Definition

Capital allocation is a financial process in which companies choose the most efficient investment strategy that will make the most of the available financial resources. The end objective of any capital allocation strategy is to maximize shareholder equity.

Example

Most real-world capital allocation strategies focus on:1. Aligning the capital budgeting process with the company's strategic initiatives2. Design and implement sound investment judgment

Why it matters

Companies may come across a number of value-creation opportunities throughout the course of business. However, it’s important to understand and identify which option will be beneficial for overall financial gains:A sound capital allocation process means that a company is likely to remain financially healthy and achieve success. For investors, the company could be worth investing in and may compound shareholder wealth. Capital allocation decisions can significantly impact the company and its future success.

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