The key difference between capital budget and revenue budget is that capital budget assesses the long-term financial viability of investments by comparing future cash inflows and outflows whereas revenue budget is a forecast on revenue that will be generated by the company. Both these type of budgets are very important for the success and stability of the company. When the revenue is growing at a swift pace, the company needs to make more investments in new capital projects. Thus, there is a positive relationship between capital budget and revenue budget.
CONTENTS
1. Overview and Key Difference
2. What is Capital Budget
3. What is Revenue Budget
4. Side by Side Comparison – Capital Budget vs Revenue Budget
5. Summary
What is Capital Budget?
Capital budgeting, also known as ‘investment appraisal’, is the process of determining the viability of long-term investments on purchase or replacement of property plant and equipment, new product lines, or other projects. There are a number of techniques in capital budgeting that managers can choose from. Every technique may not be suitable for every investment option since the appropriateness significantly depends on the nature of the investment project. The main criteria used by the following investment evaluation techniques is the comparison between the cash inflows the capital project will generate in the future and the cash outflows it will incur.
Payback Period
This measures the time the project takes to return the initial investment. Cash flows are not discounted, and lower payback period means that the initial investment will be recovered soon.
Discounted Payback Period
This is the same as the payback period with the exception that the cash flows will be discounted. Therefore this is considered more appropriate compared to the payback period.
Net Present Value (NPV)
NPV is one of the most widely used investment appraisal techniques. NPV is equal to the sum of initial cash outflow minus the sum of discounted cash inflows. Decision criteria for NPV is to accept the project if the NPV is positive and reject the project if NPV is negative.
Accounting Rate of Return (ARR)
ARR calculates the profitability of an investment by dividing the projected total net income by initial or average investment.
Internal Rate of Return (IRR)
IRR is the discount rate at which net present value of the project becomes zero. Higher IRR is preferred where the decision criteria is similar to NPV.
Figure 01: Comparison between two projects helps understand which project will be more financially profitable
Since capital projects require significant amounts of funds it will be financed by way of equity or debt. Many companies accumulate funds obtained through profit on the sale of fixed assets, profit on revaluation etc. in a dedicated reserve over time to use for such capital projects. This reserve is referred to as the ‘capital reserve’ and funds in it will not be used for routine business activities.
What is Revenue Budget?
As the name suggests, a revenue budget is a forecast of future revenue and related expenditure. Revenue budgets are generally prepared for a time span of one year, covering the financial accounting year. This is due to the fact that it will be difficult to plan revenue for a period exceeding one year since the results will be less accurate. Revenue budgets are prepared by corporates as well as by the governments. For governments, revenue budgets serve as an integral part of fiscal policy.
In a revenue budget, sales will be forecasted incorporating the demand factor and will be done based on the past revenue records. Revenue budget is closely associated with the production budget since costs should be considered prior to making decisions regarding sales quantity and price. Like with capital reserve, companies also maintain a ‘revenue reserve’ that is created out of profits made by day to day business activities. Funds in this reserve can be utilized in times of increase in the cost of production.
What is the difference between Capital Budget and Revenue Budget?
Capital Budget vs Revenue Budget |
|
| Capital budget assesses the long-term financial viability of investments by comparing future cash inflows and outflows. | Revenue budget is a forecast on revenue that will be generated by the company. |
| Preparation | |
| Different capital budgets are prepared for each investment project. | Revenue budget is a main budget that is prepared for the year as a part of the budget process. |
| Complexity | |
| Capital budget involves a number of factors that should be considered, thus complex in nature. | Revenue budget is less complicated compared to capital budget. |
Summary – Capital Budget vs Revenue Budget
The difference between capital budget and revenue budget is a distinct one with capital budget forecasting the future cash inflows and outflows of capital projects and revenue budget estimating sales revenue. Making investments should be done after considering both quantitative and qualitative factors properly. Capital budgeting techniques only take into account the financial viability of an investment; thus they should not be the sole criteria for decision making. Furthermore, qualitative factors should also be considered in revenue budgeting in relation to competitor prices and market share.
Image Courtesy:
1. “PDF2NPV” By AdamD – Own work (Public Domain) via Commons Wikimedia
References:
1. Jan, Irfanullah. “Capital Budgeting.” Capital Budgeting | Techniques | Introduction. N.p., n.d. Web. 28 Mar. 2017.
2.”What Is a Revenue Budget?” Chron.com. Chron.com, 14 June 2012. Web. 29 Mar. 2017.
3. Anand. “Difference between Revenue budget and capital budget.” Difference between Revenue budget and capital budget. N.p., n.d. Web. 29 Mar. 2017.