What is capital budgeting?

Capital budgeting is fundamentally the process of analyzing and selecting projects for investment. This involves evaluating potential expenditures or investments in long-term assets to determine their worth and viability in contributing to the firm's overall profitability and growth. Companies perform capital budgeting to prioritize projects that will yield the highest returns, aligning with their strategic objectives.

In this context, capital budgeting facilitates informed decision-making regarding which proposed projects to pursue, considering factors such as projected cash flows, costs, risks, and the time value of money. By conducting cost-benefit analyses, calculating net present value (NPV), internal rate of return (IRR), and payback periods, businesses can allocate their capital in a way that optimizes resource use and maximizes future returns.

Other options focus on different areas of financial management and do not relate directly to capital budgeting. Managing daily expenses centers on operational finance, ensuring liquidity deals with a company's capacity to meet short-term financial obligations, and planning for employee compensation pertains to human resources and payroll functions. Each of these aspects is critical to a business, but they do not encompass the systematic evaluation and selection process that defines capital budgeting.