Capital Allocation

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DEFINITION of 'Capital Allocation'

A process of how businesses divide their financial resources and other sources of capital to different processes, people and projects. Overall, it is management's goal to optimize capital allocation so that it generates as much wealth as possible for its shareholders.

BREAKING DOWN 'Capital Allocation'

The process behind making a capital allocation decision is complex, as management virtually has an unlimited number of options to consider.

For example, if a company ends up with a larger than expected windfall at the end of the year, management needs to decide whether to use the extra funds to buy back stock, issue a special dividend, purchase new equipment or increase the research and development budget. In one way or another, each one of these actions will likely benefit the shareholder, but the difficult part is in determining how much money should be allocated to each action in order to yield the most benefit.

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