Use of Investment Appraisal Tools and Techniques in Private and Public Sectors - Essay Example

The paper "Use of Investment Appraisal Tools and Techniques in Private and Public Sectors" is a great example of an essay on finance and accounting. An investment appraisal is an activity of calculating the effect of a problem, change, or incident on a business process. It involves assessing the viability of a given project and justifying the expenditure of the capital allocated to that project. There are various investment appraisal techniques used in the public and private sectors. They include the payback method, the average rate of return method, and the net present value method. These are used by many organizations in the public and private sectors (Gotze, 2010, p. 9).

            The payback method is usually preferred by small businesses due to its simplicity. The payback period can be defined as the time taken for the machinery or equipment to generate sufficient net cash flow to pay for its costs. The average rate of return technique involves taking the total yield of an asset over its whole life into account. The net present value method involves taking into account the size of the inflow cash over the life of the equipment, but it also makes adjustments for the timing of the cash (Erickson, 2013, p. 23).

In view of these, an investment appraisal is done to determine whether an investment is worthwhile or not. Generally, businesses invest to increase their profits by making certain changes or improvements. These may include improving their operations, matching supply to demand, reducing manufacturing costs, and increasing productivity and or efficiency in operations. This is common in both the public and private sectors.  However, it is different for non-profit making organizations whose incentive to invest is driven by the need to improve efficiency, effectiveness, and the economy of the organization. This provides value for money (Lumby, 1998, p. 31).

            There are some key considerations that are looked into by firms before investing. These considerations are what determines the differences between the public and private sectors. These considerations include the simplicity required, the degree of accuracy required, and the extent to which future cash flows can be measured accurately. They also consider the extent to which future interest rates can be factored in, and the necessity of factoring in the effects of inflation (Langdon, 2002, p.27).

            The public and private sectors consider the simplicity required due to the implementation of the project. However, the public sector is different in that they have a more capital base as compared to the private sector. The public sector mostly relies on tax paid therefore they have a continuous flow of cash. On the other hand, the private sector has limited capital and so they have to factor in the simplicity in terms of implementation and cash flow. The degree of accuracy required is both in the public and private sectors. This is because most of the investments require a high degree of accuracy to ensure that the expected returns are gained (Dayananda, 2002, p. 25).

            Since most business investments require huge sums of cash, it is important to know the facts related to an investment and the risks involved. These require a high degree of accuracy to ensure that the returns on the investment are worthwhile. Another consideration is the extent to which future cash flows can be measured accurately. It is important for both the public and the private sectors to make investments that are sure to bring in cash that can be foreseen. This is because the organizations need to be aware of whether the investment will lead to their continued operation and even improvement, or closure due to lack of funds (Bacon, 2010, p.33).

            The extent to which future cash flows can be measured accurately is also important for budgeting. The public and private sectors make a budget for future income and expenses. This will enable them to know which area needs cost-cutting and which area needs more attention, due to its ability to bring in more cash. It will also enable them to make prior arrangements regarding their expected supply and services offered. This is common in both sectors since they both need to continue running in an efficient way and make profits (Arnold, 2008, p. 27).

            Another key consideration is future interest rates and inflation. Most businesses require some form of lending at some point. Most of their lending comes from financial institutions like banks. If they make an investment using cash borrowed from financial institutions, they attract an interest rate. These rates change from time to time and so they need to be factored in. This is because it affects the cash flow and if wrongly predicted, might lead to financial strains. However, this applies mostly to the private sector. This is because the public sector has assured cash flow and can increase it at any time in various ways including the increase of taxes. Inflation is also a key consideration by both sectors because they are both affected in the same way (Ross, 2009, p. 36).

            In conclusion, both sectors face common issues, only that the public sector has a higher advantage over others. This is because the public sector has access to a higher amount for investing and the private sector has limited. The public sector also plays a huge role in business trends, therefore, putting the private sector in check. This is based on the reason that there are some investments that can only be undertaken by the public sector through government projects. It enables equality in the provision of services that require a huge capital to invest in (Pike, H.U. 2008, p. 29).