Capital Rationing and Budget Allocation

As should become obvious by now, capital budgeting, like an operating budget, is a long, complex, and arduous process. Much of this complexity arises from the fact that there is more demand for projects, programs, and improvement activities than the available resources. This is particularly true for government where agencies often compete with other agencies for limited resources. This discrepancy between demand for capital expenditure on the one hand and the availability of resources, on the other, makes budget allocation a complex undertaking. The process of allocating resources when faced with budget constraints is known as capital rationing. Capital rationing is not a problem for projects that are mutually exclusive or when one is restricted to selecting a few from multiple competing projects; there are usually physical reasons for that. Capital rationing is a problem when multiple projects have to compete for limited resources. Theoretically, if there are no resource limitations; in other words, no budget constraints, there would not be any need for capital rationing, but the fact that resources are limited, while the demand for projects, programs, and improvement activities is unlimited, it increases the need for capital rationing. This chapter provides a brief overview of why capital rationing is necessary, followed by a general discussion of some of the commonly used methods of capital rationing, with and without budget constraints.