Question

Explain the following as factor affecting the choice of capital structure:

Cash flow position

Answer 1

Capital structure is the proportion of debt and equity used for financing business operations.

Cash flow position: The cash flow position should match with the obligation of making payments because if the company fails to make payment will face insolvency. So, a company employs more debt securities in its capital structure if a company is sure of generating enough cash inflow. On the other hand, if there is less cash, then a company should employ more of equity in its capital structure.

Strong cash flow position ⇒ More debt

Weak cash flow position ⇒ More equity