OVERVIEW OF CAPITAL STRUCTURE AND TARGET
Capital structure
In a market economy, companies can utilize 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 uses to finance its business operations It indicates how a company chooses to fund its assets through various means, including bank loans, issuing shares or bonds, and utilizing retained earnings.
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
The capital structure irrelevancy theory, formulated by Modigliani and Miller in the 1950s, posits that a firm's valuation is independent of its capital structure This means that a company's value remains unaffected regardless of whether it is highly leveraged or employs a different financing mix.
The Modigliani and Miller Approach asserts that a firm's market value is influenced not only by the associated investment risks but also by its future growth prospects Companies with strong growth potential tend to enjoy higher market values and elevated stock prices.
The Modigliani and Miller approach is based on several key assumptions: first, it posits the absence of taxes; second, it assumes that transaction costs for buying or selling securities and bankruptcy costs are nonexistent; third, it emphasizes information symmetry, meaning investors have access to the same information as companies; fourth, it asserts that the cost of borrowing is identical for both investors and companies; and finally, it claims that debt financing does not influence a company's earnings before interest and taxes (EBIT).
Modigliani and Miller Approach: Two Propositions without Taxes
Under the assumption of a tax-free environment, a firm's capital structure does not impact its overall valuation This means that financing through debt does not enhance the company's market value.
Proposition 2 states that financial leverage is directly related to the cost of equity As the debt component increases, investors perceive a higher risk associated with the company, leading to a rise in the cost of equity to compensate for this risk However, the weighted average cost of capital remains unchanged, as the increase in the cost of equity is offset by a decrease in the cost of debt.
Modigliani and Miller Approach: Propositions with Taxes (The Trade-Off Theory of Leverage)
A company's value increases when it incorporates debt into its capital structure, as the combination of debt and equity enhances overall worth Specifically, the value of a firm utilizing both debt and equity is greater than that of a firm relying solely on equity, due to the added benefit of the present value tax shield associated with debt financing.
Proposition 2 states that when income tax is present, a company's cost of equity increases if it utilizes a mix of debt and equity compared to a company that relies solely on equity As a company takes on more debt, the required rate of return for equity owners rises due to increased risk However, the rise in the cost of equity is less significant 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.
The optimal capital structure theory posits that a company can enhance its value through an appropriate level of financial leverage By utilizing debt financing, the cost of capital can be reduced; however, an increase in debt also elevates the company's risk, leading creditors to demand higher returns As gearing rises beyond a certain threshold, the associated risks increase, resulting in a higher required rate of return for both debt and equity, ultimately negating the advantages of 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
The theory posits that the Weighted Average Cost of Capital (WACC) and a company's value remain constant despite changes in financial leverage In essence, it asserts that there is no optimal capital structure, indicating that both the value and share price of a company are independent of its capital structure.
This means that when the company finances more debt, the general rate
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.
There is an asymmetry of information between company directors and external investors, as directors possess a clearer understanding of their company's financial health Typically, companies first utilize internal capital, such as retained earnings, before resorting to new debt financing, with issuing shares being the last resort This theory elucidates why companies with low profitability often rely more on debt financing, as they lack sufficient internal capital and prioritize debt as their primary external funding source.
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, established in 1974 as a state-owned enterprise under Thanglong Construction Corporation of the Ministry of Transport, transitioned to a joint stock company in June 2007 in accordance with Decision No 1564/QD-BGTVT issued by the Ministry of Transport, and is registered under business activity 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
H 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, including marketing, finance, technical, and materials, play crucial roles in studying, managing, planning, and reporting on the company's status for 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
H 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 is meticulously inspected and sourced from reputable manufacturers in China and Russia.
The company boasts over 120 state-of-the-art imported equipment, sourced from technologically advanced countries This significant asset enhances the company's capabilities and strengthens its competitive edge in the market.
The company's operational costs are significantly impacted by the fluctuating prices of essential materials, such as iron and steel, required for building projects and manufacturing mechanical equipment To mitigate these challenges, the company collaborates with a diverse range of suppliers across Vietnam, strategically sourcing materials from locations near project sites to optimize efficiency and reduce expenses.
H expenditure and ensure supplying material.
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 favorable conditions for business growth The rapid development of construction projects has provided ample opportunities for companies to expand their operations Notable projects undertaken by the Thang Long Mechanical and Construction Joint Stock Company include the manufacture of cladding for the Cat Linh-Ha Dong rail transit project, the construction of 11 bridges in Laos, the Minh Dao bridge project, and the 3-2 Ha Giang bridge project, among over 100 others These achievements highlight the company's competitive edge in the market and enhance its reputation within 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 average capital of the company rose significantly by 44.01 billion VND, increasing from 293.85 billion VND in 2014 to 337.86 billion VND, which represents a 15% growth This increase in assets was primarily driven by a substantial rise in receivables, exceeding 133 billion VND, alongside a notable decrease in inventory by over 35 billion VND These fluctuations in receivables and inventory are reflective of the industry's characteristics, particularly in construction, where project values are high and payment timelines can extend considerably.
H company had some projects finished but the partners haven’t pay for them yet, so this target increased quickly compared to 2014 Inventory in fiscal
2015 had a fall but it is not signicant to show the decrease in size of operation.
In fiscal 2015, the company significantly reduced its inventory by minimizing stock in-store and delivering materials directly to construction sites This strategy coincided with the completion of numerous projects and the initiation of new ones within a one to two-month timeframe, contributing to a substantial decline in inventory levels.
In 2015, the company's average equity rose to 47.880,5 million dong, marking a significant increase of 45% from 33.042 million dong in 2014, resulting in a difference of 14.838,0 million dong This growth led to a decrease in the company's gearing ratio, which fell from 0.89 in 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, resulting in a decrease in gearing This strategic move helped reduce financial risk and reliance on external financing.
In 2015, the company's net revenues from construction projects declined to 378.298 million dong, a decrease of 101.188 million dong or 21% from 2014 Despite this drop, the cost of goods sold also fell by 20%, from 439.776 million dong to 350.173 million dong Notably, net income experienced a remarkable increase of 1.445 million dong, reflecting a 40% growth This revenue fluctuation is primarily due to the nature of the business, where income is contingent on project completion; in fiscal 2015, only a few projects, such as Chanh Hoa Bridge and Bo Ao Bridge, were finished enough to generate revenue, while many others remained in the early stages Thus, the decrease in net revenue did not adversely impact net income.
In 2015, H Company effectively reduced its financial expenses, cost of goods sold, and material costs, leading to increased profitability and enhanced financial resources in 2016.
In 2015, the company demonstrated strong operational performance, with Return on Assets (ROA) rising from 1.23% to 1.50%, reflecting a 22% growth, and Return on Sales (ROS) increasing from 0.76% to 1.34%, marking a significant 77% growth This indicates improved operational efficiency and effective utilization of machinery and equipment However, despite these gains, the Return on Equity (ROE) experienced a slight decline of 0.38% due to a rapid 100% increase in equity outpacing net income growth Overall, the company had 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:
Between fiscal years 2013 and 2015, Thang Long Mechanical Four and Construction Joint Stock Company experienced significant growth in total capital By the end of 2013, total capital reached 290.569 million VND, rising to 296.127 million VND in 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 rapid increase in total assets indicates that the company is expanding its operations swiftly, positioning itself for greater profit opportunities in the future.
At the end of 2014, the company's liabilities increased by 4.485 million VND, reflecting a growth rate of 1.73% compared to 2013, driven by a rise of 6.979 million VND in short-term debt and a decrease of 2.491 million VND in long-term debt By December 31, 2015, total liabilities surged to 316.913 million VND, marking a significant increase of 53.865 million VND or 20.48% from 2014 This growth occurred despite a reduction of 28.195 million VND in short-term debt (an 11.07% decrease) and a substantial increase of 82.059 million VND in long-term debt (a 989.02% increase) during fiscal 2015 The decrease in short-term debt was attributed to reduced revenue deferrals and accounts payable, as the company began financing long-term loans from banks Additionally, the completion of projects such as Rach Chiec Bridge and Lao Bridge enabled the company to recognize revenue from these projects and lower deferred revenue in 2015.
The firm has repaid accounts payable to suppliers from previous years, resulting in a significant decrease in this balance sheet item This rapid reduction in accounts payable, alongside a swift decline in deferred revenue, may hinder the company's ability to raise capital As cash reserves diminished, the company's high gearing could negatively impact its reputation While increased liabilities can provide essential resources for business expansion and ongoing projects, they also elevate financial risk Excessive reliance on liabilities may lead to difficulties in meeting loan obligations, further harming the company's market reputation Given the construction industry's capital-intensive nature, relying solely on owner’s equity is insufficient; however, it is crucial to manage debt levels 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, a slight decrease of 0.45% from the end of 2013 By December 31, 2015, this proportion 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%, highlighting a minimal presence of long-term debt Throughout 2014, there was little fluctuation between short-term and long-term debt proportions, suggesting that the company predominantly relied on short-term debt during this period This strategy lowered the cost of capital, as short-term debt is generally cheaper than long-term debt; however, it also increased the company's payable pressure By fiscal 2015, the overall debt proportion decreased to 83.71%, with short-term debt accounting for 71.49%, reflecting 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 increasingly relying on long-term debt, primarily through loans from commercial banks, which raises concerns about higher capital costs and financial risk, as long-term debt is generally riskier and more expensive than short-term options This shift is necessitated by a decline in accounts payable and deferred revenue, prompting the need for additional funds to maintain operations It is crucial for management to implement strategies to manage financial risk and ensure the company's borrowing capacity remains robust.
Owners' equity primarily derives from the capital invested by shareholders, showing a steady increase from fiscal 2013 to 2015 In 2014, equity rose by 2.073 million VND, reflecting a growth rate of 6.48%, largely attributed to retained earnings from prior years The following year, 2015, witnessed a significant surge in equity, soaring by 27.603 million VND compared to 2014, marking an impressive growth rate of 81.30% This substantial increase was primarily driven by the issuance of new shares aimed at funding investments in factory expansion and equipment acquisition.
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, rising to 11.47% in 2014 By the end of 2015, the company had increased its equity proportion to 16.29%, marking a significant 4.87% increase from the previous year Although this shift towards greater equity may elevate the Weighted Average Cost of Capital (WACC), it effectively reduces the company's gearing, thereby lowering financial risk and pressure on payables Consequently, adopting a more equity-focused capital structure is a prudent strategy given the current high levels of gearing.
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 yearly fluctuations in gearing and the debt/equity ratio, highlighting significant variations particularly when the company maintains a high gearing level.
The gearing is a comparison of how much of a firm's activities are funded by borrowed funds as compared to owner's funds.
From 2013 to 2015, the firm's gearing decreased, indicating a reduced reliance on debt within its capital structure In fiscal 2015, the company's gearing dropped by 0.0482 times, from 0.8853 to 0.8371, reflecting a decrease of 5.45%.
In 2015, the company had to borrow 0.8371 VND for every 1 VND invested in assets, a decrease from 0.8853 VND in 2014, indicating a high level of gearing compared to competitors The nature of its projects, primarily in construction such as bridges and highways, necessitates external financing, particularly through liabilities, which increases financial risk and repayment pressure During the fiscal year, the company initiated several significant 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, requiring long-term loans from Sea Bank and Agribank, resulting in a rapid rise in long-term debt Despite increasing equity through new share issuance to fund operations, the company's gearing ratio showed a reduction from 2013.
2015 but it is still at high level compared to others However, it decreased gearing by reducing misappropriation of account payable and
To manage financial risk and ensure the ability to meet liabilities, it is essential for H to reduce deferred revenue and lower the proportion of debt in its capital structure This approach will help decrease gearing levels, particularly when they are elevated.
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 company's debt-to-equity ratio was 5.1218, a decrease of 2.5970 times or 33.64% This indicates that by the end of 2015, for every 1 VND of equity raised, the company would incur a debt of 5.1218 VND The significant reduction in this ratio is a positive development, as it enhances the company's financial independence, reduces the risk of insolvency, and lowers payment risks To further strengthen its financial position, the company should focus on improving its capital structure to further decrease 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)
From 2013 to 2015, the degree of financial leverage exhibited significant fluctuations In 2013, the degree was 4.7805, indicating that a 1% change in EBIT would result in a 4.7805% change in ROE or EPS However, in 2014, this figure decreased to 4.0784, a drop of 14.69%, despite an increase in EBIT, as the company reduced its debt in the capital structure to manage high gearing levels By 2015, the degree of financial leverage plummeted to 1.4252, reflecting a substantial decrease of 65.05% This trend of reducing debt aims to mitigate financial risk, meaning that while profits may not significantly boost ROE or EPS, it helps the company avoid drastic declines in these metrics and potential bankruptcy due to insufficient funds for 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
From this table, as we can see, ROE of the company depends on decision of capital structure in each year We consider the effect of
Financial leverage significantly impacts a company's Return on Equity (ROE) when comparing scenarios with and without debt financing In 2013, the company's EBIT was 13.457 million VND; without debt, the ROE would have been a mere 3.35%, indicating that each VND of equity generated only 0.0035 VND in net income However, with a debt-to-equity ratio of 0.8899, the actual ROE rose to 7.18%, reflecting a 3.83% increase In 2014, maintaining the same EBIT, the ROE without debt would have been 5.35%, but financial leverage boosted it to 10.97%, a 5.62% increase Similarly, in 2015, without leveraging, the company would have earned just 0.0237 VND per VND of equity, whereas the actual ROE, with a debt ratio of 0.8371, improved to 10.59%, an 8.22% increase This demonstrates that effective use of financial leverage can enhance ROE when the break-even point (BEP) exceeds the required return (r) However, if the company incurs losses (BEP < r), higher leverage can exacerbate losses, underscoring the necessity for careful capital structure planning and business forecasting by management.
2.2.2.2.The effects of capital structure to financial risk of Thang Long mechanical four and construction joint stock company
The effects of capital structure to solvency of the company
Current ratio measures liquidity and shows how much of a
H company’s assets will have to be converted into cash in the next year to pay debt The higher ratio, the more chance creditors have of being paid.
The interest coverage ratio is a key financial metric that assesses a company's capacity to meet its interest obligations on debt promptly Additionally, the capital structure of a company significantly influences both its current ratio and interest coverage ratio, highlighting the interconnectedness of financial metrics in evaluating a firm's fiscal health.
TABLE 2.7: THE RATIOS OF THE ABILITY TO PAY FOR CREDITORS OF THE COMPANY Item Unit Year 2013 Year 2014 Year 2015
(Source: Balance sheet and income statement of the company on 31/12/2013, 31/12/2014,31/12/2015)
From this table, we can see the fluctuation of the ratios during
2013 to 2015 In 2014, the current ratio had a small fluctuation from
Assessment of the company’s capital structure decisions
To address its high debt ratio, the firm has issued 100% new shares, effectively doubling the owners' capital investment This strategic move aims to enhance equity and decrease the proportion of debt in the capital structure by reducing accounts payable and deferred revenue By increasing equity, the company can bridge its capital gap and mitigate the impact of debt financing, thereby reducing reliance on external funding This decision not only helps the firm avoid potential bankruptcy but also alleviates the pressure of meeting payment obligations.
Despite the firm's increasing reliance on equity in its capital structure, its high debt ratio continues to raise concerns among investors This elevated level of debt not only worries potential investors but also leads creditors to hesitate in providing loans, ultimately complicating the company's financing options.
The company maintains a high level of net working capital, typically exceeding zero, which alleviates pressure from payables but may also heighten financial risk and the weighted average cost of capital (WACC) In 2015, the company shifted its focus from short-term to long-term debt financing, as short-term debt generally offers a lower cost of capital However, long-term debt often comes with fixed or higher interest rates and longer repayment periods, making it susceptible to fluctuations in interest rates, inflation, monetary policy, and market prices for goods and services.
Long-term debts pose greater risks compared to short-term debts, resulting in higher costs associated with them Consequently, a company's Weighted Average Cost of Capital (WACC) may increase when relying on long-term debt Additionally, if a firm struggles to meet its obligations to creditors, it faces a heightened risk of bankruptcy.
In 2015, the company opted to issue new shares, effectively doubling the owners' capital investment While this strategy improved the capital structure and reduced financial risk and interest costs, it diluted the management rights of existing shareholders due to the influx of new investors Consequently, this shift could impact the company's management operations Additionally, raising equity is among the costliest capital sources, as it carries higher risks As a result, issuing new shares may lead to increased capital costs for investors and potentially cause a decline in the market price of the stock due to the increased share quantity.
The company demonstrates stable sales and profits, consistently achieving over 300,000 to 400,000 million VND annually Its strong reputation ensures minimal fluctuations in these figures from year to year, allowing the business earnings to effectively cover loan repayments This stability justifies the company's higher debt within its capital structure.
The company's high gearing raises concerns among suppliers, leading them to hesitate in selling goods before payment is received This apprehension results in a reduction of short-term debt, prompting the company to seek long-term financing solutions.
H term loans from commercial banks.
- 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 significant steps 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, businesses increased their borrowing from these banks to finance their operations effectively.
The characteristics of capital transformation significantly influence a company's capital structure Revenue from projects is closely tied to the completion rate of constructions, which often takes a considerable amount of time due to the high value of these projects As a result, companies frequently rely on accounts payable or deferred revenue for funding When concerns arise about the company's ability to repay loans or when customers delay payments, companies are compelled to secure long-term borrowing to maintain financial stability.
The company operates in the construction and mechanical industry, focusing on large-scale projects such as roads, bridges, and steel structures Due to the substantial value of these projects and the limited capital from owners, the firm relies heavily on high levels of debt to finance its operations.
In the aftermath of the economic crisis, numerous companies are struggling to regain operational stability, leading to potential cash flow issues this year As partners face challenges in making timely payments, it becomes increasingly necessary for these firms to seek additional financing to navigate their financial difficulties.
SOLUTIONS FOR ESTABLISHING THANG LONG
The development strategies of Thang Long mechanical four and
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 The establishment of the ASEAN Economic Community on December 31, 2015, further opens doors for Vietnam to engage with regional and global markets This evolving landscape presents significant opportunities for Vietnamese companies to expand their operations and acquire modern technologies from developed nations.
Despite significant progress in global integration, Vietnam's benefits from global value chains are limited due to a lack of connections with domestic firms Local companies face intense competition from foreign corporations, necessitating innovation in technology and improvements in competitiveness through enhanced project quality and better labor training However, achieving these goals is challenging in the current economic climate, as the economy is slowly recovering from a crisis, and the real estate market continues to struggle.
Construction and mechanical projects pose significant challenges for companies, particularly with the uncertainty of material prices such as steel, cement, and iron, which may fluctuate due to increased demand from Chinese firms Limited material supply, resulting from a surge in construction activities, can hinder the progress of new projects Furthermore, the sluggish recovery of the real estate market, despite the 30,000 billion VND stimulus package that expired in April 2016, is expected to impede the growth and development of companies in the construction industry.
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
To mitigate financial risk and potential insolvency, it is crucial for the firm to reassess its capital structure As the company predominantly relies on debt financing, this approach may lead to increased vulnerability to bankruptcy In the forthcoming year, a strategic priority should be to optimize the capital mix by reducing gearing, thereby minimizing the likelihood of insolvency and bolstering the firm's financial stability.
In fiscal 2016, the company raised funds by issuing new common shares for a new factory and various projects, indicating a reliance on profits for future funding Currently, the firm follows a fixed dividend policy that allocates 10% of shareholder capital, resulting in a significant portion of earnings being distributed as dividends and limiting retained earnings To enhance its equity proportion in the capital structure, management should adopt a more balanced dividend policy that allows for increased profit retention for reinvestment in subsequent years Given that the industry's average gearing is 0.72, the company should aim to align its capital structure accordingly.
Accorrding to the development plan of fiscal 2016, some financial items:
The company should spend all profit to reinvest in business: 5.500 million VND.
Shareholders seeking dividends can opt for stock dividends, allowing the company to issue new common shares However, this approach may encounter challenges, potentially impacting the market price of the shares.
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 an optimal target capital structure, the firm can collaborate with others If equity is insufficient, the company may finance the project by asking owners to contribute in the form of fixed assets, raw materials, or other resources This approach alleviates the pressure of raising capital.
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 excessively high, consuming over 90% of its annual revenue To enhance retained earnings for reinvestment and reduce reliance on bank loans, the firm must implement a strategy to lower production expenses Managers can adopt various solutions to effectively manage and reduce these costs.
The cost of construction projects is heavily influenced by fluctuating raw material prices, which can change rapidly due to customer demand To mitigate these risks, companies should maintain adequate inventory levels and cultivate strong relationships with suppliers to secure 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
In fiscal 2016, the demand for raw materials, specifically steel, is projected to reach 500,000 tons The cost of steel is estimated at 5,000 VND/kg for one variant and 8,000 VND/kg for another These figures have been calculated based on the company's information, allowing us to determine the economic order quantity of steel.
Therefore, the company should order 4000 ton of steel for an order to reduce cost of holding With others, the firm can apply this model to
H determine the quantity for a purchase This activity can help the company control the holding cost to decrease expenditure.
- It is possible to have the plan of maitaining and repairing equipments,machines,…to advoid breaking down of them
To enhance production effectiveness and prevent resource misuse, managers should align employee salaries with job wages and strengthen workplace supervision.
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.
To optimize financial management, the manager should restrict borrowing new loans from partners when alternative capital sources are available This approach encourages the company to leverage retained earnings from previous years as a viable means of raising capital.
- 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
Reducing the recovery period for accounts receivable allows a company to free up more capital for business operations without the need for borrowing This improvement leads to lower gearing ratios and reduced 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 can maintain daily operations and secure long-term profitability To enhance the management of accounts receivable and ensure sufficient funds for business activities, managers can explore various strategies.
Reducing payment terms can be highly effective when combined with email invoicing One major advantage of invoicing via email is the ability to shorten payment timelines Unlike traditional paper mail, which often leads to delays and a standard 30-day payment period, email invoicing allows businesses to request payment upon receipt, enhancing cash flow and efficiency.
Happy customers tend to pay their bills promptly, as they prioritize companies with whom they have positive relationships, especially when cash is tight To prevent late collections, focus on meeting your commitments and building strong connections with your business clients A few personal calls to the payment departments can help you avoid delays in invoice payments.
To ensure a steady cash flow, the company should expedite bill collection by sending invoices immediately upon project completion, rather than delaying until the end of monthly billing cycles This approach keeps the work fresh in clients' minds and enhances the likelihood of prompt payment.
To ensure timely payments, it's essential to offer customers a variety of payment options While traditional check payments remain popular, many clients may prefer modern methods such as PayPal or credit card payments for settling their invoices.
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 in financial markets enhances their effectiveness, allowing companies to raise capital more conveniently and establish 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 is essential for the state to monitor fluctuations in interest rates, market trends, inflation, and exchange rates This system enables companies to develop strategic business plans that effectively mitigate operational risks.
Vietnam is enhancing its international economic integration through free trade agreements with the Eurasian Economic Union, the European Union, South Korea, and the Trans-Pacific Partnership This integration presents both opportunities and increased competition for local companies To thrive in this competitive environment, Vietnamese firms must carefully evaluate their financial challenges, with capital structure being a critical factor in their development.
Thank to overview of capital structure, through the topic:
The article examines the capital structure of Thang Long Mechanical Four and Construction Joint Stock Company from 2013 to 2015, highlighting its strong reputation and performance despite the challenges posed by the 2008 economic crisis The company focused on technological innovation and enhancing the quality of its goods and services, which contributed to operational expansion and increased net income for shareholders Additionally, management implemented strategies to reduce gearing and improve the capital structure, although challenges remain in optimizing the firm's capital framework.
H 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 feedback and insights 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 successfully completing this thesis.