Are Financial Constraints an Important Determination in a Firm's Behavior

However, two known authors in this field of study believe that companies with low business risk obtains factors of production at a lower cost which may also pave to the ability of the firm to operate more efficiently (Amit & Wernerfet, 1990). Therefore, many stockholders faced a high of uncertainty; this is because some companies do not have the financial strengths to cover its debts that even may result to bankruptcy.

A capital structure policy aims to balance the trade-off between the benefits of debt financing (interest tax shield) and the costs of debt financing (financial distress and agency costs). Every firm should set its target capital structure such that its cost and benefits of leverage ultimately maximise the firm’s value. Graham and Harvey asked 392 firms’ chief financial officers whether they use target debt ratios. Results show that the majority of them do, although the level of strictness of the target policy varies across different companies. Only 19% of the firms avoid target ratios, of which most are likely to be the relatively smaller firms. This clearly

As a result, holding cash would be essential component of the firm strategy. To develop new products, buy new equipment or expand geographically, firm has to spend money on marketing research, product design, prototype development and so on. Moreover, if a recession hits and the economy start to slow down,

Liquidity is an important factor in financial statement analysis since an entity that can not meet its short term obligations may be forced into liquidation. The focus of this aspect of analysis is on working capital, or some computer of working capital.

Everyday is another day of experiencing fear; We all live terrified in our daily lives because of this. Fear is believed to what gives people courage, giving strength to overcome a danger or obstacle in daily activities. Everyone has this feeling because of experience or what is frightening to experience. Madeline’s few appearances in Edgar Allan Poe’s “The Fall of The House of Usher” reveals how Roderick’s existence is tied to his sister's life and how her soon-to-be death is his biggest fear.

In their thorough study of financial constraint correlation with investment-cash flow sensitivity, Kaplan and Zingales (QJE,1997) were able to show the more realistic findings. A more narrow scope of samples used in their research which only include group of firms which have the least dividend payout ratio and more possibility to show the relationship. The counterexample and conflict of findings between different literatures is not uncommon, this is due to different assumptions raised by the researcher as explained in the journal. For instance, the study on cash holdings and financial constraint by Kashyap,

In comparing the companies to each other it is important to take into account the liquidity or ability of a firm to meet its current obligations, and solvency

If the firms funding requirements are larger than their retained earnings, they must issue debt as this is preferred to issuing equity. Based on this theory, a firm’s financing policies could be viewed as signalling management’s view of the firm’s stock value (Wang & Lin 2010).Myers and Majluf (1984) also add that if firms issued no new securities but only used its retained earning to support the investment opportunities, the information asymmetric could be resolved. This suggests that issuing equity turn out to be more expensive as asymmetric information insiders and outsiders increase. Large firms should then issue debt to avoid selling under priced securities. As the requirement for external financing increases, businesses will work down the pecking order, from safe to riskier debt, perhaps to convertible securities or preferred stock, and finally to equity as a last resort. Each firm's debt ratio therefore reflects its cumulative requirement for external financing (Myers 2001).The pecking order theory clarifies why the bulk of external financing comes from debt. It also describes why organizations that are more profitable borrow less: since their goal debt ratio is, low-in the pecking order they do not have a goal since profitable firms have more internal financing available.

And the company is suffering from liquidity challenges because it is not in a position to finance its day-to-day activities, so its bank account stands over drawn. This situation has impacted negatively on the company's ability to repay its earlier loans and customers are upset because of delayed delivery.

This study will further lead to the dynamics of KSE listed firms. Investor trends towards highly leveraged firms and determination whether the optimum capital structure effects the decision of investor resulting change in the balance sheet of a company.

Harris and Reviv (1990) gave one more reason of using debt in capital structure. They say that management will hide information from shareholders about the liquidation of the firm even if the liquidation will be in the best interest of shareholders because managers want the perpetuation of their service. Similarly, Amihud and Lev (1981) suggest that mangers have incentives to pursue strategies that reduce their employment risk. This conflict can be solved by increasing the use of debt financing since bondholders will take control of the firm in case of default as they are powered to do so by the debt indentures. Stulz (1990) said when shareholders cannot observe either the investing decisions of management or the cash flow position in the firm, they will use debt financing. Managers, to maintain credibility, will over-invest if it has extra cash and under-invest if it has limited cash. Stulz (1990) argued that to reduce the cost of underinvestment and overinvestment, the amount of free cash flow should be reduced to

Although the income statement and balance sheet provide measures of a company’s success in terms of performance and financial position, cash flow is also vital to a company’s long-term success. Disclosing the sources and uses of cash helps creditors, investors, and other statement users evaluate a company’s liquidity, solvency, and financial flexibility. Financial flexibility is the ability of a company to react and adapt to financial adversities and opportunities. McDonald’s cash flow is

The management of cash is essential to the survival of any organization. Managing an organization’s financial operation requires knowledge of the economy and ways to maximize revenue. For any organization to operate on a daily basis adequate cash flow is required. Without cash management the organization will be unable to function because there is no cash readily available in case of inconsistencies in the market. Cash is also needed to keep the cycle of the company’s operations going.

* A firm is financially liquid if it is able to pay its bills on time

In order to distinguish the various confounding factors that may impact the responses from firms that are financially constrained or unconstrained, Campello, Graham, and Harvey use the methods of Abadie and Imbens (2002) and Dehejia and Wahba (2002) and match their firms according to size, industry, ownership structure, credit score, profitability, whether or not they pay a dividend, and prospects for future growth. In this manner, they analyze financially constrained firms (as the treatment group) with the constructed counterfactual firms that were not financially constrained (the control group).