OVERVIEW OF CAPITAL STRUCTURE AND TARGET
Capital structure
In a market economy, companies can leverage various sources of capital to meet their business demands It is crucial to strategically combine these capital sources to create an optimal capital structure that aligns with their value objectives.
Capital structure refers to the proportion of different sources of capital that a company utilizes to finance its business operations It illustrates how a company chooses to fund its assets through various means, including bank loans, issuing shares or bonds, and utilizing retained earnings from its operations.
The dicision about capital structure is very important with the company because:
- Capital structure of the company affects the cost of capital.
- Capital structure affects the company’s return on equity or earning per share and financial risk.
Capital structure of the company is usually expressed by the relationship between debts and equity ( owner’s capital) Capital structure is discribed through some main ratios:
Total assets ∨source of capital This ratio shows the percentages of debt in capital structure of the company.
Shareholder s ' equity The company can have various capital structure, but all of them are to maximize the value of the company.
1.1.2 The theories of capital structure 1.1.2.1 Modigliani and Miller approach
This theory was devised by Modigliani and Miller during 1950s.
Modigliani and Miller advocates capital structure irrelevancy theory The valuation of a firm does not depend on the capital structure of a company.
Whether a firm is highly leveraged or not in the financing mix, the value of the company is not affected.
The Modigliani and Miller Approach suggests that a firm's market value is influenced not only by the risks associated with its investments but also by its future growth prospects Companies with strong growth potential tend to have higher market values and elevated stock prices.
The Modigliani and Miller approach is based on several key assumptions: there are no taxes, and both transaction and bankruptcy costs are nonexistent Additionally, it assumes that information is symmetrical, meaning investors have access to the same information as companies Furthermore, the cost of borrowing remains consistent for both investors and companies, and importantly, debt financing does not influence a company's Earnings Before Interest and Taxes (EBIT).
Modigliani and Miller Approach: Two Propositions without Taxes
According to Proposition 1, under the assumption of no taxes, a firm's capital structure does not affect its valuation This means that financing through debt does not enhance the company's market value.
Proposition 2 states that financial leverage directly affects the cost of equity As a company's debt increases, investors perceive a higher risk, leading to an elevated cost of equity to compensate for this risk However, the weighted average cost of capital remains unchanged, as the rise in the cost of equity is balanced by a decline in the cost of debt.
Modigliani and Miller Approach: Propositions with Taxes (The Trade-Off Theory of Leverage)
A company's value is enhanced when it incorporates debt into its capital structure, as opposed to relying solely on equity This means that a firm with a combination of debt and equity is valued higher than one that does not utilize debt, with the added value being equivalent to the firm's equity value plus the present value of the tax shield gained from the debt.
Proposition 2 states that when income tax is present, a company with a combination of debt and equity experiences a higher cost of equity compared to a company that relies solely on equity As a company increases its use of debt financing, the required rate of return for equity owners rises due to increased risk However, this rise in the cost of equity is less than the difference between the asset return rate and the cost of debt, leading to a decrease in the weighted average cost of capital.
1.1.2.2 Capital Structure theory – Traditional approach.
This theory states that there is a optimal capital structure where the value of the company can be magnified by suitable financial leverage level.
Utilizing debt financing can lower a company's cost of capital; however, increasing debt also elevates the company's risk, leading creditors to demand higher returns.
As gearing rises to a critical point, the associated risks escalate, leading to an increased required rate of return on both debt and equity This surge in costs ultimately diminishes the advantages of utilizing debt financing.
1 The rate of interest on debt is constant for a certain period and thereafter with increase in leverage, it increases
2 The expected rate by equity shareholders remains constant or increase gradually After that the equity shareholders starts perceiving a financial risk and then from the optimal point and the expected rate increases speedily.
3 As a result of activity of rate of interest and expected rate of return, the WACC first decreases and then increases The lowest point on the curve is optimal capital structure.
Diagrammatic Representation of Traditional Approach to Capital Structure
PICTURE 1.1 COST OF CAPITAL AND TRADITIONAL APPROACH
1.1.2.3 Capital Structure theory – Net operating income approach
According to this theory, a company's value and Weighted Average Cost of Capital (WACC) remain unchanged despite fluctuations in its financial leverage level In essence, the theory posits that there is no optimal capital structure, suggesting that a company's value and share price are independent of its capital structure composition.
This means that when the company finances more debt, the general rate company do not change.
1 The overall capitalization rate remains constant irrespective of the degree of leverage At a given level of EBIT, value of the firm would be
2 Value of equity is the difference between total firm value less value of debt i.e Value of Equity = Total Value of the Firm – Value of Debt
3 WACC (Weightage Average Cost of Capital) remains constant; and with the increase in debt, the cost of equity increases Increase in debt in the capital structure results in increased risk for shareholders As a compensation of investing in highly leveraged company, the shareholders expect higher return resulting in higher cost of equity capital.
1.1.2.4 Capital Structure theory - Pecking order theory.
Information asymmetry exists between company directors and external investors, as directors possess a clearer understanding of their company's operations Typically, companies first finance projects through internal capital sources, primarily retained earnings, followed by new debt issuance, with issuing shares being the last resort This approach is particularly evident in companies with low profitability, which tend to rely more on debt financing due to a lack of internal capital, making debt the preferred option among external funding sources.
SITUATION OF CAPITAL STRUCTURE OF COMPANY
Overview of company Thang Long mechanical four and construction joint
2.1.1 The basic information about company Thang Long mechanical four and construction joint stock company
+ The name of the company: THANG LONG MECHANICAL FOUR AND CONSTRUCTION JOINT STOCK COMPANY
+ Address: Hai Boi commune- Dong Anh district- Ha Noi City.
- Email: thanglong@meco.vn Website: meco.vn
Thang Long Mechanical Four and Construction Joint Stock Company, originally established as a state-owned enterprise in 1974 under Thanglong Construction Corporation of the Ministry of Transport, transitioned to a joint stock company in June 2007 This change was in accordance with Decision No 1564/QD-BGTVT issued by the Ministry of Transport and is reflected in the business registration No 0100104436.
- Manufacturing and installing steel structure and steel girder for transportation fied and other line of business.
- Manufacturing and installing towers for electrical transmission line, telecomunation, broadcast station.
- Installing, managing and constructing high – voltage system 35kv.
- Manufacturing bridge crane and elevating machineries.
- Manufacturing pressure – producing equipments and pressure vessels.
- Manufacturing standard size and non standard size with a lot of kind bolt.
- Inspect welding quality by non destroy method: penetration testing, magnetic testing, ultrasonic testing, radio graphic testing.
- Construction of transport projects, civil projects, hydraulic power plant projects.
- Construction of infrastructure of urban area, industrial zone, resident area.
- Trade in exporting, importing material, equipment machinery.
2.1.1.2 The organization chart of Thang Long mechanical four and construction joint stock company.
PICTURE 2.1: THE ORGANIZATION CHART OF THE COMPANY
- Board of general management: this department is in charge of general management of the activities of the company, making decisions concerning all of operations of the firm.
- General director is the person that represents the board of general management to run directly the daily operations of the company.
- Supervisor board will control and check the management of the general director and general board management.
- Dubty general directors are the persons that supports the general director in management and decisions of aspects such as: marketing, economic, technical economic and industrial.
Various departments within a company, including marketing, finance, technical, and materials, are responsible for studying, managing, planning, and reporting on the company's overall situation to the management.
2.1.1.3 The system of accounting of the company.
SYSTEM OF ACCOUNTING OF THE COMPANY
The business characteristics of company Thang Long mechanical four
The machineries of the company all have the best quality because they are imported from Europe and the countries which are good at technology like China, Japan or Russia…
- Power capacitor 0,4KV from Korea with the capacity of 6x30 KVAR.
- Generator 600KA from Germany with 600KVA
- Generator 25KVA from Japan which is the equipment has great capacity in building or constructing projects.
- The compressed air dryer system with the best quality:
+ Air compressor cyclon 6075 from France with the capacity of 10m3/p.
+ Compare Set 1200 Air – cleaning equipemt from Italya The cutting, punching, sawing, bending machine of the company which support the worker to buil and construct projects, such as:
+ MIB 610 KN steel plate cutting machine from France It can operate at the capacity of 7,5 kw.
+ FICEP – 604N punching and shearing machine is imported from Germany with the capacity of 15kw.
+ Q34-16 Gouging machine with 2 center punchs from Japan.
+ VPIAP angle steel Gouging machine from France.
- Plate - bending machine – edge beveling machine such as:
+ NIKATA hydropierce Plate bending machine which is imported from Japan with the capacity of 30kw.
+ ZB41 Plate bending machine which is from China has the capacity of 22kw.
To maintain high-quality standards in its projects, the company utilizes various machines, including milling machines, lathes, and drilling machines Each of these machines undergoes thorough inspections and is sourced from reputable manufacturers in China and Russia.
The company boasts over 120 advanced pieces of equipment, all imported from countries renowned for their cutting-edge technology This significant asset not only enhances the company's capabilities but also strengthens its competitive edge in the market.
The company incurs significant expenses in acquiring materials for construction projects and manufacturing machinery, making market prices crucial to its operations The costs of essential production materials, such as iron and steel, fluctuate dramatically, directly impacting the business's financial stability and operational efficiency.
The company's material supply is consistently secured through partnerships with numerous suppliers across Vietnam, ensuring a stable and reliable source of materials By strategically selecting suppliers located near the project site, the company is able to minimize expenditure and guarantee a seamless material supply chain.
2.1.2.3 The capability of skilled workmanship of Thang Long mechanical four and construction joint stock company.
The workmanship in Thang Long mechanical four and construction joint stock company all are well schooled in machanical and construction before working at the company.
TABLE 2.1: THE CAPABILITY OF SKILLED WORKMANSHIP THANG LONG MECHANICAL FOUR AND CONSTRUCTION JOINT STOCK
: The document of the capacity) 2.1.2.4 Output market and the ability to compete of the company.
In 2016, significant global events, such as the establishment of the Asian Economic Community (AEC) and the signing of the Trans-Pacific Partnership among 12 Pacific nations, created a favorable environment for company development.
The rapid development of construction projects enables the company to expand its business operations effectively Over the years, the company has successfully completed numerous significant projects, including the manufacture of cladding for the Cat Linh-Ha Dong rail transit project, the construction of 11 bridges in Lao DRP, and the Minh Dao and 3-2 Ha Giang bridge projects, among more than 100 others This impressive track record highlights the company's competitive edge in the market and enhances the reputation of Thang Long Mechanical Four and Construction Joint Stock Company in Vietnam.
Overview of financial situation and performance of company Thang
TABLE 2.2: SOME FINANCIAL RATIOS OF THE COMPANY IN RECENT
5 Cost of good sold Million
(Source: Balance sheet and income statement of the company in year
Acorrding to this table, we can show some features of financial stuation of the company in recent years:
In 2015, the company's average capital rose to 337.861 million VND, reflecting a 15% increase from 293.847,5 million VND in 2014, driven by a significant rise in receivables exceeding 133 billion VND and a notable decrease in inventory by over 35 billion VND This fluctuation in receivables and inventory is typical for the construction industry, where high-value projects often involve extended payment timelines Despite completing several projects in 2015, payments from partners were still pending, contributing to the rapid increase in receivables compared to the previous year.
2015 had a fall but it is not signicant to show the decrease in size of operation.
The company's inventory levels experienced a significant decline, primarily due to its just-in-time delivery approach, where materials are directly transported to construction sites, minimizing in-store inventory Fiscal 2015 was a pivotal year, marked by the completion of multiple projects and the initiation of new ones, which contributed to the substantial reduction in inventory.
In 2015, the company's average equity rose significantly from 33.042 million dong in 2014 to 47.880,5 million dong, marking an increase of 14.838 million dong, or 45% This growth in equity contributed to a decrease in the company's gearing ratio, which fell from 0.89 in the fiscal year 2014 to 0.84 in 2015.
In 2015, the company increased its asset size by issuing common shares to fund three new projects and a new factory, which effectively reduced its gearing ratio This strategic move decreased financial risk and lessened the company's reliance on external financing.
In 2015, the company's net revenues from construction projects declined by 21%, falling from 479.486 million dong in 2014 to 378.298 million dong, a decrease of 101.188 million dong Simultaneously, the cost of goods sold also decreased by 20%, from 439.776 million dong to 350.173 million dong Despite this decline in revenues, the company achieved a remarkable increase in net income, rising by 1.445 million dong, which represents a significant growth of 40%.
The company's revenue fluctuations are closely tied to project progress, rather than a reduction in business activities In fiscal 2015, revenue was primarily generated from a few completed projects, such as Chanh Hoa Bridge, 1A Highway, and Bo Ao Bridge, while many others were still in the initial stages Despite a decline in net revenue, the company maintained its net income by effectively managing expenses, including financial costs and materials, which not only boosted profits but also enhanced financial resources for 2016.
- The operating ratios of the company in 2015 had a good performance.
The company's Return on Assets (ROA) and Return on Sales (ROS) improved significantly, with ROA rising from 1.23% to 1.50% (a 22% increase) and ROS growing from 0.76% to 1.34% (a remarkable 77% increase), indicating enhanced operational efficiency The effective utilization of machinery and equipment contributed to these positive results However, despite a substantial growth in equity at 100%, the Return on Equity (ROE) experienced a slight decline of 0.38% in fiscal 2015 Overall, the company achieved a successful fiscal year.
Situation of capital structure of Thang Long mechanical four and
Situations of size and structure of capital in Thang Long mechanical four and construction joint stock company
TABLE 2.3: SIZE, STRUCTURE AND FLUCTUATION OF CAPITAL STRUCTURE FROM FISCAL 2013 TO 2015
1 Capital invested by the owners.
Overview of situation of capital:
From fiscal years 2013 to 2015, Thang Long Mechanical Four and Construction Joint Stock Company experienced significant growth in total capital At the end of 2013, the company's total capital was 290.569 million VND, which rose to 296.127 million VND by the end of 2014, marking an increase of 2.26% By December 31, 2015, total capital further increased to 378.595 million VND, reflecting a substantial growth of 81.468 million VND or 27.42% compared to 2014 This remarkable rise in total assets indicates that the company is rapidly expanding its operations, thereby enhancing its potential for future profitability.
- Liabilities at the end of the year 2014 had an 4.485 million VND increase with growth rate of 1,73% compared to the same time in year 2013.
In 2015, the company's total liabilities rose to 316.913 million VND, marking an increase of 53.865 million VND or 20.48% compared to 2014 This change was driven by a 6.979 million VND increase in short-term debt and an 82.059 million VND surge in long-term debt, despite a decrease of 28.195 million VND in short-term debt The rise in liabilities was influenced by the completion of projects like Rach Chiec Bridge and Lao Bridge, allowing the company to recognize revenue and reduce deferred revenue Additionally, the firm utilized this fiscal year to pay off accounts payable to suppliers from previous years.
The recent financial activity has led to a significant decrease in the balance sheet, with both accounts payable and deferred revenue declining rapidly This situation poses challenges for the company in raising capital, as a sharp drop in cash alongside decreasing liabilities could negatively impact its reputation due to high gearing While increased liabilities can provide essential resources for business expansion and ongoing projects, they also heighten financial risks Excessive reliance on liabilities may hinder the company's ability to meet loan obligations, further damaging its market reputation Operating in the construction industry necessitates substantial capital for project development, making it impractical to rely solely on owner equity Therefore, it is crucial for the company to manage its debt levels effectively to mitigate payment risks.
- Debt structure of the company is very important to study carefully On
As of December 31, 2014, the company's debt constituted 88.53% of its capital structure, reflecting a slight decrease of 0.45% from the end of 2013 By December 31, 2015, this figure further declined to 83.66%, indicating a gradual reduction in the company's gearing from fiscal 2013 to fiscal 2015 In 2013, short-term debt comprised 95.83% of total debt, suggesting a minimal proportion of long-term debt The end of 2014 saw only minor fluctuations in the proportions of short-term and long-term debt, indicating a continued reliance on short-term borrowing, which lowers the cost of capital due to the lower interest rates associated with short-term debt However, this strategy also increases the company's payable pressure By fiscal 2015, the overall debt proportion decreased to 83.71%, while short-term debt fell to 71.49%, marking a significant decrease of 25.40% compared to the previous year.
It means that the proportion of long term debt increased from 3,15% to
The company is increasing its long-term debt, primarily through loans from commercial banks, which could elevate its cost of capital and financial risk, as long-term debt is generally riskier and more expensive than short-term options Despite the decline in accounts payable and deferred revenue, the company needs to secure long-term financing to support its operations It is crucial for management to implement strategies to mitigate financial risk and enhance the company's borrowing capacity.
- Owners’ equity comes mainly from the capital invested by the owners or shareholders From fiscal 2013 to 2015, equity has continued increasing.
In 2014, the company's equity rose by 2.073 million VND, reflecting a growth rate of 6.48%, primarily driven by retained earnings from prior years The following year, 2015, saw a significant increase in equity, which surged by 27.603 million VND compared to 2014, resulting in an impressive growth rate of 81.30% This substantial rise was largely attributed to the issuance of new shares aimed at financing investments in a factory and equipment.
2015 This activity made the gearing and financial risk of the company decrease It means that the company depends fewer on outside.
In fiscal 2013, owners’ equity represented 11.01% of the capital structure, increasing to 11.47% in 2014 By the end of 2015, the company enhanced its equity mix, raising the proportion to 16.29%, marking a significant 4.87% increase from the previous year Although a higher equity ratio may lead to an increased Weighted Average Cost of Capital (WACC), it effectively reduces gearing, thereby lowering financial risk and repayment pressure Consequently, adopting a greater equity base is a prudent strategy, especially in a context of elevated gearing levels.
Gearing and debt/equity ratio.
TABLE 2.4: GEARING AND DEBT/EQUITY OF THE COMPANY FROM FISCAL 2013 TO FISCAL 2015
Table 2.4 illustrates the year-to-year fluctuations in the company's gearing and debt/equity ratio, which are expected given the high level of gearing.
The gearing is a comparison of how much of a firm's activities are funded by borrowed funds as compared to owner's funds.
Between 2013 and 2015, the firm's gearing ratio declined, indicating a reduced reliance on debt within its capital structure By fiscal year 2015, the company's gearing decreased by 0.0482 times, dropping from 0.8853 to 0.8371, which corresponds to a 5.45% reduction during that period.
By the end of 2015, the company's gearing ratio stood at 0.8371, indicating that for every 1 VND invested in assets, it had to borrow approximately 0.8371 VND, a slight decrease from 0.8853 VND in 2014 Notably, the company's gearing level remains relatively high compared to its peers, largely due to its focus on construction projects such as bridges, roads, highways, and factories, which necessitate significant external financing.
Liabilities serve as a crucial source for the company, helping to bridge financial gaps while simultaneously increasing financial risk and pressure on payables In fiscal 2015, the company initiated several major projects, including the Bo Ao Bridge valued at 18 billion VND, the Rach Chiec Bridge at 127 billion VND, and the Chain Bridge for mountainous regions, among others To finance these endeavors, the company secured long-term loans from Sea Bank and Agribank, resulting in a rapid increase in long-term debt.
Although the company is using more equity by issuing new shares to provide more money for its operation, its gearing reduced from 2013 to
Although the gearing ratio remains elevated compared to industry standards, it has been reduced by minimizing the misappropriation of accounts payable and deferred revenue Additionally, the company has lowered its debt proportion within its capital structure to mitigate financial risks and enhance its capacity to meet liabilities Therefore, it is essential to continue decreasing the gearing ratio while it remains high.
This ratio shows the independence on finance of the company In
2013, when the company raised a debt of 8,0786 VND , it would finance an equity of 1 VND At the same time in 2014, this ratio decreased 0,3598 times, corresponding with 4,45% And on 31 st in
In 2015, the debt-to-equity ratio stood at 5.1218, a significant decrease of 2.5970 times or 33.64% This indicates that for every 1 VND of equity raised, the company borrowed 5.1218 VND in debt The notable reduction in this ratio reflects a positive trend, enhancing the company's financial independence and reducing the risk of business failure and payment default To further strengthen its financial position, the company should focus on improving its capital structure to lower its gearing ratio.
2.2.1.2 The situation of financial leverage
TABLE 2.5: DEGREE OF FINANCIAL LEVERAGE FROM FISCAL 2013
(Source: Income statement of the company from 2013 to 2015)
The analysis of financial leverage from 2013 to 2015 reveals significant fluctuations In 2013, the degree of financial leverage stood at 4.7805, indicating that a 1% change in EBIT would lead to a 4.7805% change in ROE or EPS However, by 2014, this figure decreased to 4.0784, marking a 14.69% decline, despite an increase in EBIT and interest expenses This reduction in leverage was a strategic move to lower the company's high gearing ratio From 2014 to 2015, the degree of financial leverage plummeted to 1.4252, a staggering 65.05% decrease, as the company continued to reduce its debt to mitigate financial risk While this trend may limit the amplification of ROE or EPS during profitable periods, it is a prudent approach to prevent drastic declines in these metrics and avoid bankruptcy when cash flow is insufficient to cover loan repayments.
2.2.2 Evaluating the effect of capital structure to the firm
2.2.2.1 The effect of financial leverage to ROE.
We propose that tax rate income "%, we consider the fluctuation of ROE with the same amount of EBIT in each year.
TABLE 2.6: THE EFFECT OF FINANCIAL LEVERAGE TO ROE
II Incase not use debt
III In case use debt
(Source: Balance sheet and income statement of the company from 2013 to
The company's Return on Equity (ROE) is significantly influenced by its capital structure decisions each year Analyzing the impact of financial leverage reveals that maintaining the same EBIT results in different ROE outcomes depending on debt usage For instance, in 2013, with an EBIT of 13.457 million VND, the ROE would have been a mere 3.35% without debt financing, indicating that 1 VND of equity generated only 0.0035 VND of net income However, with a debt-to-equity ratio of 0.8899, the actual ROE improved to 7.18%, reflecting a 3.83% increase In fiscal 2014, the ROE would have been 5.35% without debt, but leveraging financial resources boosted it to 10.97%, marking a 5.62% rise Similarly, in fiscal 2015, without financial leverage, the company would have earned only 0.0237 VND from each invested VND of equity Instead, by employing a debt-to-equity ratio of 0.8371, the ROE increased to 10.59%, an 8.22% improvement, demonstrating that each VND of equity invested generated 0.1059 VND of net income.
Assessment of the company’s capital structure decisions
To address its high debt ratio, the firm is enhancing its capital structure by issuing 100% new shares, effectively doubling the owners' invested capital This strategy aims to increase equity while decreasing the proportion of debt by reducing accounts payable and deferred revenue By improving its capital position, the company mitigates the impact of debt financing, reduces reliance on external funding, and avoids the risks of late payments, bankruptcy, or financial pressure.
2.3.2 The shortcomings and reasons 2.3.2.1 The shortcomings.
Despite the company's increasing reliance on equity in its capital structure, its high debt ratio raises concerns among investors and creates hesitation among creditors regarding lending This situation complicates the company's financing efforts.
The company maintains a high level of net working capital, typically exceeding zero, which alleviates pressure from payables but may elevate financial risk and the Weighted Average Cost of Capital (WACC) In 2015, the company shifted from short-term to long-term debt financing, as short-term debt generally incurs a lower cost of capital compared to long-term debt, which often has fixed or higher interest rates Long-term debt carries higher risks due to its extended repayment period, making it susceptible to fluctuations in interest rates, inflation, and market prices Consequently, the cost of long-term debt is greater, potentially increasing the company's WACC If the firm struggles to meet creditor obligations, it risks facing bankruptcy.
In 2015, the firm opted to issue new shares to double the owners' invested capital, enhancing its capital structure and reducing interest costs and financial risk However, this decision diluted the management rights of existing shareholders, potentially impacting company operations Additionally, raising equity is one of the most expensive capital sources due to its higher associated risks, leading to increased costs for investors Consequently, this move could result in a decline in the market price of the stocks due to the increased number of shares available.
The company demonstrates consistent sales and profit stability, typically exceeding 300,000 to 400,000 million VND annually Its strong reputation ensures that these figures remain relatively stable year over year, allowing the business earnings to effectively cover loan repayments This financial reliability contributes to a higher level of debt within the company's capital structure.
The company's high gearing ratio raises concerns among suppliers, leading them to hesitate in selling goods before payment is received As a result, this situation contributes to a reduction in short-term debt, prompting the company to seek long-term loans from commercial banks to stabilize its financial position.
- The company doesn’t have a department which is specializes in management of finance So this situation is reason why the company’s establishing capital structure is not stusied carefully.
In fiscal 2015, the government took measures to support the real estate sector following the economic crisis, leading commercial banks to offer loans to companies at preferential interest rates As a result, many businesses increased their borrowing to finance operations, taking advantage of the favorable lending conditions provided by these banks.
The characteristics of capital transformation significantly influence a company's capital structure Since project revenue relies on the completion rate of lengthy construction processes, which often involve substantial financial investments, companies frequently depend on funds from accounts payable or deferred revenue to manage cash flow effectively.
When they worry about the company’ability to pay for loans or the customers don’t transform money for the company, it has to borrows money with long term.
The company specializes in the construction and mechanical industry, focusing on significant projects such as roads, bridges, and steel structures With a strong emphasis on high-value undertakings, the firm demonstrates its expertise and commitment to delivering quality infrastructure solutions.
While the money of the owners is limited, it is obvious for the firm to raise debt with high level.
Following the economic crisis, numerous companies are struggling to restore their operations, leading to potential cash flow issues this year As partners are unable to make timely payments, it becomes increasingly necessary for these firms to seek additional financing to navigate their financial challenges.
SOLUTIONS FOR ESTABLISHING THANG LONG
The development strategies of Thang Long mechanical four and
Vietnam is enhancing its international economic integration through numerous free trade agreements with entities such as the Eurasian Economic Union, the European Union, South Korea, and the Trans-Pacific Partnership The establishment of the ASEAN Economic Community on December 31, 2015, further opens doors for the country to engage with regional and global markets This evolving landscape presents significant opportunities for Vietnamese companies to expand their businesses and adopt modern technologies from developed nations.
While Vietnam has successfully integrated into global value chains, domestic firms face challenges due to a lack of linkages, leading to intense competition with foreign corporations To thrive, local companies must innovate their technology and enhance competitiveness through improved project quality and better labor training However, these efforts are hindered by ongoing economic conditions, as the economy is recovering slowly from the crisis and the real estate market struggles to stabilize, creating significant difficulties for construction and mechanical projects.
In the future, the prices of construction materials like steel, cement, and iron are expected to remain unstable due to competition from Chinese firms Additionally, limited material supply may hinder construction projects, posing challenges for companies in the industry Furthermore, the real estate market has not seen a strong recovery since the implementation of the 30 trillion VND policy in April 2016, which will likely impede the growth of construction companies.
3.1.2 The development strategies of Thang Long mechanical four and construction joint stock company
In 2016, the company will have to continue finishing the projects from previous years, including:
- Bo Ao bridge project which is begun in July 2015.
- Rach Chiec Bridge project which is begun in 2015
- 1A highway in Nha Trang – Khanh Hoa
- To direct the implementation of projects with required period.
- To improve the ability to organize and manage of the staffs in departments , factories and the production team.
- To renovate equipments, technology and machines to increase the quality of projects.
- To establish more sensible capital structure and decrease gearing of the company.
Solutions for establishing Thang Long mechanical four and construction
3.2.1.Improving capital structure by decreasing gearing
Chapter 2 highlights that the firm primarily relies on debt rather than equity for financing, which can lead to financial risk and potential insolvency To mitigate these risks, the company should focus on improving its capital structure by reducing its gearing in the upcoming year.
In fiscal 2016, the company raised funds by issuing new common shares to finance a new factory and various projects, while also adhering to a fixed dividend policy that allocates 10% of shareholders' capital Consequently, the company frequently distributes nearly all its earnings as dividends, resulting in limited retained earnings To enhance the equity proportion in its capital structure, management should implement a more prudent dividend policy that allows for greater profit retention for reinvestment in future projects Given that the industry's average gearing ratio is 0.72, the firm should aim to align its capital structure accordingly.
Accorrding to the development plan of fiscal 2016, some financial items:
- Net income: 5.500 million VND The company should spend all profit to reinvest in business: 5.500 million VND.
Shareholders seeking dividends may opt for a stock dividend, but the company's decision to issue new common shares in 2015 could pose challenges, potentially leading to a decrease in market share prices.
Raising capital with the target gearing for each projects.
Example, in 2016, the company will have a project with the value of 18.000 million To finance for this project, the company establish capital structure with gearing of 0,72.
- Total demand of capital: 18.000 millon VND
The company can raise money accorrding to this solution:
- Borrowing money from banks or different sources:
To establish a target capital structure, a firm can collaborate with others or consider alternative financing options If equity is insufficient, the company can seek additional funding by requiring owners to contribute money in the form of fixed assets, raw materials, or other resources This approach enables the company to alleviate the pressure of raising capital and achieve its financial goals.
Liquidating fixed assets which are not in good productivity
Beside, the company should liquidate the asset which is ancient or its effectiveness of production is not good This can generate revenue for purchasing new equipments
Improving management of expenditure in business operation
The company's cost price is significantly high, accounting for over 90% of its annual revenue To enhance retained earnings for reinvestment and minimize reliance on bank loans, the firm must implement a policy to reduce production expenditures Managers can adopt several strategies to effectively manage these costs.
The cost of construction projects is heavily influenced by the fluctuating prices of raw materials in the market, which can change rapidly due to customer demand To mitigate these challenges, companies should ensure they maintain adequate stock of raw materials and foster strong relationships with suppliers who can offer stable pricing.
The company can determines the quantity of raw material by Economic Order Quantity ( EOQ):
C2: Total ordering cost c1: Holding cost per unit c2: Ordering cost per order
QE: Economic optimal quantity Relevant total cost: C =C 1+C 2
In fiscal 2016, the demand for raw materials, specifically steel, is projected to be 500,000 tons The cost of steel is estimated at 5,000 VND/kg for one type and 8,000 VND/kg for another, based on calculations derived from company data Utilizing this information, we can determine the economic order quantity for steel.
To minimize holding costs, the company should purchase 4,000 tons of steel By utilizing this model, the firm can effectively determine optimal purchase quantities This strategic approach will enable the company to manage holding costs and reduce overall expenditures.
- It is possible to have the plan of maitaining and repairing equipments,machines,…to advoid breaking down of them
To enhance productivity and prevent resource misuse, managers should align employee salaries with job wages and strengthen supervision in the workplace.
3.2.2 Reducing gearing of the company to decrease financial risk and insolvency of the company by borrowing less money and establishing a flexible devidend policy
Finding the source of capital which will be used to finance the project and decrease gearing of the company.
The manager should prioritize alternative sources of capital over borrowing new loans from partners, emphasizing the importance of utilizing retained earnings from previous years to raise funds for the company.
- To spend more money for business, the company should establish a flexible devidend policy inspite of the fixed policy which is used at moment with 10% of net income
3.2.2.Strengthening the management of recievable account to recover capital in short term
By reducing the accounts receivable recovery period, a company can increase its available capital for business financing without relying on loans This improvement lowers the company's gearing and interest expenses, ultimately contributing to a decrease in both the Weighted Average Cost of Capital (WACC) and Net Working Capital (NWC).
Effective cash flow management is essential for optimal financial performance By efficiently handling accounts receivable, businesses not only maintain daily operations but also secure long-term profitability To enhance the management of receivables and ensure sufficient funds for business activities, managers can implement several strategic approaches.
Reducing payment terms is more effective when invoicing via email, as it allows companies to specify payment due upon receipt instead of the traditional net 30 billing The immediacy of email invoicing eliminates delays associated with paper mail, enabling businesses to streamline their payment processes and improve cash flow.
Happy customers are more inclined to pay their bills promptly, especially when faced with cash shortages, as they prioritize businesses with whom they have positive relationships To minimize late payments, it's essential to meet your commitments and cultivate strong connections with all clients A few personal calls to the payment departments can help ensure timely invoice payments and prevent delays.
To enhance cash flow, the company should expedite the collection of bills by sending invoices immediately upon project completion instead of delaying until the end of the month This approach not only accelerates payments but also keeps the work fresh in clients' minds, ensuring timely financial stability.
The petitions for the government
- The state shoud establish a fully worked- out system of law to generate convinent, equal and clear business enviroment for the companies in the market.
- Developing research institutes about capital structure to generate basics for the companies in approaching agruments of capital structure and applying them into their business.
Enforcing regulations is essential for the effective development of financial, monetary, and capital markets These rules enable companies to raise capital more conveniently, allowing for a more flexible capital structure.
- The sate should reduce interest rate and enforce the conditions which are more benefitive for the companies to encourage them to expand its operation
A robust predictive system for interest rates, market trends, inflation, and exchange rates is essential for the state This system enables companies to develop strategic business plans that effectively mitigate operational risks.
Vietnam is enhancing its international economic integration through various free trade agreements with entities such as the Eurasian Economic Union, the European Union, South Korea, and the Trans-Pacific Partnership This integration presents local companies with increased opportunities while also intensifying competition To thrive in this challenging environment, Vietnamese firms must carefully evaluate their financial strategies, with capital structure emerging as a critical factor influencing their growth and development.
Thank to overview of capital structure, through the topic:
This case study examines the capital structure of Thang Long Mechanical Four and Construction Joint Stock Company from fiscal years 2013 to 2015 The company has maintained a strong reputation and impressive performance over the years, highlighting its effective management of capital resources.
Despite facing the economic crisis of 2008, the company continued to innovate and enhance the quality of its products and services Additionally, it expanded its operations and increased net income for shareholders The management made strategic decisions that reduced gearing and strengthened the capital structure.
However, in establishing capital structure of the firm also exsits the shortcomings So I decided to propose the solutions which can help the firm limit them.
Due to constraints in knowledge and time for research, my thesis has certain limitations I welcome constructive feedback from the lecturers in the corporate finance department to enhance its quality.
I would like to extend my heartfelt gratitude to PhD Pham Thi Thanh Hoa and the team at Thang Long Mechanical Four and Construction Joint Stock Company for their invaluable support in helping me successfully complete this thesis.