Cash Flow Risks, Capital Structure Decisions and Cash Flow Shortfalls

Firstly, this research investigates the relationship between cash volatility and financing decisions and then, investigates the effect of cash flow shortfalls on the relationship between financing through debt and cash flow volatility. So, based on theoretical background and pervious researches two hypotheses were developed. Based on first hypothesis, a positive relationship is expected between cash flow risks and debt level in capital structure of firms. Those firms facing with increased risk of cash flows, may need extra cash for the financing of their operations or they may face with a shortage of cash which in this case they will look for ways of financing through issuing debt. Also, it is expected that a shortage in operating cash flows affects the relationship between cash flow risk and capital structure. In another words, the relationship between debt in capital structure and cash flow risks is stronger for those firms with a shortage in operating cash flows.

This is an applied research and we have used the regression to run the research models. The Research sample consists of 178 firms (1068 firm-years) listed on the Tehran Stock Exchange (TSE) during 2014 and 2019. Research sample is excluded from financial firms, banks, insurance firms or firms with missing data. All data have been winsorized at the one percent and 99 percent levels.

As expected, the results show that there is a positive and significant relationship between cash flow volatility and capital structure (use of debt). So, it can be said that those firms facing a higher risk of cash flows, issue more debt.  In addition, the results show that the relationship between cash flow risk and the use of debt in capital structure is tenser for firms with low operational cash flows. For those firms with high operating cash flow this relationship does not exist.

increased risk of cash flows results in the need for financing of activities through cash flow or creates a loss or shortage of cash flows by firms. Thereby, firms look for the way to finance through issuing debts. Thereby, it is advisable for lenders and also for investor and analyst to pay especial attention to cash flow variances and risk when analyzing cash flow statements, operating cash flows and the financial statements of companies. Also, auditors should consider these risk when assessing the continuity principle for issuing an audit report. Future researches can identify other factor affecting the relationship between cash flow risk and issuing debt. Also, the effects of financing level limitation on the relationship between cash flow risk and capital structure can be investigated in future papers.