Capital rationing is the decision process used to select capital projects for funding when there is a limited amount of funding available. There are a number of ways to engage in capital rationing, including the following:
- Restrict funding to those areas most likely to generate the highest returns.
- Channel funding toward strategically important areas.
- Focus funding on bottleneck operations to enhance throughput.
- Apply a higher cost of capital to net present value calculations to strip away lower-return projects.
There may be a funding limitation that causes capital rationing when a business is unable to obtaining funding from outside sources at a reasonable price, or when management decides to allocate available funds to other purposes, such as the payment of dividends to investors.