This paper proposes an efficient methodology for optimal location and sizing of static shunt capacitors in radial distribution systems to reduce real power loss, improve voltage profile and to maximize total cost saving. The solution methodology has two parts: In part one, the buses to be compensated is identified using loss sensitivity factors. In the second part, modified artificial bee colony algorithm is used to select the optimal size of capacitors to be placed at the candidate buses. In addition the number of candidate buses is selected by searching for maximum cost saving. The results of proposed approach have been presented and compared with previous methods reported in the literature using four test cases. The presented results indicate the efficiency and quality of solution.