In Eq. (2), we also include the beginning-of-the-year stock of cash and liquid securities (CASH), accounts receivables and inventory items (INVENTORY), gross plan, property, and equipment (PPE), and the debt to equity ratio (DEBT/EQUITY) into the specification. Further, we include one-period lagged value of the external financing variable as an independent variable to control for dynamic nature of capital structure decisions. As the focus of this study is to check whether the external financing – cash flow relationship differs across financially constrained and unconstrained firms, following the existing capital structure literature, we estimate Eq. (2) separately for financially constrained and unconstrained firms.

## Credit multiplier test

To examine the effect of credit multiplier on the relationship between external financing and cash flow, we run the following model.

Following Gracia & Mira (2014), we define TANGIBILITY as dummy variable, which takes value 1 if the value of tangibility is above the sample mean and otherwise 0.

## Financial constraints criteria

There are different approaches to divide the sample firms into financially constrained and unconstrained type. These approaches generally include asset size, annual payout distribution, commercial paper ratings, bond ratings, costs of external financing, the interest coverage ratio, and Wu and Whited index (Whited & Wu (2006)). We use the following three criteria for classifying firm-year observations as financially constrained and unconstrained.

We rank firms into two groups on the basis of KZ index. Firms with the KZ index above the sample mean are considered as financially unconstrained and are considered financially constrained otherwise. Although the KZ index has widely been used in the previous empirical literature for measuring financial constraints, several studies have critiqued the performance of the KZ index in identifying financially constrained and unconstrained firms (e.g., Almeida et al., (2004) and Hadlock & Pierce (2010)). Footnote 5 Therefore, we use two other measures of financial constraints as well.

Scheme 2: We also classify the sample firms into two groups based on the interest coverage ratio. The interest coverage ratio is the ratio of earnings before interest and tax to financial expenses. Greater the interest coverage ratio, the fewer the problem the firm would have to face in repaying its debt. Thus, if a firm’s interest coverage ratio is above the sample mean, it is considered as financially unconstrained (see, for example, Whited (1992) and Banos-Caballero et al. (2014)). We also considered the mean value of the interest coverage ratio to divide the firm-year observations into financially constrained and unconstrained type. Firms with the interest coverage ratio above the mean are considered as financially unconstrained, whereas, firms having value below the mean of all firms are considered as financially constrained firms

Scheme 3: Finally, we divide the sample firms based on the debt to assets ratio. Arugaslan & Miller (2006) also used the debt to asset ratio to divide the firms into financially constrained and unconstrained types. The debt to asset ratio is the sum of short-term and long-term debt to book value of assets. We use this measure to classify the firms into financially constrained and unstrained. If the debt to assets ratio of a firm is greater (less) than the mean value of all firms, the firm is considered as financially constrained (unconstrained). We use three different measures to ensure the robustness of our empirical results

The definition of variables used in the study is given in Table 1. Summary statistics are presented in Tables 2 and 3. The mean value of external financing variable is 52%, whereas, the mean value of the debt to equity ratio is about 28%. Yet, the standard deviation indicates that the debt to equity ratio is more volatile as compared to external financing variable. Firms hold about 7% of total assets on average in terms of cash and other marketable securities. The mean value of inventory is click here now about 15% with the standard deviation of about 30%. The mean value of tangible assets indicates that on average, firms hold 85% of their total assets in terms of fixed assets.