survival, sustainability and growth.

In this present study, Macy and Arunachalam’s (Citation1995) Contingency model has been adopted in
order to assess the influence of management skills and owners on current capital budgeting planning and
practice small business enterprises within the eThekwini Springfield Industrial Park.

3. Research methodology

Given the aim of this study was to assess the influence of management skills and owners on current capital
budgeting planning and practice in a specific area, based on the richness of information from a rather large
sample of 146, the quantitative method was more suitable. This study used a larger sample size to draw
conclusions, hence a quantitative analysis using a questionnaire was used as the research method. The use
of quantitative analysis was the finest strategy to guarantee the findings’ measurability, correctness, and
reliability.

This study targets a population size of 146 respondents consisting of SMEs in Durban. Data collection from
every individual of this population would be both extremely difficult and expensive. Therefore, it would be
suitable to gather information from a representative sample of the population, and if the sample results
are reasonable, one may draw conclusions and make inferences about the population. A non-random and
purposive sample size was chosen for the survey amongst the SMEs in the Springfield Industrial Park in
Durban.

To assess the competitiveness and sustainability of SMEs, the researchers made use of a quantitative
approach in this study. A descriptive research design was adopted targeting 146 registered SMEs in the
Springfield Industrial Park in Durban. A purposive sample of 108 participants was selected using non-
probability sampling. The completed sample questionnaires were received representing a 74% response
rate. The validity of the study’s questionnaire was established as the validity test of the data met the
Cronbach's alpha cut-off point of 0.70. Owners of SMEs or appropriate representatives were given a self-
administered, four-point Likert scale-style questionnaire to complete to collect data for the study.

The questionnaires were distributed to respondents to complete. The data, which were converted into
numerical values, were analysed using a scientific statistical analysis program. With the aid of a Smart
Partial Least Squares (SmartPLS) configuration set up on a computer system, the data acquired for this
investigation were analysed.

4. Results and discussion

The following questions and responses were discussed with regard to the influence of
management/owners on current capital budgeting planning and practice.

4.1. Skills and influence of managers/owners

Figure Figure 1 represents the statements related to decision-making of owners and/or managers. The
initial question probed whether prompt management decision-making affects CBP and practices in SMEs
with results indicating agreement from all respondents (23% agreed, 77% strongly agreed). Close
corporations and sole proprietorships account for most of the SMEs’ ownership (De Moura et al.,
Citation2019). Therefore, they are the only ones that decide on budgeting procedures. In most of the
SMEs, the owners typically choose cash flow budgeting over capital budgeting.

The second question, sought to determine whether the CPB, is impacted by the terms and circumstances
of loans made by the different financial institutions such as interest rates or lending rates. Ninety-six
percent of respondents strongly agreed, and 4% agreed which reflects the difficulty for SMEs in getting
finance.

The last inquiry related to the availability of funds impact on CBP and practices in the SMEs. All
respondents agreed on the impact, with 85% of the respondents strongly agreed and 15% agreed. This
finding is a clear indication of the challenges encountered by SMEs in obtaining credit. As indicated in the
literature review, outsourced and third-party funds and borrowings is indeed a critical component of SMEs
financial viability.

Various financial institutions provide loans to SMEs at a very high rate of interest, which deters SMEs from
investing in long-term bigger projects or capital budgeting. It has also been noted that a failure to ensure
creditworthiness and financial performance will adversely influence the financial institutions’ promptness
to pledge to medium- or long-term, investments. This scarcity to gain credit worthiness is a major
limitation for manufacturing SMEs that wish to expand their activities (Yoshino & Taghizadeh-Hesary,
Citation2018).
5. Conclusion

In this modern age of competition, coupled with the challenges of globalisation and borderless markets
made possible through technology, this study revealed that SMEs need special skills, namely CBP, from its
executives in order to sustain.

The results of this study showed that management skills are key determinants of the capital budgeting
procedures utilised by SMEs. These findings highlight some significant policy ramifications in the context of
Springfield’s developing SME sector. Government and regulatory bodies should adopt legislation and
develop regulations that emphasize capital budgeting management as a critical competence for decision-
makers. SMEs should implement rules within their management to improve financial literacy and overall
organisational effectiveness.

This study’s results demonstrated that the largest percentage of SMEs’ ownership are sole proprietorships
and close corporations. The executives are largely not conscious of their creditworthiness, various policies,
rules, and programmes offered by government agencies and tax incentives.

Many managers/owners lack the ability to network with other municipalities and also require the
assistance of external consultants in capital budgeting due to their shortage of internal financial
knowledge. They also require the capability to control, lead, identify and resolve business challenges
within the CBP process.

It is recommended that executives of today’s SMEs should depend less on manual processes and venture
into technology to enhance the performance of CBP which will definitely lead to efficiency and
effectiveness in their service delivery to their respective communities.

Reference: Nunden, N. (2022, October 22). Full article: An Assessment of Management Skills on capital
budgeting ... An assessment of management skills on capital budgeting planning and practices: evidence
from the small and medium enterprise sector.
https://www.tandfonline.com/doi/full/10.1080/23311975.2022.2136481