What are capital budgeting capital structure and working capital?

Answer 1

Capital Budgeting: Capital budgeting is the process of determining whether real assets (tangible assets such as machinery and equipment or intangible assets such as patents and trademarks) are worth investing in or not. The decision on whether to acquire the asset or not is made based on the assessment of the value of the return on investment. An investment will be made if there is value added (basically, if the investment is worth more than the cost incurred).

Capital Structure: Capital Structure mix of financing in the company. Financing is raising money to pay for investments in real assets. There are two forms of financing: debt financing and equity financing. Debt financing is when a company borrows (money, assets, etc) from an investor and must one day repay it. There is usually an interest charged on the loan on top of the principal amount that has to be repaid. The benefit of this form of financing is that interest expense is tax deductible. Obvious examples are taking out a loan from the bank, borrowing from an individual, etc. Equity financing is when a company issues a share in the company to investors. Investors in exchange for cash receive a share in future profits and are partial owners of the company. The benefit of this is that the company does not incur more debt; however, owners lose power as they own less of the company this way.

Working Capital: Working capital is the difference between the current asset (assets that are likely to be converted to cash within the fiscal period) and current liability (liabilities that are due in the fiscal period). This metric represents the operating liquidity of the firm (basically the potential reservoir of cash the company has). This value is an indication of its ability to pay off debt as they mature and allows the business to continue its operation. (Note: a negative working capital does not mean that the company cannot continue its operation, it just means that the company may run into some problems - as an illustration, if we as individuals are in debt, and have no cash, it doesn't mean that we're going to die, it just means that we're in a little bit of trouble.)

In a nutshell:

· Capital budgeting is deciding which real asset to acquire

· Capital structure is a firm's mix of methods for financing investments (equity or debt financing)

· Working capital is the difference between the current asset and current liability and is a gage of the company's cash position