Reduce the Cost of External Financing Finance Essay

The main objective of working capital management is to conserve an optimal balance among each of the working capital contraption. Business success heavily depends on the financial executives’ capability to efficiently manage receivables and loans, account, and payables (Filbeck and Krueger, 2005). Firms can diminish their bankrolling costs and raise the funds available for development projects by reducing the amount of speculation tied up in current assets. Van Horne (1995) explains that, working capital management is the administration of current assets in the name of cash, merchantable securities, receivables and staff loans, and inventories. Osisioma (1997) recognized that good working capital management must guarantee an suitable relationship between the different mechanisms of a firm’s working capital so as to make an efficient mix, which will guarantee capital acceptability. Thus, working capital management should make sure that the necessary amounts of each element of the working capital are available for management. However, the question is “What controls the necessary workings of a bank are working capital and how much of such necessary components can be observed as acceptable or desirable?” The necessary mechanisms of an establishment’s working capital, basically, depend on the type of business and industry. Cash, debtors, receivables, accounts, marketable securities, and redeemable futures can be predictable as the mutual components of organization’s working capital. However, the question is to recognize the factors that regulate the capability of working capital based on growth, size, operating cash flow, etc. The incapability to understand the influential factors and dimension of passable amounts of working capital will main an association to bankruptcy.

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Determination of cash level of Bank:

Among the key factors which inspiration level of cash situation of firms comprise but not incomplete to leverage, firm size, growth occasions, efficiency of firms, firm productivity, age, previous level of cash and firm risk. (Kim et al., 1998; Ferreira and Vilela, 2004; Ozkan 2004) establish a discount in cash levels when firms raise their financial influence. This may be because the advanced the financial leverage, the higher the budgets of the funds used to advance in liquid assets (Baskin, 1987). According John (1993) maintains, firms that can access the debt market can alternative to providing as a additional for liquid assets. Size is another momentous variable that affects cash holdings. The traditional models to determine the optimal cash levels (Baumol, 1952; Miller and Orr, 1966), or more recent models such as that of Mulligan (1997), demonstrate that there are economies of scale associated with the cash levels required to confront the normal transactions of the firm, so that larger firms can keep lower cash holdings. Moreover, firm size is related to another set of factors that may influence liquidity levels. More specifically, smaller firms suffer more severe information asymmetries (Berger, Klapper and Udell, 2001), more financial constraints (Fazzari and Petersen, 1993) and they are more likely to suffer financial distress (Rajan and Zingales, 1995). Also, financial distress is related with high fixed costs and these costs are consistently better for minor firms. Therefore, we would imagine a adverse relation between firm size and cash properties.

Growth opportunity:

The existence of growth opportunities in firms is an important factor that affects cash levels, as has been shown in various empirical studies (Kim et al., 1998; Opler et al., 1999; Ferreira and Vilela, 2004; Ozkan and Ozkan, 2004). As Myers and Majluf (1984) point out, firms whose value is largely determined by their growth opportunities have larger information asymmetry. Consequently, firms with greater growth opportunities incur higher external financing costs. They also suffer more serious agency conflicts associated with the debt, which can lead to underinvestment (Myers, 1977), insofar as it discourages shareholders from embarking on profitable projects. On the other hand, firms with more growth opportunities may also incur greater costs of financial distress (Harris and Raviv, 1990; Shleifer and Vishny, 1992). This is because their value depends on their growth opportunities rather than on tangible assets or specific cash flows. Thus, this type of firm will keep higher cash levels to avoid costs of financial distress. In this respect, John (1993) finds that firms with good growth opportunities but few tangible assets tend to keep higher cash holdings. Hence we might expect firms with more investment opportunities to keep higher liquidity levels, in order not to limit or cancel their profitable investment projects. Their value depends on carrying out these projects, so that the cost of not having sufficient cash to make the investments is higher. This notwithstanding where firms have projects on-going their levels of cash may dwindle as more of their cash are put into investment projects. Thus age and bank growth (measured as change in interest income) are used as proxies for firm growth.


Profit is a source of cash flow for firms. The amount of profit made by a firm is either retained for funding future investment opportunities or distributed to shareholders as dividend. Even though the amount of profit made in a particular year by a firm does not automatically translate into exactly the same amount of cash, it is unlikely that less profitable firms would have more cash flows than highly profitable firms, all other things being equal. Therefore, profitable firms are expected to have more cash than less profitable firms.


Firms that are risky tend to use cash holding as buffer against future uncertainties. Guney et al. (2007) contend that firms with more volatile cash flows are expected to hold more cash in an attempt to mitigate the expected costs of liquidity constraints. After short falling of liquid asset, when firms have valuable growth opportunities, then these opportunities are given up and firm value will drop. Minton and Schrand (1999) find that firms with higher volatile cash flow permanently forgo investment rather than reacting to cash flow shortfalls by changing the discretionary investment timing. Again, firms that hold a lot of debt are considered to be more risky than others. In order to manage working capital efficiently, there is the need that financial

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Reduce The Cost Of External Financing Finance Essay. (2017, Jun 26). Retrieved November 29, 2022 , from

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