CASH FLOW AND LIQUIDITY

Assignment 1: Cash Flow Management and Liquidity Crisis

Assignment 1: Cash Flow Management and Liquidity Crisis

Question No. 1

Credit ratings and financial performance directly affect the decisions of the capital structure. Capital structure is determined on the basis of the nature of operations, market characteristics, product offering, industry structure, and financial performance of the companies. When a company expands, it needs capital; depending on the kind of business, financing sources distinguish on borrowing or internal funds. Borrowings have two significant advantages. First, the interest paid shall be deducted when calculating the tax, which reduces the actual cost of the loan. Secondly, those who provide the loan, receives a fixed income; in this case, shareholders do not have to share the profits with them, if the company is successful (Helfert, 2001).

However, the debt has its drawbacks. First, the higher the debt ratio, the riskier the company, and consequently, higher cost of capital for firms. Second, if operating profit of a company is not enough to cover interest costs, the shareholders have to compensate for a deficiency. The company is declared bankrupt in case its financial liabilities exceed the total assets capitalization (Ehrhardt, 2010).

One of the biggest challenges that entrepreneurs are facing today is managing cash flow.  The company needs to understand the prospects of its business development approach, and potential cash flows that it generates (Brigham, 2008). The daily process of cash management in a company includes various activities, the determination of liquidity based on current bank account balances (cash position), receivables and payables remaining unpaid (liquidity forecast ), to the movements of manual input stream (opinion) and balancing several bank balances on a target account (Helfert, 2002). Additionally, it is necessary to focus on what ways have been used for borrowing funds from external sources, and to what extent the company is in a position to manage the financial charges and principal amount on earlier loans.

Management of cash flows main objective of providing funds sufficient liquidity to cover all payment obligations expired. Its other objective is to ensure optimum control flow collection and disbursement. Effective management of cash flow creates a basis for making investment transactions or borrowing (Helfert, 2001). The main objective of cash flow analysis is to identify the level of adequacy for the accumulation of funds, their effectiveness in the business operations management, managing the company's cash flows balances by volume and time. Therefore, companies that have unstable earnings and operating cash flows should limit the financing through loans. On the other hand, those companies that have stable cash flows are free to attract debt financing. This section of the report shows the cash flow statement of Belton Limited for the year ended Mar 31, 2011 and Mar31, 2012. These cash flow statements have been prepared in accordance with FRS1.

Cash Flow Statement for the Year Ended 31st March 2011

Belton Limited

Cash Flow Statement

For the Year Ended 31st March, 2011

(in 000's)

Cash Flow from Operating Activities

$ 660

Returns on investments and servicing of finance

Interest paid

$ (100)

Interest received

$ -

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