IW*«l|i > t M l lW» W«s W I II M I I' M «'I H « I ) t^TI [ESS ORGlIilZATIOlM ADMIMISTRATION 5*^/ .^•. [TON DE HAAS ii "" ■ m ill mmtmm J HF5K)Q W-5 Hem ^atk Hsitt a^alh^t of AgticttUutB l^t OJarnell UmnetBttH atljata, Kf. S. ffiibcatjt Cornell University Library The original of tliis book is in tlie Cornell University Library. There are no known copyright restrictions in the United States on the use of the text. http://www.archive.org/details/cu31924013947142 BUSINESS ORGANIZATION AND ADMINISTRATION BY J. ANTON DE HAAS, M. A., Ph.D. Professor of Foreign Trade at New York University. Formerly Instructor at Stanford University, Adjunct Professor at the University of Texas, Professor at Ohio State University, Lecturer at Columbia Uni- versity, Professor at the University of Washington, Professor at the University of Rotterdam, Holland. Author of Foreign Trade and Shipping, etc. THE GREGG PUBLISHING COMPANY NEW YORK CHICAGO BOSTON SAN FRANCISCO, LONDON COPYRIGHT, IQZO, BY THE GREGG PUBLISHING COMPANl G-S7-F-10 \,2'^l^'^ Made in the United States of America BUSINESS ORGANIZATION PREFACE This book is written in the belief that there exists a need for a text which may form the basis of a short course iti the fundamentals of business administration and management and which will bring before the student those bigger business problems upon the proper solution of which success in business largely depends. In some schools such a course may supplement the work in book-keeping and office practice, while in others it may form an introduction to the more specialized and advanced courses in the field. Even a bare statement of the most essential facts of business practice is an ambitious under- taking. Much had to be omitted which might have been included. In fact, the most difficult task in the preparation of this volume was the elimination of material. It is hoped that in this process of trimming, nothing has been pruned away which is absolutely necessary to give the student a picture of the most common business situations. The references at the end of each chapter are not intended to present a complete list of books on any one subject. The limited resources of most 11 BUSINESS ORGANIZATION libraries make it advisable to give only those books which are considered standard, and which are best suited to the needs of the kind of students for whom this book is intended. Teachers may also find these references an aid in planning their own collateral reading. As will be observed, the references given in con- nection with the "Questions for Further Study" are usually taken only from one or two of the references mentioned. This is done intentionally, so that these questions may be useful in schools where only a limited number of the most essential reference books can be obtained. Both sets of questions are to be taken merely as suggestions. They do not by any means exhaust the -possibilities. Many other and more vital questions will be brought out in the class discussion which must form an important element in the teaching of this subject. The teacher's chief task will be to bring the ma- terial of the text in intimate relation with the busi- ness life of the community. This is no small task, but it would be difficult to find a field of study which offers the teacher a greater opportunity to draw upon the knowledge which the student has unconsciously acquired and to sharpen his powers of observation and analysis. A large amount of space has been devoted to the problems of labor management and to the payment BUSINESS ORGANIZATION 111 of wages. These are at present our most vital indus- trial problems. Wrong prejudices are more likely to lead to disastrous results in the settlement of these problems than in any other business situation. If this little volume proves an aid to the teacher in awakening in the mind of the student a critical, analytical attitude toward his surroundings, it will not have been written in vain. J. Anton de Haas New York City. BUSINESS ORGANIZATION CONTENTS Chapter Page I. The Elements of Business Success ... i Knowledge — Scientific Attitude — ^Absolute Honesty — . Service — Social Sense — Human Sympathy — Character — ;Summary. II. Business Organization 13 Modern Business Is Highly Specialized — The Two Larfee Classes of Business Enterprises — Industrial' Enter- prises — ^The Extractive Industries — Conserration of ^ Assets — Manufacturing Industries' — ^The Commercial Enterprises — ^The Relative Importance of These Enter- . prises — Efficiency a Social Duty — Business Analyzed According to Functions — Departmental Division: (i) , Purchasing (2) Service (3) Production (4) Selling (5) Accounting — Organization Charts — ^Summary. III. The Proprietorship of a Business ... 35 The .Owners May Be One or Many — ^The Corporation — Advantages of Incorporation — ^Launching a Corpora- tion — ^The Value of Stock — Diflferent Classes of Stock — Preferred Stock. How It Arises — Different Kinds of Preferred Stock — ^The Control of the Corporation — ^The Payment of Stock — Transfer of Stock — Dividends — Summary.' IV. Financing an Enterprise (Working Capi- tal) 54 The Owned Capital of an Enterprise — Working Capital and Investment Capital — ^Factors Influencing Amount of Working Capital Needed. The Turnover — ^Seasonal Production Requires Large Working Capital — Borrow- ing Working Capital. Trade Credit — Borrowing from the Banks — ^The Promissory Notfe — ^The Security Back of the Loanf— Merchandise as Security for Loans — Bills of Exchange or Drafts — ^The Acceptance — ^The Credit System— The Note Broker— The Credit Man- Summary. VI BUSINESS ORGANIZATION Chapter Page V. Financing an Enterprise (Borrowing on Long Time) * 7^ Problems of Financing a Growing Business — ^Advan- tages of Borrowing on Long Time — Disadvantages of Borrowing on Long Time — Need for Security — ^The Mortgage — The Bond Issue — The Trust Company — Closed and Open Mortgages — Equipment Trust Bonds — Collateral Trust Bonds — The Income Bond — The Debenture Bond — The Life of Bonds — The Price of Bonds — The Repayment of Bonds — Summary. VI. Financial Institutions 91 The Bank — The Commercial Banks — The Making of a Deposit — The Receiving Teller — The Individual Bookkeeper — The Paying Teller — The Note Teller — The Clearing House — Safety Deposit Department — Other Departments of a Commercial Bank^Loan and Trust Companies — Savings Banks — Insurance Companies — Reducing Uncertainty to Certainty — Insurance as a Business — Different Types of Insurance — Fire Insurance — Marine Insurance — Credit Insur- ance — Fidelity Insurance — The Stock Exchange — The Brokers — How Stocks and Bonds Are Sold — Summary. VII. Management 124 The Problems of Management — The Manager as a Jack of All Trades — The Line Organization — ^The Duties of the Foreman — What Keeps the Men' at Work — The Problem of Securing Co-operation — The Planning — Lack of Accurate Knowledge Becomes Evi- dent^ — Scientific Management — ^T he Management Should Look After All Management Functions — The Human Factor — Motion Study — Rest Periods Must Be Planned — Other Considerations — Summary. VIII. The Wage Question 152 What the Employer Buys — He Buys a Workingman's Time. The Day Wage — He Buys Output. The Piece Rate — Need for Accurate Information — Co-operation between Employers and Employees — He Buys Output and Time. The Task — Setting a Task — Summary of BUSINESS ORGANI Z A T I O N VU Chapter Page Wage Payments — The Demand for Standardized Con- ditions — The Group Bonus — Profit Sharing — The Wages of Store and Office Workers — Relation of Workman to Employer — Summary. IX. The Service Department 174 What Is Included in the Service Department — The Employment Office — Labor Turnover — Labor Turnover an Expense — Hiring Men — Securing Applicants — Fil- ling Vacancies — Selecting the Workers — Vestibule Schools — Introducing the Employee to His Surround- ings — Record of Service — Investigation of Grievances — ^A Check on Labor Turnover — ^The Educational Office — ^The Suggestion Box — Health Department — Safety and Sanitation Department — Welfare Work — Summary. X. Selecting the Site . . > 202 The Location of 'the Plant Demands Careful Study — Nearness to Raw Material — Nearness to Market — Available Labor Supply — ^The Power Factor — ^Associa- tion with Other Industries Is Beneficial — ^Transporta- tion — Whether to Locate in City or Country — Induce- ments Offered by Cities — Deciding upon the Site — Wholesale and Retail Locations — ^The Retail Store Location — Summary. XI. Planning the Building 223 A Poor Building Means High Cost — ^The Factory Lay- out — The Various Types of Factories — The Assembling Industries — ^The Production Centers — Transportation in the Factory — Other Considerations — ^The Building Itself — Planning the Retail Store — ^The Retail Building — The Receiving and Shipping Rooms — Planning the Office — Summary. XII. Purchasing 244 Careful Buying Is Essential to Successful Selling — ^Three Classes of Purchases — The Requisition — Checking the Quantity — The Stock Clerk's Duties — Collecting In- formation — Sending Out Requests for Quotations — Vlll BUSINESS ORGANIZATION Chapter Page What Determines the Placing of the Order — Following Up the Order — The Purchasing Agent as a Seller — The Retail Buyer — Determining the Demand — How- Buying Is Done — Supervising the Selling — ^The Pur- chasing Agent in the Retail Store — Summary. XIII. Marketing 266 The Term Defined — The Marketing of Farm Products — ^The Local Buyer — Grading of Products — The Ex- changes — The Wheat Trade — Financing the Wheat Crop — ^The Cotton Market — The Marketing of Other Farm Products — ^The Marketing of Manufactured Products — The Various Middlemen Defined — Selling at Retail — ^The Department Store — The Chain Store — The Mail Order Business — ^Advantages and Disadvan- tages of Selling by Mail — ^The Manufacturer and the Market — Summary. XIV. Selling and Advertising 289 Selling an Important Function — Manufacturer and Middleman May Co-operate in Selling— Advertising as an Aid in Selling — Advertising and Selling Compared — Attention — Interest — Meeting Argument s — Where Advertising Differs — ^Af tion — Knowledge of the Goods — Knowledge of the Buyer — ^The Advertiser Faces Pecu- liar Problems — ^Local Advertising — Price Maintenance — ^The Sales Organization — The Buyer — ^Summary. XV. Foreign Trade 316 Foreign Trade Necessary — The Foreign Traders. Sell- ing Direct — Selling through Middlemen — It Is Neces- sary to Study the Market — The Tariffs Must Be Studied — Private Sources of Information — Banks Pro- mote Trade — Commercial Museums — Government Sources of Information — Miscellaneous Government Aid — Combination for Export Trade — Protection of Trade-Marks — ^Advertising in Foreign Markets — The Sample Fair — How Goods Are Quoted — Methods of Payment — Summary. BUSINESS ORGANIZATION IX Chapter Page XVI. The Technic of Foreign Trade 336 Checking the Order — Preparing the Order — Procuring Freight Space — Marine Insurance — Invoicing the Ship- ment — The Boxes — The Dock Receipt — The Bill of Lading (B/L) — The Export Declaration — Other Docu- ments Required — Requirements of the Customs Author- ities — Disposition Made of These Documents — Notify- ing the Consignee — ^The Functional Middleman — Importing — Buying Methods — The United States Cus- toms — ^How the Appraisals Are Standardized — ^Sum- mary. BUSINESS ORGANIZATION CHAPTER I THE ELEMENTS OF SUCCESS IN BUSINESS Knowledge. The first thing required for success in business is accurate knowledge of business affairs in general, and of the business in which one is engaged in particular. The old-time business man learned all that he knew about business by "doing." In the same way, the physician and the lawyer at one time prepared for their profession by reading in an office of an es- tablished practitioner and by assisting him in his cases. The training which these professional men received in this way was very inadequate as com- pared with the training students now receive in our medical and law colleges. The practitioners had poor laboratory equipment, could devote but a portion of their time to the giving of instruction, their own preparation was not any too thorough, their experience limited, and their teaching ability questionable. This Inefficient method of training for the professions has been universally abandoned. The business man, however, must still to a large degree depend on the old-fashioned "ap- prentice" method of training. 2 BUSINESS OR GANIZATION Only recently have the schools and universities in the United States undertaken to teach the essentials of business. Their neglect in this respect has led many corporations, industries, banks, foreign trade concerns, and wholesale and retail stores, to establish their own schools. This is unsatisfactory, for it re- sults in an unnecessary duplication of equipment and personnel, placing, thereby, a heavy burden upon business. The need for better trained men and women in business has become daily more and more apparent to the business man. The high prices of raw material and labor make it more urgent than ever that the entire staff be well trained. Lack of knowledge of methods and processes, lack of training in the keep- ing of correct records, or in the management of finances, in fact, every lack of knowledge means les- sened efficiency, high cost, smaller profits, and pos- sible failure. The impression that prevails in many places that "nerve" will make one's way is entirely erroneous. To be sure, a certain amount of aggressiveness is needed to press to the front, but a position thus achieved cannot be held unless the "nerve" be backed up by ability and knowledge. Scientific Attitude. In order to make one's knowl- edge truly useful it is necessary to cultivate what may be called the "scientific attitude of mind." This means the attitude towards life of one who desires to BUSINESS ORGANIZATION 3 know the actual facts and is not satisfied with opin- ions or offhand guesses. There is a premium in active life upon arriving at decisions quickly and without loss of time. But fre- quently conclusions which are the result of careful investigation lead to wiser actions. The scientific mind does not jump at conclusions, its methods may arouse impatience with those who are accustomed to trusting to intuition, but the days of the "rule of thumb" methods are numbered. More and more careful, deliberate action based upon carefully ac- cumulated knowledge is taking the place of quick, snap-judgment, and hair-trigger action. To take an example in the accounting field. Many business men fail to keep good accounting records and are remiss in the keeping of cost records, and still there is no other way in which accurate knowledge of the condition of a business can be obtained. The lack of good records lies at the bottom of much reckless price cutting. Many retailers are actually selling goods at a loss from ignorance in regard to the cost of doing business. The recent interest of busi- ness men in "uniform accounting," i. e., standardized sets of accounts, is in part the result of the hope that competing firms may, by their adoption, gain a better knowledge of costs. Price cutting which is not based upon accurate cost data results in injury to all firms dealing in the same line. 4 BUSINESS ORGANIZATION William C. Redfield, in The New Industrial Day (p. 185), gives an interesting illustration of the igno- rance of many business men of important aspects of their own business: . Into the office of a large factory in New York State went one day a competitor of the concern who thought it courteous to call upon his rival. He was cordially received by the unassuming owner and finding the atmosphere congenial, began to talk on matters of mutual interest. Being asked whether he had not se- cured a certain order, he answered in the affirmative, saying that that work was a specialty with him and that he had been able to reduce the cost for material and labor to about eighteen cents each piece. His host said that he had not himself given any special study to that particular article, and that he was very glad to have suggestions. When the visitor left, the owner crossed the room to his cost-keeper whose eye he had seen twinkling, and asked him what the last lot of these goods cost for labor and material, and was told six cents each. The trouble with the visitor was that he had no realizing sense of his own heavy burden charges, and, ignoring them and forgetting selling cost, he had underbid the man whose actual outlay was but one-third his own. This is but one of many possible illustrations showing that the man who "knows his own business" is often ill-informed about important factors in it. In every field of business activity there is found the man who is not satisfied until he knows, until he BUSINESS ORGANIZATION 5 has discovered, the one best way of reaching his goal, and also the man who is satisfied to trust to his bluflf to carry him through, and is willing to follow the rut of precedent. The latter may score an occasional spectacular success; the former builds more slowly for a certain future. Science is merely an orderly system of collecting information. It is impossible to gather information which will be really useful until the problem is first carefully analyzed and taken to pieces so that the essentials may be separated from the non-essentials. This, therefore, is the first step in all scientific work. First comes an analysis of the problem. The next step is to gather information which is lacking. In gathering this information, great care must be exer- cised that hearsay and opinion are not taken for accurate facts. Where no facts are available, enough "opinions" should be gathered to make it possible to discover in how far these opinions are likely to be correct, and in how far they are merely based upon prejudice. The next step is to arrange this information — to tabulate it so that it is possible to arrive at a conclu- sion. A wastebasket full of facts is meaningless. They should be arranged so that all those which point in one direction are brought together and are offset by those which seem to point to a different solution, very much in the same way as accounting records give a systematic and understandable expo- 6 BUSINESSO RGANIZATION sition of a large variety of facts which otherwise would be meaningless. In the interpretation of these facts, the business man will find ample opportunity to use all his knowledge and experience. To sum up the whole matter in simple language, the scientific method as applied to business means: 1. Determine just what it is you want to do. 2. Collect all possible infornriation. Make certain that you collect facts, not opinions. 3. Determine on the basis of this information which is the best way to proceed. 4. Then go ahead. 5. Keep careful records to make it possible to check constantly the results obtained, for in no other way can the efficiency of different methods be compared. Absolute Honesty. After all, there is a streak of dishonesty in the man who depends on his "nerve" or "bluff." He is parading unjder false colors; is assum- ing a knowledge which he does not possess. In deal- ing with customers, such a man will "never admit that he does not know, even in cases where it would be to the interest of the customer to be frank. He is afraid to throw off the mask which he has chosen to wear. Honesty is the backbone of business; without it no bank can exist; and the retailer depends upon the honesty of his customers as much as they depend upon his. BUSINESS ORGANIZATION 7 If sinyone doubts whether the world is getting better, let him study the history of business relations. The modem business mam is honest cmd knows that his success depends not upon his being able to squeeze the last penny out of any transaction, but upon the degree to which he serves. Service, dependable ser- vice, and absolute honesty, constitute the foundation of all business success. The large firms that supply the nation and many customers in foreign lands with trade-marked goods are evidences .of the supreme de- mand for honesty. A trade-mark is a promise to maintain quality which, if broken, means failure. If any proof were needed that the dictates of our conscience, which prompts us to deal justly and fairly with all men, reveal to us the moral law ac- cording to which the world is governed, business experience can furnish that proof. Honesty pays in a business sense because honesty is a fundamental need in human relations. It pays to observe it for the same reason that it pays to observe the law of gravity. Such laws cannot 'be ignored without dis- astrous results. Service. The introduction of the concept of service m business has given all transactions a different as- pect. The retailer no longer looks upon the customer as legitimate prey to be exploited to the limit; he considers how he may best please this stranger so that their relations may be peimanent. The old 8 BUSINESS ORGANIZA T ION dealer would say, "A sale is a sale," and would not encourage his dissatisfied customers to register their complaints and to return the goods that displeased them. The modern concern says, "If not satisfied, tell us." No sale is successful in the eyes of the modem business man which does not pave the way for future sales. In order to instill this spirit into the minds of all who are connected with the enterprise, the same spirit of honesty and fair dealing should prevail in the internal relations of the business. Social Sense. The business man should have a social sense. He should feel that he is performing a social service and that he has social duties. As a dealer, h^ should be instrumental in building and strengthening ethical standards in the relations be- tween himself and his competitors, and between the business men and the general public. As an employer he should consider himself responsible to society for the treatment he gives his working people, for the wages he pays them, and for their health and general welfare. A business concern which ruins the health of its workers, which turns them out into the world broken in body and spirit, which arouses through its unfair dealings a spirit of revolt and unrest — such a concern is a social menace. From the point of view of society it were better if such a concern did not exist.^ The benefits which society derives from its existence can BUSINESS ORGANIZATION 9 never compensate for the burdens which it throws upon society. Human Sympathy. A keen appreciation of social responsibiUty should go hand-in-hand with a sympa- thetic understanding of man and his problems. It is impossible to conceive of a business man who deals only with "things." All business is based upon a relation of man to man in which the goods are but an incident. In the factory or the mine, the physical equipment, the raw material, and the finished product are important. But success is not determined by them, but primarily by the spirit of those who work among them. A fine factory building, a well-equipped shop, an attractive-looking store building, do not make a suc- cessful business, any more than a few buildings, how- ever well equipped, make a school or a university. And just as it is the faculty and the relation between the faculty and the students which make a school, even if there is no building at all, according to the same principle, it is the men and women, and the relation between the managers and the workers in an organization which determine its success. The ability to awaken in others a desire to co- operate, a realization of a community of interest Is a rare quality which is worth more from a business standpoint than the ability to design clever machines or to keep books accurately; for the ability to handle human problems is rarer than the ability to handle 10 BUSINESS ORGANIZATION material problems. May not this be the reason why an executive and a salesman usually receive a higher salary than the man who designs or makes the article? This may not seem just to the one who produces the product. To him the product is the principal thing. Without it, so he says, there would be no salesman and no executive. The producer, the work- er, the designer, therefore, believes himself the most essential. But he forgets that the matter may well be turned around. If there were no salesmen there would be no call for the product. If there were no executives there might be no factory organization. A group of machines, a mob of workers, and a pile of raw material do not make a factory. It requires the personality of a true executive to make out of this complex a productive unit. It requires accurate knowledge of processes and of machines, of market demands and of costs. But most of all, it requires that understanding of the motives of men, that ability to see life from their point of view without which it is impossible to establish a successful organization. The day is past when labor was classed along with raw material and equipment as something bought and paid for, and the control of which entailed no special responsibility. We are now beginning to regard the employer as directly responsible to society for the moral and physical welfare of the human beings who place themselves under his control. BUSINESS ORGANIZATION II The success of a business man will, in the future, no longer be measured solely by the amount of money he has succeeded in accumulating, but will also be measured by the mark he has left upon the lives of those with whom he has come in contact. Character. Business success, therefore, in the fu- ture more even than in the past, will be built upon character. Honesty with oneself and with others, a demand for the truth about business facts, a sympathetic and fair attitude toward one's asso- ciates, a sense of responsibility for one's actions — these are the prerequisites of success. Summary. Success in business is impossible with- outknowledge of business in general, and of the kind of business in which one is engaged in particular. This may be acquired by the "apprenticeship" method, or, and this is more economical in time and money, by a preliminary school training. This will shorten the period of apprenticeship. One should cultivate the "scientific attitude of mind"; business men are beginning to realize this. Honesty, more than ever, is a business asset — ^honesty in dealing with competitors, customers, -employees, and with oneself. Service expresses the true ideal of business; it is based on social sense and human sympathy. 12 BUSINESS ORGANIZATION REFERENCES W. C. Redfield. The New Industrial Day. The Century- Co. QUESTIONS FOR FURTHER STUDY I. What is meant by the scientific spirit in manage- ment? Reference: Redfield, Chapter VIII. . 2. What are the benefits which a business man may derive from a complete knowledge of costs? Reference: Redfield, Chapters IV, V. 3. What opportunities are open for the study of business in your community? in your state? TEST QUESTIONS 1 . Outline the steps by means of which a business man should reach his conclusions. 2. Explain what is meant by service in business, and contrast this new spirit with the attitude that used to prevail. Give an example of some actual experience you have had which illustrates the new and the old spirit. 3. What qualities should a man possess in order to become a leader among men? BUSINESS ORGANIZATION I3 CHAPTER II BUSINESS ORGANIZATION Modern Business Is Highly Specialized. When someone says that he is "in business," this statement does not convey a very definite picture of what his actual occupation is. All that we know is that he evidently does not belong to the professions; he does not teach, preach, plead cases, or fill teeth; that much we know, but we do not know what he does do. He may sell peanuts, write advertisements, manufacture hats, or build houses. In this textbook we shall study business in its various aspects. Before we enter upon that study it is necessary that we begin by considering somewhat carefully what we mean by business. Studying the anatomy of a worm does not give anyone a knowledge of zoology. Not until other animals have also been studied and the relation among them has been pointed out, does a detailed study of any one of them have any meaning. It is the same with the study of business. First, we must get a bird's-eye view of the various kinds of business enterprises and their relation to each other, before we can derive any benefit from a detailed study of any one of them. The best method to 14 BUSINESS ORGANIZATION follow in finding one's way in a strange city is to study the map carefully before venturing out. The present chapter will draw a picture of the business world which will serve as a map to those who desire to find their way in the business world. The Two Large Classes of Business Enterprises. All business enterprises may be divided into two large classes. First, there are those which produce raw material or change its form, possibly combining it with other raw material, and in that way producing a finished product. Such enterprises are called indus- trial enterprises. The second is a group of business activities which do not change the form of the products, but are instrumental in passing them from hand to hand and from place to place until they finally reach the consumer. These are called com- mercial enterprises. This division into two large groups is based upon a fundamental distinction. An industry changes the physical form of the goods; a commercial enterprise does not, though it may sometimes bring minor changes in the packing and finishing of the goods. Industrial Enterprises. The industrial enterprises may again be subdivided into two main groups: the extractive industries, and the manufacturing industries. The extractive industries include min- ing, forestry, agriculture, and fisheries. They produce the raw materials which are used by the manufacturing industries. These extractive indus- BUSINESS ORGANIZATION I5 tries, from a business point of view, present interest- ing problems, quite different from those connected with manufacturing industries. In later chapters we shall study the various factors which refer to plant location; why it is better to locate a manufacturing plant in one place rather than another. The fact that it is necessary to study this question shows that there is in the matter of location, room for the exercising of judgment. The Extractive Industries. One may locate a steel plant in Seattle, Pittsburgh, or Philadelphia ; a furni- ture factory in Grand Rapids, or San Francisco ; but no such possibility of choice exists in an extractive industry. In order to exploit a mine, to lumber a forest, or to work a farm, one must go where the mine, the forest, or the farm is. The natural resource to be worked predetermines the location of the extrac- tive industry based upon it. This is not, however, the only distinctive feature of this type of enterprise. To a varying degree, these industries are based on wasting assets; the larger their scale of production, the more quickly they put themselves out of business. In a mine the amount of ore is fixed ; every ounce of ore removed is removed once for all, and the mine becomes poorer by that amount. A forest lumbered according to the old-fashioned American method is transformed into a barren waste from which, if situated on a hillside, all good soil is washed away in a few years, rendering it even unsuited to farming. l6 BUSINESS ORGANIZATION Every foot of lumber removed leaves the country that much poorer. To a certain extent this is true of farming. Many sections of the country, renowned at one time for their fertility and great productiveness, are now yielding small crops. The cotton and tobacco fields of the South are not as good as they once were. The fishery industry faces a similar problem. The destruction of the spawning grounds, coupled with the excessive yearly catch, are rapidly dimi- nishing the fabulously rich fishery resources of both the Atlantic and Pacific coasts. Conservation of Assets. Well managed, extractive industries take measures to offset the effects of this decrease in assets. In the mining industry such measures take the form of development and explora- tion. As the old mine gradually nears the point of exhaustion, new veins may be opened up on the same claim, or some other claim in another part of the country may be prepared for production. Such measures perpetuate the industry as a business undertaking, but cajinot do away with the fact that physical exhaustion is inevitable. Forestry, agriculture, and fisheriesare in asomewhat different position since they deal with the products of the vegetable and animal kingdom which, if properly cared for, will replenish themselves. By a scientific policy of reforestation, forests may be made to yield lumber, not once, but indefinitely. BUSINESS ORGANIZATION 17 The commercial forests of England, France, Norway, and Germany, are eloquent examples of this. The wonderful forests of our great Northwest are rapidly being destroyed. Bjire hills with blackened stumps like so many crosses in a cemetery, mark the path of the lumber mills that work their way further and further into the mountains impoverishing the coun- try.^ A reforestation policy rigjdly enforced upon all owners of timber lands would make these forests permement sources of wealth to the nation. The farming industry may also take measures by means of which its permanent asset, land, may notonly be prevented from diminishing in productivity, but may actually be improved. By raising the same crops year after year land soon becomes exhausted. Crop rotation, a combination of dairy or chicken farming with the raising of crops, and the proper use of fertilizers are all means of increasing the fertility of the soil. The farms of England, Holland, and Bel- gium, though cultivated for centuries, are constantly increasing their yield per acre. The farms of the United States are on the whole decreasing their yield. The reason lies in the ignorance of the American farmers of the proper methods of soil conservation. Better care of our rivers, scientific propagation of fish in Federal and State hatcheries, and^- rigidly enforced fishing laws may save the fish resources of this country from destruction. These matters are of national concern and it is, therefore, logical that the l8 BUSINESS ORGANIZATION private ownership of such resources and the use that is made of them should be rigidly controlled by the Government. One other element enters in to distinguish the extractive industries. Their operation is always subject to heavy risks. A mine may give out suddenly; a forest fire may destroy millions of dollars worth of timber; storms may raise havoc with the big trees; a drought may destroy all chances for a good crop no matter how carefully planted and cultivated; or a swarm of locusts may clear a field ready to be harvested. These uncertainties make such industries the basis of much speculation. "Get-rich-quick" schemes are usually associated with mines, while speculation in food products is one of the most objectionable kinds of gambling. The lumber industry is not entirely free from such speculation and fortunes have been made and lost in the industry. Manufacturing Industries. Manufacturing indus- tries take the raw materials obtained from the extractive industries and fashion them into finished articles. Such industries require a building and more or less elaborate tools and machinery. They use, on the whole, a different class of labor from the extractive industries. These latter need a large number of unskilled laborers of whom no other qualification is asked than physical strength. A manufacturing concern needs as a rule a large num- BUSINESS ORGANIZATION I9 ber of highly skilled and intelligent workmen. Extractive industries draw to themselves an army of foreign laborers, many of them unmarried and constantly shifting from one job to another. The manufacturing plants appeal more to the man with a family, who is willing to stay in one place. This condition is emphasized by the fact that the extractive industries are to a large extent seasonal. They are very active one part of the year and close down during other seasons. This seasonal fluctua- tion increases the cost of doing business and makes it necessary when borrowing money to borrow for long periods from season to season. It also aggra- vates the labor question since it forces the workmen to adjust themselves to intermittent work. Cities near mining or lumber camps, or selected as the winter homes of fishermen are notorious for their social instability and for the rough and restless labor element. Many manufacturing enterprises are also subject to seasonal fluctuations. The clothing trade and the ice and coal trade are of this nature. Driven by the desire to make complete use of the plant throughout the year and to secure a stable, reliable labor supply, many of the seasonal business enterprises are more and more eliminating their seasonal character. They do this by a wise advertising and selling policy, by co-operation with their customers and with their competitors. They n^y reach the same results by 20 BUSINESS ORGANIZATION developing a foreign demand for their goods, or they may undertake to produce two types of products subject to dovetailing demands. The ice business may for that reason be profitably combined with the coal business. The Commercial Enterprises. Many business undertakings of widely different nature may all be spoken of as commercial enterprises, for they are engaged in facilitating the flow of products from maker to consumer. These enterprises fall into three large classes: (i) marketing or trading, (2) trans- portation, and (3) financial enterprises. Those of the first group buy products from a producer to sell them again to some other producer or middleman, or directly to the consumer; or they may act merely as agents for the producers and sell on a commission basis. To this group belong the brokers dealing in produce, lumber, and metals, and also the wholesalers, jobbers, and retailers. The transportation group consists of such business concerns as railroads, interurban and urban electric roads, and inland and ocean transportation com- panies. Financial enterprises include banks, trust com- panies, stock exchanges, brokerage firms, and insur- ance companies. The functions of the last two groups are easily distinguished. Transportation supplies the means of carrying goods from one place to another, whether from mine to factory or from BUSINESS ORGANIZATION 21 factory to wholesaler or retailer, or from retailer to consumer. The financial enterprises, on the other hand, supply in part at least, the funds needed to enable the various persons to buy the goods they need, either for consumption or ior production. The Relative Importance of These Enterprises. Which one of these various enterprises is the most important? They are all essential. Man cannot get along without food ; neither can he get along without shelter; nor can he raise his food without tools. The manufacturing industries, though producing many luxuries, have made the making of a living easier by supplying man with more efficient tools. Transportation facilities carrying goods from place to place, allow the entire world to share in the products of the most favored spots. The products of the tropics are found in the remotest comers of the. globe, while the manufactured products, the lumber, and the wheat of the temperate zones are common necessities in tropical lands. Without the aid of the various traders such wide distribution of goods would not be possible. The middlemen, so often accused of all the evils in the dictionary, perform a necessary service. The retailer who keeps within convenient distance from every home a well-selected stock of goods, contributes no little to the comforts of life. Who, indeed, would care to return to frontier conditions when once a year the supplies for the family were bought and 22 BUSINESS ORGANIZATION stored away? All these enterprises are, therefore, essential and socially valuable, but only so long as they are conducted efficiently and honestly. Efficiency a Social Duty. From a purely selfish standpoint, middlemen may look upon an increase of their number in the path that connects producer and consumer, as a good thing. It means great profits. From the point of view of society at large, " an unnecessary multiplication of middlemen is bad ; for all inefficiency is a social loss. If more men are engaged in loading a ship, in cutting down a tree, in selling groceries, or in directing the money resources of the community than are absolutely necessary, the total productivity of society is, by that much, less than its maximum. Ultimately every member of society suffers by inefficiency, for if many men are engaged unproductively, there are just as many mouths to feed, just as many human wants to satisfy, but less goods to go around than when the same men are engaged in productive work. This consideration may change somewhat our at- titude toward the successful business man. The small, inefficient business man is frequently looked upon with sympathy as entitled to our aid and sup- port, while the big, successful man is at times thought to have made his income at the expense of society. Frequently, however, the situation is quite the reverse. The poor business man — or, as the economist would call him, "the marginal man" — is BUSINESS ORGANIZATION 23 the culprit. His inefficiency means an increased cost to everybody concerned and an increased profit to the efficient. The poor business man throws bur- dens upon the banks and the insurance companies; he is frequently responsible for congested freight ter- minals and for labor unrest. The instability of his business endangers all other business in the same way as a bad fire risk endangers all other buildings in the same block. Efficiency in business, therefore, is a matter, not of" purely individual interest, but of social concern. The greater the efficiency of the link connecting nature and consumer, the more human wants may be satis- fied with the same work and capital. In the pages that follow, various factors affecting the efficiency of business enterprises will be discussed. The discussion will frequently be technical and de- tailed, for no useful information can ever be im- parted in mere generalities. However much the question under discussion may seem to be of impor- tance only to the pocketbook of the individual business man, it should at all times be remembered that individual efficiency and productivity are of direct and intimate concern to society as a whole. The consumer is as much interested In the installa- tion of good accounting systems as the business man and his employees, while a lower selling or transpor- tation cost is of equal importance to producer, middleman, and consumer. There is, therefore. 24 BUSINESS ORGANIZATION nothing dismal or materialistic in a study of business problems. It is, in fact, a study of the practical means of increasing human happiness. Business Analyzed According to Functions. We have discussed the various business enterprises and grouped them according to types. Within each of these types many men are at work in charge of a large variety of fimctions. There is a great similarity between the functions necessary to operate widely differing types of enterprises. In the first place, a line may be drawn between ownership and operation. In a more primitive organization of society, these functions were combined in one man, and a business was operated by its owner with the aid of clerks and workmen. As the business unit grew, it became necessary to look for funds outside. Many people who have surplus funds are willing to use them pro- ductively, but frequently cannot spare the time or do not possess the ability to actively engage in the operation of the concern themselves. The growth of the corporate type of organization has made it possible for anyone with funds to invest in many business enterprises. But this investment does not carry with it the burden of operation. In modem business, ownership and operation are, there- fore, quite distinct. The owners exercise direct con- trol over the finances of the enterprise and direct the general policy, but the operation is placed in the hands of a different group of persons. BUSINESS ORGANIZATION 25 In this group we may recognize three large sub- divisions: management, administration, and labor. The functions of the management are to plan all processes of operation and to direct the execution of the plan. The labor force, whether in the office or the shop, receives the instructions and orders from the managers and is expected to carry them out. The administrative force acts as a link between the managers and the shop or office; first, in making a record of the orders issued; second, in keeping a rec- ord of results ; and third, by tabulating this informa- tion in accounting or statistical form for the use of the managers. In few business concerns are management, admin- istration, and execution as sharply separated as the foregoing description might indicate. There is, how- ever, a general tendency throughout the business world to carry through this fundamental division more clearly than formerly. Departmental Division. Still another subdivision usually takes place according to the various depart- m'ents of -activity which jointly constitute the "opera- tion" of the enterprise. In the manufacturing busi- ness this subdivision would logically result in the following departments: I . Purchasing. Here is concentrated the buying of raw material; partly finished goods and parts; supplies for the shop, such as oil arid waste; supplies for the office, such as typewriter ribbons, paper, glue, and paper clips; 26 BUSINESS ORGANIZATION equipment, such as machinery, office fixtures, and small tools. 2. Service. This department hires the workmen, selects them, assigns them to their jobs, trains them for their work, supervises their efficiency, and transfers them to other work if this proves desirable. It cares for the comfort and physical and spiritual welfare of the workers. 3. Production. In this department the product is made. Usually this department is subdivided into at least the following subdepartments : engineering or drafting department; and the shop with its many subdivisions such as storerooms of raw material, finished stock rooms, tool rooms, power plant, and the shop proper. 4. Selling. This again may be subdivided into: ad- vertising, selling, correspondence, delivery, and other subdepartments. 5. Accounting. Here the records are kept of the fi- nancial relations of the firm with the outside world and with its own employees, and records from which the cost of production of the goods and the efficiency of various departments and persons may be determined. Organization Charts. The human mind has diffi- culty in grasping abstract statements. For this rea- son, more and more general use is made in business of charts and graphs. There is usually connected with the accounting department a department charged with the duty of collecting data regarding operation and administration, and of presenting them in such a form that the conclusions to which BUSINESS ORGANIZATION 27 they point may be quickly grasped. This is called the statistical department. One of its functions is to present monthly, weekly, or even daily charts, show- ing in pictures the facts of intere^ to the different managers or executives. To give an example: In case the manager for whom the graph is being pre- pared is primarily interested in selling, many such pictures may be drawn ; one to show the total "sales of the department day by day; another to show the daily records of individual salesmen ; and another to give the relation between certain advertisements and the sales that took place as a result. So each depart- ment gives rise to many such data which may form the material for graphical representation. To illus- trate how much more easy it is to grasp a pipture than to understand figures, compare the following: OUIft V»1MyOetWS«e9WMO4W0O9ISOMOiM T W TH S ^ Production during the week ending June 25th of No. A 3 spools M T W Th F S 606 575 585 310 450 610 28 BUSINESS ORGANIZATION From the above chart it is immediately clear that something happened on Thursday, possibly a break- down at the end of the day. This statistical department is also charged with the duty of preparing organization charts. These charts have several purposes. They show in a clear picture the departments of which the organization consists, their functions, their interrelations, and the flow of authority. In many large concerns such charts are kept either on the walls of all offices or under a glass plate upon the desks of executives and departmental managers. Two such organization charts are given below. Besides satisfying the purposes Indicated below, such .charts may also be a source of inspiration to the younger members of the organization. They see the steps by which they may climb into the better posi- tions. One good way to attain success is to prepare oneself constantly for the "job ahead." No matter how far we progress in life, there is always some better position ahead. By preparing conscientiously for the position, the day's work seems more worth while ; it becomes a stepping-stone to something better. Our widened horizon makes us see our position as the man above is seeing us. Many large industrial corporations make it a definite policy to require of each man that he train some other employee to be his "understudy." This accomplishes a variety of beneficial results. The BUSINESS ORGANIZATION 29 C0B1ESKWD£I«I||«»ILINC|| TBAmc IBEBVICEl CREHTS CllLECTIONS |EmcirHEKI||srENOi;i)AmiU|SI)n Or ||FlllNe [ACCOIMTIKG I p DMSIOH I |_ LEGAL ll CREDIT I j" DIH5I0W 1 1 DIVISION I I I HLUHC I fcLAJMS |[p55TiHg]| STATISTICAL | I BUPEET II CHECHWG ||CA11[)1H6| ORCAMZATION CHART OFA LARGt HANUrAaURINE CONCERN IKM HDOICWCST 30 BUSINESS ORGANIZATION tf> LI Q -J O z o a u " 5 o z BUSINESS ORGANI ZATION 3I younger man realizes that he Is in line for promotion and this encourages him and gives him enthusiasm in his work. The higher employee no longer feels himself indispensable and begins to look to the job ahead of him. Enthusiasm and alertness in this way communicate themselves to the entire organization. Moreover, should some employee resign or fall sick there would be no difficulty in filling his place. . The National Cash Register Company attributes a large part of Its esprit de corps to this policy of training understudies. In order to aid employees in obtaining this vision, some firms prepare promotion charts, showing In a simple way the steps by which It is possible to climb to higher positions. Lord and Taylor, a large department store In New York City, has prepared the following chart: I pE5IGNER~l I 5ALE5 ~l IBOOKKEEPErI I MILLINER I I DBESSMAKERH IJUNIOR SALESl ISTENOGRAPHERl I BILLCLEHiTl ; I APPRENTICEl I PACKER 1 I TYPIST 1 |W0RK roomI I STOCK 1 I orncE ciaLI — 1 I r- I CHECKGIBL I PROMOTION CHART OFALARGE DEPARTMENT STORE In the pages that follow the questions hinted at in the present chapter will be discussed in more detail. .Summary. There are two classes of business en- terprises, industrial and commercial. The Industrial enterprises change the form of goods, while the com- mercial enterprises facilitate exchange and produc- 32 BUSINESS ORGANIZATION tion. Industrial enterprises may again be divided into manufacturing and extractive industries, each with its own characteristics. Commercial enter- prises may be trading, transportation, or financial undertakings. Within each business three main functions may be recognized : management, administration, and labor. The following departmental divisions are frequently found: purchasing, service, production, selling, and accounting. Organization charts are used to enable the members of the organization to understand their relation to the organization as a whole. BUSINESS ORGANIZATION 33 REFERENCES H. C. Adams. Description of Industry. Henry Holt and Company. C. C. Parsons. Business Administration. A. W. Shaw Company. J. R. Smith. Industrial and Cdmmercial Geography. Henry Holt and Company. * . QUESTIONS FOR FURTHER STUDY 1 . What does Smith mean when he says : "Civilization is a product of adversity"? Reference: Smith. Chapter I. 2. Explain the difference between "money crops" and "supply crops." Reference: Smith. Chapter H, 3. Show by examples how the application of science to agriculture has changed methods and crops. Reference: Smith. Chapter XVH. 4. What is the position of an auditor, and in how far do his duties differ from those of a controller? Reference: Parsons. Business Administration. Chapter H. 5. In what respects does the classification of industries given by Adams differ from the one given in this chapter? Reference: Adams. Chapter H. 6. What, according to Adams, are the marks of a successful industrial organization? Reference: Adams. Chapter VH. 34 BUSINESS ORGANIZATION TEST QUESTIONS 1. Give a definition of extractive industry, manu- facturing industry, commercial enterprise. Give two examples of each type of enterprise. 2. What problems of labor and financial management are characteristic of the extractive industries? 3. Are these problems entirely absent from the manu- facturing industries and the commercial enterprises? 4. Explain why individual efficiency is a social du^j^. BUSINESS ORGANIZAT ION 35 CHAPTER III THE PROPRIETORSHIP OF A BUSINESS The Owners May Be One or Many. Where a man owns his business, as a great many of the small busi- ness men do, we speak of "single ownership," or "sole proprietorship." A few of the large and nationally known concerns are also of this type. John Wana- maker continued to be the sole proprietor and mana- ger of his large department stores until a few years ago, when he changed the form of ownership. The advantage of this kind of ownership is that the owner receives all the profits which are made, but this is offset by the consideration that he must also bear all losses. Legally, he is responsible with all that he possesses — whether invested in his business or not — for all debts contracted, either private or on ac- count of his business. Another drawback of sole proprietorship is that the growth of the business is often limited by the amount which the owner is able to invest. Except where the business prospers to an ' unusual degree, and where the owner is willing to leave a large portion of these profits in the business — thereby increasing his investment year by year — single proprietorship may seriously hamper growth. At best, reinvesting earnings is a slow proeess 36 BUSINESS ORGANIZATION and may often be too slow to allow normal develop- ment to take place. In order to obtain additional capital so that the enterprise may expand, the proprietor may take in one or more partners. The basis upon which he will take in these coproprietors will depend upon the agreement he is willing to make. A contract will be drawn up in which the amount which each is to in- vest in tiie partnership, the form of this investment, whether cash, goods, or good will, the way in which profits and losses are to be divided, are carefully stated. Usually there is also a clause dealing in detail with the exact method according to which the part- nership may be dissolved. It is easy to see that taking in partners is a serious business which should not be done without careful consideration. All part- ners, except those who have been declared "dormant" or "non-acting," have a right to control the affairs of the concern, and are legally empowered to bind the partnership by their contracts. In selecting partners it is, therefore, necessary to find not only someone with the necessary amount of cash, but also someone who commands the entire confidence of the owner. It is bad enough to be held responsible with all that one possesses for debts con- tracted in the pursuit of one's business, as in the single proprietorship, but it is worse to be held re- sponsible for the debts contracted for the under- taking by all other partners. This "unlimited liabil- BUSINESS ORGANIZATION 37 ity" is a serious drawback to the partnership. An- other objection is that death or insanity or even vol- untary withdrawal may disband the partnership, thereby leaving the original owner high and dry, frequently unable to carry on his business alone and unable to find another partner. Where & large amount of capital is needed, a correspondingly large number of partners would have to be taken in, thereby increasing the dangers and difficulties men? tioned. The Corporation. The corporation presents itself as a forni of ownership which has all the advantages of a partnership, and few of its disadvantages. A partnership is a contract between persons, but this personal element disappears in the corporation, which is an artificial person created by law. In most states, corporations may be created under the "gen- eral corporation law" of the state by fulfilling the requirements of the law and by filing the necessary papers with the propfer state officials, usually the Secretary of State. If all conditions have been ful- filled, a "charter" or "articles of incorporation" are issued. The capital of a corporation, corresponding to the net investment of the single partnership or proprie- torship, is once for all fixed and cannot be changed without sanction from the sam'e state officials. For the sake of convenience, the total capital is divided into shares of equal amounts. These are called shares or 38 BUSINESS ORGANIZATION shares of stock. Those who contribute to the capi- tal are called stockholders or shareholders. The stockholders are, therefore, the owners of a corpora- tion in the same sense as partners are the owners of a partnership. In most states at least three incorporators are re- quired before a corporation can be formed. They must have agreed to take a certain percentage of the total, capital stock — this is called subscribing to the stock — and before business can be begun a certain percentage of their subscription must be paid into the treasury of the company. In applying for incor- poration the following information must, as a rule, be submitted : I.- The name and purpose of the organization. 2. The amount of capital and classes of stock tobeissued. 3. The location of the main business office. 4. The expected life of the corporation — as a rule a cor- poration has perpetual life. 5. The names and addresses of the incorporators. Advantages of Incorporation. One of the principal advantages of the corporation is found in the limited liability of its shareholders. Usually their liability is limited to the amount which they have invested, though in rare cases, as in the case of banks, "double liability," i. e., liability for twice that amount is found. This limited liability feature is one of the reasons why state regulation is needed. The inter- ests of the creditors must be given some degree of BUSINESS ORGANIZATION 39 protection, though it may curtail the freedom of ac- tion on the part of the owners. The fact that such corporations may have a per- petual Ufe, and that their existence is not affected by changes in the body of owners is another important advantage over the partnership, the life of which is always more or less uncertain. The stockholders or shareholders, though dividing the ownership of the undertaking, have no right to act as agents for the corporation unless duly appointed to such office. This protects against recklessness or lack of business knowledge on the part of a joint owner, a danger which is very real in the case of a partnership. All that a stockholder is expected to do is to supply funds, to cast his vote at the stockholders' meetings, and to take the profits, if any, while in case of loss he knows that he cannot lose more than he invested. A corporation may, therefore, look for its shareholders among people of all kinds ; the possession of a certain amount of cash is the only necessary condition of membership. The fact that losses are limited to a known amount makes the finding of persons able and willing to become part owners of a new enterprise comparatively easy. To sum up the advantages of incorporation — they are found principally in: S 1. Limited liability. 2. Separation of ownership and management. 3. Life independent of changes of ownership. 40 BUSINESS ORGA NIZATION Launching a Corporation. Until the incorporation is completed the incorporators are "jointly and sev- erally" liable for all debts contracted by them for the undertaking. A considerable amount of business may have to be transacted before incorporation can be started. It may be necessary to pay down money to secure patent rights or mining claims or to secure options for later purchases. Lawyers may have- to be engaged to advise in respect to legal complications which are likely to arise in connection with such ownership and rights. These and a multitude of other details must be attended to before it is possible to incorporate. It is not an easy matter, therefore, to launch a cor- poration. Few people know how to go about it, and still fewer are willing to face the risks involved. The making of all preparations and the finding of the initial finances is called promotion, and the men un- dertaking it are called promoters. Some individuals, usually men with experience in finance and a knowl- edge of the financial world, make a specialty of pro- motion. They are professional promoters. Some of these promoters have incorporated their business and have added a staff of engineers. By so doing they are able to give expert advice concerning the feasi- bility of engineering projects, and to undertake the construction and initial operation of such propositions. Sometimes a group of bankers forms a syndicate, which is a kind of temporary partnership for the pur- BUSINESS ORGANIZATION 4I pose of investigating, organizing, and starting a new corporate enterprise. The promoters are usually re- warded by being made shareholders of the new cor- poration. In other words, they are given a block of stock or are allowed to purchase it at a low figure. The Value of Stock. Each stock- or shareholder receives as evidence of his part ownership a stock cer- tificate. In this stock certificate is stated the number of shares of stock which it represents. The par value of the stock is also indicated. By par value is meant the sum which represents the proportionate amount of the total capital which the share represents. If the total capitalization is $100,000 and one thousand shares have been issued, then each share is said to have a par value of $100. Whether it is worth $100 is another question. The value of the shares is deter- mined not by their par value, but by the actual or expected earnings of the corporation and by the pro- portion of these earnings which will fall to each share. The larger the number of owners, the smaller the share which each one will receive. Different Classes of Stock. There is still another factor which influences the value of shares of stock. Each share of stock has three important rights. These are : 1 . A vote in the election of the directors of the company. 2. A share in such part of the profits as the directors have declared can safely be distributed. 42 BUSINESS ORGANIZATION 3. A share of the total net assets of the corporation in case of dissolution. As long as all shares are on the same basis and none have special rights, all shares of stock will have the same value, but sometimes there exist different kinds of stock. Certain shares have privileges and rights which are not given to the ordinary or common stock. Stock with special privileges is called preferred stock. Preferred Stock. How It Arises. Why should such special privileges be given? Because under certain circumstances this may be the only way of saving the company from ruin. Suppose that a company has been operating for some time and is desperately in need of more capital. It is found impossible to "float," i. e., sell more common stock. The directors do not judge it expedient to borrow money for the undertaking, for that would mean shouldering a heavy responsibility for the regular payment of in- terest. Preferred stock opens the way to meet this difficult situation. It means taking in more co- owners, and it means granting them rights which the original owners do not possess. It means a sacrifice of rights on the part of the original owners, but it is a necessary sacrifice. Money must be secured and cannot be secured in any other way. Or it may be that the company has borrowed money in the past and has difficulty in meeting its obligations. The creditors may have been given BUSINESS ORGANIZATION 43 rights when the debt was contracted, which might make it uncomfortable for the company. This is usually the case where bonds have been issued. These will be discussed in a later chapter, but at this place it may be explained that bondholders are long-time creditors of a company who usually have the right to take possession of the property and to operate it for their benefit, or to sell it and to apply the proceeds on the debt, whenever the comp?my fails to pay either interest or principal at the agreed time. Should the company fail to live up to its obligations, the bond- holders may take steps to exert their rights. In such cases preferred stock forms a compromise. The original owners sacrifice rights and the old bond- holders sacrifice some of their rights to become privi- leged part-owners rather than wreck the concern by insisting upon exercising their full legal rights. Pre- ferred stock may also arise as a result of the desire to give old part-owners, who have invested different amounts in cash an equal voting power in the man- agement of the corporation. Different Kinds of Preferred Stock. Almost all pre- ferred stock is preferred as to dividends, i. e., in re- spect to the profits to be divided. There is an almost unlimited number of ways in which this special privi- lege may be granted. The agreement may be that no dividends are to be paid to the common until the preferred has received a certain amount, say 6 per cent, after which all may share equally or in some 44 BUSINESS ORGANIZATION other way agreed upon. As an example may be given the preferred stock of the Chicago and Northwestern Railway. This stock draws 7 per cent which is fol- lowed by 7 per cent on the common. After this the preferred draws another 3 per cent before the com- mon draws anything further. In some cases preferred stock is cumulative; this means that a minimum of yeasly dividends is guar- [anteed. If during any one year no dividends are paid, they must be paid at some later time before the common stockholders can receive any share in the profits. This may be an agreeable arrangement for the preferred stockholders, but it is easy to see how this affects the common stockholders. They may have to go without income for years and years. As far as they are concerned this arrangement is al- most, though not quite, as bad as borrowing money and facing the heavy yearly interest burden. The situation grows worse when preferred stock- holders are granted additional voting privileges. This is frequently the case, and it is not uncommon for the control of the corporation to pass practically into the hands of the preferred stockholders. Some- times provision is made by which control passes into their hands automatically,' as soon as dividends have not been paid for a certain number of years, say four or five years, in succession. Preferred stock may also have special rights in re- spect to the final division of the property in case of BUSINESS ORGANIZATI ON 45 dissolution or — and this is becoming more and more common — an additional inducement may be held out in the privilege of exchanging the preferred for com- mon stock, in which case a share of preferred may be considered the equivalent of one and a half or even two shares of common. The Control of the Corporation. All stocks have, as a rule, the right of vote in the stockholders' meeting. All internal affairs are usually regulated by a set of by-laws which supplements a charter or constitution. In these by-laws the following matters are included : 1. Time, place, and manner of calling and conducting stockholders' meetings. 2. The number of stockholders which constitutes a quorum. 3. The manner in which absent stockholders may cast their votes. This is called voting by proxy. 4. The method of electing directors, their duties, and qualifications. 5. The method of appointing the officers, their duties, and qualifications. 6. The salaries and other methods of compensation of directors and officers. The stockholders elect a board of directors. The duties of the directors are to appoint competent officers, to direct the general policy of the corpora- tion, and to examine the periodic statements sub- mitted to them in order to inform themselves in regard to the honesty and efficiency of the managers. 46 BUSINESS ORGANI Z ATION In this country, directors are seldom paid for their services except by a nominal fee for expenses. In other countries directors receive a percentage of the profits and they are, therefore, more vitally interested in the success of the concern even though they may hold only small amounts of stock. The only way in which a stockholder can control the management of an undertaking of which he is a part-owner, is by casting his vote in a general stock- holders' meeting for those directors who, he believes, will best look after his interests. But one stock- holder can do very little unless he has a very large amount of stock, and even then he can do very little unless in some way he succeeds in getting a majority vote in the meeting. This does not necessarily mean 51 per cent of the total shares issued; much less than that is sufficient as a rule, for the stock is frequently held by widely scattered owners who never even con- sider attending a meeting. And even if they did attend, the fact that they do not "pull together" makes it possible for any small and well-organized group with a comparatively small amount of stock to dominate. Frequently a group of financiers control the vote not only by means of their own holdings, but also by means of the proxies of absent voters. A proxy is a document by means of which the stockholder author- izes someone else to vote for him. BUSINESS ORGANIZATION 47 The Payment of Stock. As will be remembered, the stockholders who agreed to buy stock when the com- pany was first started were said to subscribe to this stock and are consequently called subscribers. Since the company is not permitted by law to begin operation before at least a certain percentage of the amount subscribed has been paid in, the stockholders must make this initial payment before the concern begins to be a "going concern." The board of directors may decide — if the by-laws do not compel them to follow a certain course — ^how much money the stockholders shall pay, and whether this sum shall be paid at once or in regular or "called" installments. Stock paid for at one time or paid in regular installments is full-paid stock. When only a partial payment has been made the remainder continues to be an obligation on the part of the stockholder. Such stock is called assessable stock. The element of uncertainty connected with this type of stock does not make it very popular. When one buys such stock one never knows whether he is buy- ing a source of income or a debt. A corporation will, therefore, as much as possible issue only stock which is full-paid. Where only a partial cash payment is received the difference is frequently made up by a transfer of property, tangible or intangible, such as patent rights or "services." It is clear that in such a case the difference between the par value of the stock and 48 BUSINESS ORGANIZATION the actual cash payment constitutes the supposed value of the services or of the property transferred. The board of directors or the promoting syndicate determines these values. If their estimates are far above the actual value, then the par value of the issued stock and consequently of the authorized capi- tal is in excess of the actual value of the assets both tangible and intangible. Such a condition is called overcapitalization and the stock thus issued is called watered stock. This may or may not be a bad thing. Frequently an overcapitalization is fully justified by the advantages resulting from incorporation, such as more favorable credit and better management. Transfer of Stock. The original owners do not al- ways care to continue to invest their money in the corporation, and may wish to sell their ownership rights to others. This they do by selling their stock certificates. Since each one of these stock certificates bears the name of the original owner and the certifi- cate is, moreover, recorded in his name on the books of the company, it is necessary that he formally re- linquish his right. This he does by placing his name on the back of the certificate, in other words, by in- dorsing the document. This is called indorsement in blank because the name of the new owner has not yet been inserted. Such a certificate may now pass from hand to hand and not until the time comes when dividends are to be paid is the name inserted of the person, who at that time is the owner. The BUSINESS ORGANIZATI ON 49 certificate is then sent to the transfer agent of the corporation, who will make the transfer on the books and will issue a new certificate. It is important that this transfer take place in proper time, for dividend checks are mailed to the persons whom the books show as owners of the stock. In order to prevent the issuing of more certificates than are authorized, a registrar is appointed who checks the certificates issued by the transfer agent. Dividends. After the net income for the year has been determined by the accountants, the directors decide how it shall be spent. They may decide to divide it among" the stockholders or to retain all or a part of it in the business. Since the capital of the corporation has once for all been determined in its articles of incorporation, this addition to the per- manent investment must appear under another head- ing on the balance sheet. The account which almost invariably receives this charge is surplus. It is cus- tomary never to use this surplus for the payment of dividends, though there is no legal reason why it should not be so used in the future. By not receiving the dividends during any one year the stockholders suffer a loss in income, although this loss is offset by the increase in value of the corpora- tion's assets. Where the body of stockholders is fairly constant the benefit fully ofifsets the sacrifice, but in the case where the body of stockholders is con- stantly changing, the financial interests of the present 50 BUSINESS ORGANIZATION group of owners are sacrificed, while some future group will reap the results. The stockholders may disapprove, but they have no way of forcing the direc- tors to pay them a defiinite part of the profits made. The declaring of any dividend is entirely at the op- tion of the directors. As a rule the directors will try to maintain a steady rate of dividend. Their act of withholding a portion of the net income may be merely the result of that ideal. Stocks with a fairly uniform rate of dividend find a more ready market and prepare the way for other issues of securities by the same company. It is usually unwise to pay out all the profits made in a year of exceptional prosperity. Careful financial management should be wide awake to possible hard times to come, especially in industrial concerns, which as a rule are subject to great fluctuations. A portion of the profits laid aside in times of prosperity may aid the company to face the dangers of a temporary slackening of business. A company may be seri- ously troubled through a neglect of this principle. As a rule dividends are paid in cash. In order to have sufficient cash available at the right time the company must take proper measures to convert enough assets into cash in advance of declaring divi- dends. Where this is neglected it may become necessary to borrow money to pay dividends. It may not always be wise to pay dividends in cash. There may be reasons for hiding the actual profits BUSINESS ORGANIZATION 5I made from the general public. A withdrawal of cash may seem unwarranted, especially where a large ac- cumulation of surplus has taken place. In such cases stock dividends may be paid. This means that the stockholders are presented with one or more shares of additional stock. It will usually be necessary to increase the capitalization in order to accomplish this. This means capitalizing the surplus, a legiti- mate act as long as the surplus has resulted from actual earnings and not from the marking up of assets. The stockholders' position is not thereby improved. Whether one owns shares with a face value of $200 out of a total capitalization of $100,000, or $400 worth out of a capital of $200,000 makes no differ- ence. In either case one is entitled to 1/500 of the total profits. The principal advantage is derived from the fact that the market price of each share of stock has become less and that it is, therefore, more readily sold. Summary. The proprietorship of a business may be in the hands of one person or of many. In the latter case, the business may be organized as a part- nership or as a corporation. The advantages of the corporation are limited liability, perpetual life, sepa- ration of management and ownership. Frequently corporations are organized by promoters. Evidences of ownership are called shares of stock ; the corpora- tion issues certificates which are recorded by a regis- 52 BUSINESS ORGANIZATION trar and a transfer agent. There are many different kinds of stocks. They may be divided into two large classes : common and preferred. Preferred stock may be preferred as to dividends, voting rights, or assets. The payment of dividends is in the hands of the board of directors. REFERENCES L. H. Haney. Business Organization and Combination. The Macmillan Company. T.L.Greene. Corporation Finance. G.P.Putnam's Sons. E. S. Mead. Corporation Finance. D. Appleton and Company. W. H. Lough. Business Finance. The Ronald Press Company. QUESTIONS FOR FURTHER STUDY 1. It is said that stockholders in the United States are largely ignored in matters of management by the directors of the corporations. Can you discover a reason why this condition is not found to the same extent else- where? Reference: Lough. Part I, Chapter IIL 2. What is the purpose of a voting trust? Reference: Lough. Part II, Chapter V. 3. What are some of the effects of lack of care in the declaring of dividends? Reference: Lough. Part IV. Chapter XIX. 4. Describe in detail the operation of an underwriting syndicate. Reference: Lough. Part III, Chapter XV. BUSINESS ORGANIZATION 53 TEST QUESTIONS 1. What are the advantages of the corporate organi- zation? 2. What is meant by the terms par value, cumulative preferred, proxy, subscription? ^ 3. How is a corporation controlled? 4. How is stocfe transferred? 5. What are the advantages of regular dividends? 6. What is a stock dividend? 54 BUSINESS ORGANIZATION CHAPTER IV FINANCING AN ENTERPRISE (Working Capital) The Owned Capital of an Enterprise. As we have ■seen in the preceding chapter, a business may be •owned singly or by a group of owners who form a partnership, a joint stock company, or a corporation. These owners supply the necessary funds with which to launch the enterprise. The first decision which the owners face is how the money shall be spent. They must buy land, build- ings, possibly machinery and tools, and they must invest in raw material, labor, and fuel. It is no easy matter to decide how much should be allowed for •each purpose. Many concerns are doomed to failure from the very outset on account of an unwise decision of this important question. There is a great tempta- tion to buy a fine building and the very best and most •expensive machinery, in a belief that this means "starting out right." As a matter of fact, it may mean the very opposite. Working Capital and Investment Capital. Many farmers are said to be land poor. By this is meant that they are landowners and, therefore, not poor in the ordinary sense of the word, but th^t they are poor BUSINESS ORGANIZATION 55 in that they have no ready cash — no working fund. When they are called upon to pay wages or to buy necessities they must borrow from others. Many a business concern is in somewhat the same condition. A large proportion of the funds or capital of the enterprise is tied up in buildings, machinery, and more or less permanent equipment; and little is left to operate the enterprise, and to carry on enough business to keep the capital investment working at full time. Business failures frequently result frorq. this mistake in the distribution of the available funds. When starting a business undertaking two ques- tions must, therefore, be studied. 'The first question is how much money is needed to start the enterprise, and the second question, of equal importance, is how shall these funds be divided between capital investmenf and working capital? Only experience can determine how much working capital is needed in a business.. Certain fundamental principles may be recognized. Factors Influencing Amount of Working Capital Needed. The Turnover. One of the most important factors in determining the amount of working capital needed is the rapidity of the turnover. By turnover is. meant the number of times the stock is sold out and replenished. If a store has on hand goods, valued at $100,000, that is to say, valued at sales. price, and the total sales of the store amount to- $300,000 a year, then it is said that this store turns over its stock three times a year. By investing; 56 BUSINESS ORGA N I Z A T I O N $100,000 in goods the store has done a business of $300,000. Another store, with a less rapid turnover, in order to do a $300,000 business must tie up more than $100,000. Take, for example, a concern which turns its goods over twice a year instead of three times. This will necessitate a constant investment in stock of $150,000. Hence, it is plain that in order to carry on the same volume of sales the second store needs more working capital. This same situation exists in a factory. Here it is the rapidity with which the goods are sold out of the warehouse which determines the amount of money tied up in stock. But still another factor enters in. The stock which must be kept on hand to fill orders promptly is one factor, the length of the manufactur- ing process is another. The more time is consumed in that process the more "goods in process" are on hand at any one time in the factory. These, too, represent investment. The raw material which must be kept in stock is still another factor. If the factory is forced to import its raw material in large quantities from foreign countries the raw material investment may be very considerable. When, on the other hand, the factory is placed near a source of material so that any needs may be quickly filled and hardly any raw material need be carried in store, then the invest- ment in raw material becomes negligible. In a fac- tory the amount of funds tied up in stock is, there- fore, determined by the rate of turnover of finished BUSINESS ORGANIZATION 57 goods, the raw material stores, and by the length of the manufacturing process. ''Seasonal Production Requires Large Working Capi- tal. Whenever anything interferes with the regular turnover of a business, stock will accumulate and tie down a large share of the ready funds. Seasonal in- dustries such as tiie straw hat industry and the clothing industries, must manufacture their goods months in advance in order to have them in the re- quired quantity when the summer demand comes. This means that the working capital is, to a very large degree, tied up in finished goods. The amount of business the concern can do ^t the time the tem- porary demand is active is limited beforehand by the amount of capital the concern has been able to invest in finished goods during the manufacturing months of the slack season. If firms always paid cash for their purchases of raw materials and other necessary goods, such seasonal industries would re- quire huge amoimts of working capital. A firm does not necessarily supply all of its working capital. Borrowing Working Capital, Trade Credit. It is not always necessary to pay cash for goods. It is possible to postpone payment or, as it is called, to buy on credit. By this method a business may be carried on with comparatively little actual working capital. Retailers buy their goods in this way from the wholesaler or manufacturer, and are allowed to postpone their payment long enough, so that they 58 BUSINESS ORGANIZATION frequently sell the goods to the consumer before payment is due. They can then use the money they received from their customers to pay the wholesaler or manufacturer. Manufacturers may in this way buy their raw material, or partly finished goods, and wholesalers may again make similar terms with manufacturers. This buying on credit is most frequently found in the retail trade, and here principally among the small concerns, while the manufacturer uses this method of raising funds but very little. There is a good reason for this. Although by this method a business may get along with little working capital, the firm which allows the postponement of payment does not grant this privilege for nothing. The price of goods sold on credit is always higher than that of goods sold for cash. This needs no ex- planation for it is clear that the firm selling on credit is really lending its working capital to its customers. The more a firm is compelled to sell on credit and the longer the period of credit that must be allowed, the more working capital that firm will need, and the -higher is its cost of doing business. It is, therefore, fair that the buyer should pay for the privilege of re- ceiving credit. When in ordinary business transac- tions goods are sold for, say, $i,ooo and 5 per cent off for cash within ten days, and the custom of the trade is that credit shall run no longer than two months, then it means that the business firm is pay- BUSINESS ORGANIZATION 59' ing a very high rate of interest for the credit accom- modation. The choice lies between a cash payment of $950 at the end of ten days or a $i,ooo payment fifty days later. For the fifty days use of $950 the buyer pays $50 or the equivalent of 37.89 per cent a year^ Whenever the buyer is able to find some cheaper way of obtaining temporary use of funds other than this commercial credit, it will pay him to make use of it. For this reason large department stores and well-established manufacturing fin^s, who can bor- row money readily and at a moderate rate, find it to^ their advantage to pay cash for their purchases aud- io borrow money in some other way. Borrowing from the Banks. One method of securing cash with which to pay for purchases is to borrow from the banks. The banks are always on the look- out for safe investments in which to place their sur- plus funds, but they must be Careful in the choice of their investments. The principle that should always be borne in mind when investing the funds of a com- mercial bank is that in order to be able to meet de- mand obligations one must invest only in liquid loans, A liquid loan is a loan which has only a com- paratively short time to run and which is self- liquidating. This last feature is quite as important as the first. A loan is self-liquidating if the funds are spent in such a way that the transaction itself, pro- viding everything goes as anticipated, will produce the means of its own payment. 60 BUSINESS ORGANIZATION Take an example : If a man borrows, with the de- sire to buy an automobile, that loan cannot be called a liquidating loan, for the possession of the machine does not increase his power to repay the sum bor- rowed. As a matter of fact, the cost of the gasoline, tires, and repairs may place him financially in a less favorable position than before the purchase. But let him invest the same amount in a delivery wagon for his store and the situation is different. Now he can please his customers by quick delivery, he may be able to do away with two or possibly three horse and wagon outfits, or he may be able to expand his busi- ness in another section of town. The delivery equip- ment increases his earning capacity. This is a self- liquidating investment. It earns money to pay for itself. In order to make certain that the funds of the bank are invested in the right kind of loans, the banker will request from the prospective borrower a state- ment of hiri business and of the purpose for which the loan is to be used. A model of such a statement as prepared by the Federal Reserve Board is attached opposite this page and should be studied carefully. If properly filled out such a statement gives a clear picture of the financial condition of the firm in question. The Promissory Note. After the banker has studied this statement and has been convinced from conver- sation with the borrower that the purpose for which BUSINESS ORGANIZATION 6l statement of. Business. . . . . . To •Address.. .Bank op. We make the foUowine statement of all the assets and liabilities of our firm at the close . of trasiness on. and give othet material Information tor the purpose of obtaining advances on notes and bi*ls bearing our signature or indorse- ment, and for obtaining credit generally on present and future applications. [PLBASK ANSWER ALL QtJSSTIONS AND FILL IN ALL BLANKSl ASSETS LIABILITIES N Qtes Pa va ble to Banks . Notes Payable to Others Notes Receivable Other Quick Assets (Item- Other Current Liabilities — ™ — ■ Current Liabilities . - — Other Deferred Liabili- — Current and Deferred Liahilittes . Net Worth __— TOTAL TOTAL Contingent Liability. As indorse t $ Finished $ Unfinished If any goo^s are on coi amount and circumstances $ Raw 5. .. isignment, state As guarantor $ No accounts have been sold or assigned except as follows'. . . . Sales and Profits Last Fiscal Year. Net Sales Accounts and Notes Receivable, If any past due or doubtful state amount and circum- were at maximum ($ ) on r • ■ • ■ and at a minimum {$ ' ) on If any amounts are due from n firm, employees, branches or s state amounts and circumstan lembers of the milar sources, of mortgages and on what assets a hen Is mortgage a lien on any current assets? and if readily salable at value stated :::::::: Reserves and Depreciation. State what pro- :::::::::::: 1 vision is made *::.:: avc >r of firms. . .1 We hereby certify that the foregoing figures are taken from the books of our firm and that they and the statements contained on both sides of this sheet are true and give a cbr* /ect showing of our financial condition. Firm Name Signed this. .day of .191- By. (OVER) Member of Firm Federal Reserve Bank of New York Statement Form 62 BUSINESS ORGANIZATION Date op Partnership Date of Expiration. Generai. Partners | Special Partners Name Amount Con- tributed Net Worth Outside This Business Name Amount Con- tributed Partner UnUl If the 6rm has any branch offices state location and how accounts are handled. If the firm or any member is connected with any other business, state nature of the busi- ness and extent tc which interested What is the practice of the firm in regard to trade discounts?. Are books audited by a certified public accountant? Give date of last audit Location and Description of Land Owned Estimated Value Assessed at Mtgd. for Insured for Titte- The legal and equitable title to all pieces of above described real estate is solely In the name or names of one or more of the members of the firm, except as follows (The balance of this space may be used for printing any questions desired to be asked amplifying statement of condition as shown on opposite page) the loan is to be spent is sound, he will consent to the loan. Before the money is handed over to the bor- rower he must prepare an evidence of his debt which is to be left with the bank until redeemed. This evi- dence will usually take the form of a promissory note. The form of such a note is simple. No stated form is required. It is necessary, however, that it contain the name of the person to whom the payment is to be made, the date when the payment is due, the amount of the payment, the date when the contract BUSINESS ORGANIZATION 63 was made, and that it is signed by the person making the promise to pay. When any of these features are absent the note is not complete and there may be doubt as to its legality. (See model below.) $ __.__ Pato Alio, California, . On . after date, for value received, 1, we, or either or us, promise to pay Go ordeTof- . - . - i- U the FIRST NATIONAL BANK OF PALO ALTO, CALIFORNIA.' DOLLARS with InicTMKclehi pet c«^l.p«innum ,- ■ - _ ln«.«t «v.bU quinnlv, .nd tatCT« tlid prindml n« •pmul >t miiuritv to dr.w «ght pet «tit. .tttiu.! ItitetMt.both pHtwip.! .titl Ititcmt piydjle Iti United Sieiei gold eoln. TTie tn«ket% entJonete ■ttd guatmloti of thu note SBTee to p.y ■ teawneble '■ '" " l.™..*.. k...nn .^ h,„U, »u.n>L1u w.lv. nrsmtiTienc erf d.v- mene, notice of iwrn-pevment. ptoteit end i — • — ~' -- titne oF pivmeni me. be e.iei\ded wiiKoul •hole iuin to beeomc dtie etid payebl^ Due . P.O As a rule there is included in the note a statement in regard to the interest to be paid on the money thus obtained. Such a promissory note may be single-name paper, which is the case when one signature appears on a note, or it may be a joint note, in which case two or more signatures appear. A joint note may be two,- three-, or four-name paper, according to the number of signatures. In order to make a note negotiable or transferable, it is necessary to add to the name of the one who is to receive the money the words "or order," or "or bearer"; this makes it possible for the creditor to transfer his right to some other person. This trans- 64 BUSINESSORGANIZATION fer takes place through indorsement, and may be ac- complished by affixing the signature of the payee on the back of the document. This is called a general indorsement to distinguish it from a specific indorse- ment, which names the person to whom the payment is to be made. The Security Back of the Loan. In the case of the notes just described, the only security which the bank has is the honesty of those who signed the note. The banker may know these men and may have con- fidence in them ; he may be certain that the borrower and his friends may be perfectly willing to pay when the note falls due, but the question is whether the borrower will be able to pay. A loan is, then, only safe when the borrower combines ability with willing- ness to pay. There is nothing in the ordinary promissory note that gives any information about this ability to pay, nor any certainty in regard to the way in which the money is to be spent. The banker may, therefore, ask some additional security. This security is called collateral. A very common method is to deposit with the bank a. security of bonds, stocks, or other valu- able documents acceptable to the bank. These must be properly indorsed or made, as it is called good de- livery, for unless so indorsed the bank could not sell them as the need arose. Many merchants offer their accounts receivable as security for loans. An account receivable is an ac- BUSINESS ORGANIZATION 65 count upon the books of the borrowing firm which shows that a certain amount of money is due from another concern. This method is becoming quite general. In a way it is efficient and safe, but it may give rise to fraud for it is possible for a business man to assign his accounts receivable to one bank and then to use these same accounts as a basis for direct loans from some other bank. Another method to obtain ready money is to bor- row money on merchandise. Manufacturers fre- quently place their raw material in warehouses and borrow money from banks and give the warehouse receipts as security. The amount which the banks are willing to lend will be determined by the charac- ter of the merchandise. Only merchandise for which there is a steady and fairly constant market can be made the basis of loans, while perishable goods form very dangerous security. Banks never lend up to the total value of the mer- chandise, they hardly ever lend more than about 80 per cent, and usually less. Merchandise as Security for Loans. It is not neces- sary to keep the merchandise stored away in a ware- house while it is being used as collateral. Goods may move freely from one part of the country to another, or even to foreign countries, and may change hemds several times, financed all the while, not by those who deal in the goods, but by banks. 66 BUSINESS ORGANIZATION Agricultural products travel that way from farmer to domestic or foreign buyer. The farmer usually needs and demands cash for his product. He hcis in all probability accumulated a large bill with his local grocery and dry goods stores during the period be- tween harvests, and he may also have to pay for his farm machinery which he bought eeirlier in the year on credit. He needs the meams of payment, there- fore. He demands cash or a deposit in his favor with a bank against which he can draw checks. The traveling buyers have only a limited amount of cash at their disposal. They may be able to pay cash for the crops of one or two farmers, but if they had no other way of obtaining cash they would have to wait with further purchases until the crops had been moved to some central market like St. Louis, Chi- cago, or Kansas City, and sold to the middlemen who form the link between these large primary markets and the consumers. The local buyer is able to borrow from the bank by the following process : he draws a bill of exchange or draft on the commission men or wholesaler at the primary market to whom the products are consigned. Bills of Exchange or Drafts. A draft is an order to pay a specified amount of money to a specified person at a definite time. This order to pay is worth money and the banks are willing to buy it. Since the money is not due immediately but only after a certain period of time, BUSINESS ORGANIZATION 67 and since a certain amount of risk is also involved in the transaction, the banks will charge a fee for this service. .This fee is deducted in advance, so that a draft of, say, $i,ooo which is due three months later may not bring much more than $985. The difference between the face value of the draft and the amount actually received, in this case $15, is called discount. Discount is calculated like interest on the basis of a certain percentage a year. In the example the dis- count charged was 6 per cent. The security back of this draft may be merely the reputation of the firm on which it is drawn. Fre- quently the merchandise which forms the basis of the transaction is given as a collateral. The banks do not receive the goods themselves, but instead a receipt of the railroad company, called a bill of lading or waybill, which is evidence that a certain quantity of grain or cotton or some other kind of product has been shipped. The railroad company will only make delivery of the goods against return of this bill of lading. The bank receiving this document is, there- fore, certain that the goods will not be released with- out its knowledge, and will not hand this valuable document to the firm upon which this draft was drawn, until certain that payment has been made, or until some satisfactory arrangement has been made for payment at some future date. A draft may be a sight draft, which means that it is payable upon presentation, or it may be a time 68 BUSINESS ORGANIZATION draft. A time draft is a draft payable on a certain day or a certain length of time after being presented, after sight. The Acceptance. The firm upon whom a time draft is drawn may, upon presentation, accept the draft. The acceptance is made by writing across the face of the draft the word accepted, with the signature of the party accepting. Usually there is also added the date and the place where payment is to take place. The draft is then called a trade acceptance. Sometimes banks will accept drafts for their clients against a moderate fee. Such drafts are known as bank acceptances. Acceptances are not used very much in the United States, but they are very commonly used in England. The Federal Reserve Board has at various times sug- gested the more general use of this method of financ- ing transactions. The accepted draft is an evidence of a live business deal. As a rule such documents arise as the'direct result of the sale of goods. Such a transaction is very likely to be self-liquidating. An accepted draft is, therefore, readily discoimted at the bank and may even be sold in the open market. This is done in other countries to a very large extent. Many firms which have funds temporarily available for a short- time investment, find in the buying of these accept- ances a way of employing their idle cash safely. This safe kind of commercial paper, therefore, aids in BUSINESS ORGANIZATION 69 mobilizing resources of the community which would otherwise lie idle. The banks momentarily imable to invest in com- mercial paper thus lend their credit by accepting the draft, after which it will be readily bought in the open market. This situation illustrates better, per- haps, than any other banking transaction, that a bank's main function is to exchange unknown credit for known credit, thereby greatly facilitating the processes of exchange. The Credit System. As a result of the use of credit, either trade credit or banking credit, a merchant is enabled to get aloi^ with little working capital. He can buy more than his actual cash would allow. He can expand his business, the volume of his goods on hand, and his sales, way beyond his cash resources. He can expand as long as the banks and merchants continue to have confidence in his ability and hon- esty. Only when they begin to doubt his ability "to swing the deal" is a man's growth retarded. A mer- chant's progress is no longer limited by what he pos- sesses in the way of money, but by his ability and energy. In so far the credit system is far superior to a system under which no one can engage in a new transaction until some other transaction has been completed and has yielded its proceeds. The only danger in the credit system lies in the fact that men are inclined to be overoptimistic. They carry others along with their enthusiasm, and 70 BUSINESS ORGANIZATION as a result merchants will sometimes overbuy, i. e., overreach themselves, and they may then find it impossible to make good their promises of future payment. It is claimed by some that optimism and pessimism run in waves, and that periods of over- buying are followed by periods of depression, when everyone is afraid to allow further postponement of payment. Everyone owing money will then try to sell, with the result that business becomes disorgan- ized. Prices decline sharply, banks are called upon to produce cash, and a panic results. The only way in which such a panic can be avoided is by a limita- tion and a careful scrutiny of new credit, and an ex- tension and gradual liquidation of the old credit. If given time the situation will right itself. The Note Broker. Much of the commercial paper is sold not directly to banks but through note brokers. These are men who have made a special study of this kind of investment, and are in touch with banks in different sections of the country. The bank, to a large extent, relies upon the judgment of the broker from whom it buys commercial paper and is thereby saved the time and expense of an investigation. The notes range in value from $2,000 to $200,000, The Credit Man. It is very difficult to know whether to allow credit to a certain person or a firm, and for what amount. In all large commercial con- cerns and also in many banks there is a special official who is charged with the duty to decide these difficult BUSINESS ORGANIZATION 7I problems. He is called the credit man. The credit man gets his information through various channels. He may obtain it through the traveling salesmen of the firm who are required to report upon such mat- ters, and who gather their information from observa- tion, and from conversation with the customers and others acquainted with the local business conditions. Some credit men place very little confidence in these reports because salesmen frequently lack the knowl- edge and the analytical mind necessary to come to sound conclusions in credit matters. He may get his information from the banks. This method cannot be very successful for more than one reason. The bank does not necessarily know the financial condition of the firm, but more than that, even if the bank did know, the relations between bank and customer are somewhat of a private nature, and banks often feel that they would be committing a breach of confidence in giving the information asked for. The next method is to use the reports of the mer- cantile agents. There are two important agencies in the United States: R. G. Dun and Company, and the Bradstreet Company. Both of these agencies inves- tigate the credit of firms and individuals, and gather data regarding their business experience and reputa- tion and the amount of capital invested. The infor- mation collected by these agents is published in books issued quarterly to subscribers. These volumes 72 BUSINESS ORGANIZATION contain some 1,900,000 names arranged alphabeti- cally under the names of the cities. Behind the names of the firms appear symbols constituting the rating, which indicate the estimated net worth of the firm and its past record of business ability and hon- esty. The symbols bf R. G. Dun and Company are arranged as follows : KEY TO RATINGS LEFT-HAND COLUMN RIGHT-HAND COLUMN ESTIMATED PECUNIARY STRENGTH GENERAL CREDIT High Good Fair Limited AA A + A B + B C-l- c D-f D E F G H J K L M Over Ji, 000, 000 Over $750,000 $500,000 to $750,000. 300,000 to 500,000. 200,000 to 300,000. 125,000 to 200,000. 75,000 to 125,000. 50,000 to 75,000. 35,000 to 50,000. 20,000 to 35,000. 10,000 to 20,000. 5,000 to 10,000. 3,000 to 5,000. 2,000 to 3,000. 1,000 to 2,000. 500 to 1,000. Less than 500. Ai Ai Ai I I I iK iM 2 2K I I I 2 3 3 3 3 3 iK iK 2 2 2 2ji 3 s'A zH z'A zH 3K zA 2 2% 2}/i 3 3 3 3K 4 4 4 4 4 4 4 When only a credit rating appears this line of credit designation applies i 2 3 4 {d) Where an italic d in parenthesis precedes a rating, it is an indi- cation that one or more of the partners in the firm are liable in another or other firms, and the responsibility is in that sense divided, thus: (d) B-fi. BUSINESS ORGANIZATION 73 The absence of a Rating, whether of capital or credit, indicates those whose business and investments render it difficult to rate satisfactorily. We therefore prefer, in justice to these, to give the detailed reports on record at our Offices. Ratings of branch houses should be looked up at Headquarters also R. G. Dun & Co. These general reports may be supplemented by means of special reports from the agency which are furnished to subscribers upon request and are much more detailed and specific. In addition to these commercial agencies there are established a number of co-operative credit informa- tion undertakings, such as the various local credit men's associations, which exchemge informatidn upon requests from members. Summary. The amount of working capital needed in any business depends upon many factors: the rapidity of turnover, the terms of sale and purchase, the length of the manufacturing process, and the seasonal fluctuations. More working capital rRay be secured by: 1. Postponing payment on purchases. 2. By borrowing from banks on promissory notes, with or without collateral (collateral may be stocks, bonds, or merchandise). 3. By discounting a bill of exchange or draft. Such drafts are made more marketable by acceptance, either by merchants or banks. 74 BUSINESS ORGANIZATION Note brokers act as middlemen between borrower and lender. The credit man supervises loans and per- forms an important service in the business enterprise. REFERENCES Same as preceding chapter. Additional references: F. A. Cleveland. Funds and Their Uses. D. Appleton and Company. J. E. Hagerty. Mercantile Credit. Henry Holt and Com- pany. W. A. Prendergast. Credit and Its Uses. D. Appleton and Company. A. W. Douglas. Merchandising. The Macmillan Com- pany, QUESTIONS FOR FURTHER STUDY 1. Can you see any good reason why in figuring the turnover it is necessary to use sales price or retail price, both for the total sales and for the valuation of stock on hand? Reference: Prendergast. Chapter VIH. 2. How much does a firm lose when it can earn lo per cent a year on its working capital, and it neglects to take advantage of a cash discount of 6 per cent within ten days on a purchase of $2,000 payable in 60 days? 3. How is a note protested? Reference: Cleveland. Chapter VII. 4. How are credit accounts collected? Reference: Cleveland. Chapter VII. 5. What are the special financial problems involved in selling on installments? Reference: Lough. Part IV. Chapter XVII. BUSINESS ORGANIZATION 75 6. Explain how the experience of the Westinghouse Electric and Manufacturing Company illustrates the necessity of extreme care in the investment of capital funds. Reference: Lough. Part IV, Chapters XVI, XVII. TEST QUESTIONS 1. It is sometimes said that a society where all pay- ments are made in cash is a "static society" and that a society where transactions are carried on by credit is a "dynamic society." (Static means stationary, not sub- ject to expansion. Dynamic means growing, expanding.) Can you explain this statement? 2. Enumerate-the various ways in which a merchant may secure the use of more working capital. 3. What are the different kinds of security which one may offer a bank when making a loan? 4. What is a trade acceptance and what a bank acceptance? 5. What are the duties of a credit man and how does he secure his information? 6. What is meant by a credit rating? 76 BUSINESS ORGANIZATION CHAPTER V FINANCING AN ENTERPRISE (Borrowing on Long Time) Problems of Financing a Growing Business. A business may be seriously handicapped and even in danger of financial failure from an insufficient amount of working capital. But as we have seen, . many avenues are open to supply the need by means of borrowed money. A firm is also handicapped when it has insufficient capital investment, when its factory is too small, its delivery equipment inadequate, or when its machin- ery is out of date. The effect is not likely to be as disastrous as when the working capital is insufficient and will in most cases be confined to a checking of the further development of the enterprise. The owners, anxious to supply the imdertaking with the necessary funds, may follow two methods. They may borrow on long time, or they may enlarge the amount of proprietorship funds, either by investing more themselves or by inviting others to become part owners. Advantages of Borrowing on Long Time. Borrow- ing has one advcintage which the other method does not possess. It supplies new capital without taxing BUSINESS ORGANIZATION 77 the resources of existing owners, and it does not in- •crease their number, which would resuh in a decrease in the share of the total profits falling to the original owners. Suppose that a firm, whether a single ownership, partnership, or corporation does not matter, has $100,000 capital and is making lo per cent on its investment a year. Suppose that the business de- mands an investment of $150,000, and suppose that the firm then makes 9 per cent on its total invest- ment. It must then be plain that the original owners would have been wise to secure the addition in capital by borrowing money at 5 or 6 per cent, rather than to invite in new shareholders or partners. Had they invited in new owners then they would have reduced the yearly income on their original investment from $10,000 to $9,000. By borrowing funds at the rate of 6 per cent a year they improved their financial returns, for of the total earnings which amount to $i3i500, only 6 per cent of $50,000 — or $3,000 — goes to those who supplied the new funds; $10,500 is, therefore, left to the original owners, who instead of receiving 10 per cent on their investment now make 10.5 per cent. Disadvantages 0} Borrowing on Long Time. There is, however, one great disadvantage attached to this method of raising funds. The yearly interest charge may become a heavy burden upon the concern. The owners of a business have no right to demand any- 78 BUSINESS ORGANIZATION thing as a return from a business unless it is earned, and in case of a corporation, not unless the board of directors have declared the earnings available for distribution. It is different with the interest pay- ment on borrowed money; this falls due every year or every half year or quarter, whether the business prospers or not. If anything goes wrong, this pay- ment may become a heavy burden and may lead to disaster. Need for Security. Nor will it be possible to obtain money on loan for a long period without offering good and unmistakable security. The situation is quite different from securing working capital. The mercantile loans or bank loans discussed in the last chapter are all for short periods — thirty, sixty, and ninety days. A keen business man can look that far ahead, or at least he believes he can, which amounts to the same thing. When a loan is asked for ten, twenty, fifty years or even longer, too many uncer- tainties enter in which make it necessary to ask for good security. This security is usually given in the form of a special right or lien on a specific piece of property, sometimes on property already in existence, at other times on property to be bought with the funds made available by the loan. The owners thereby sacrifice the right of free disposal of their property. The Mortgage. This right or lien is usually evi- denced by a contract called a mortgage. A mortgage BUSINESS ORGANIZATION 79 is a contract of sale, but a conditional sale which be- comes automatically void upon the payment of the loan with interest upon the date of maturity. The loan itself is evidenced by a promissory note, in every respect like an ordinary note of that kind, but at the bottom of which are affixed the words, "This note is secured by mortgage of even date herewith." The amount borrowed, the rate of interest, the maturity of interest and principal, are all mentioned in the note. What is commonly called a mortgage consists, therefore, of two documents, the contract of con- ditional sale, and the promissory note. Should the borrower fail to pay interest as agreed upon or should he fail to pay the principal when due, then the holder of the note and the mortgage has the right to take possession of the property and to operate it for his benefit or to sell it as the case may be. This is called foreclosure of the mortgage. The Bond Issue. As long as the amount of money which is involved is not very large the borrower will not have very great difficulty in finding someone to^ lend him the funds, provided the security offered is above question. One reason why a comparatively high rate of interest is charged for such loans is that mortgages are not readily marketable. They are for odd amounts and the security is only locally known. The larger the amount, the more difficult it becomes to find anyone willing to invest that much in one kind of security. 80 BUSINESS ORGANIZATION This objection is met by the subdivision of the promissory note into a number of convenient denomi- nations such as $100, $500, or $1,000 each. Such notes are called bonds. The only difference, then, between a promissory note secured by a mortgage, and a bond secured in the same way, is that the bond is one of a series all of which together take the place of the promissory note. The Trust Company. When there is one promis- sory note, the lender holds the note and the mortgage. The mortgage or conditional sale is recorded at the courthouse, and the lender may feel certain that no other loan will be made which may endanger his rights. It is different when instead of one note there are a large number of bonds, and when these are sold in widely scattered places. The first problem is who shall hold the mortgage, and the next problem is who shall see to it that no more bonds are issued than are called for in the agreement. The trust company here steps in to fill this need. This trust company must not be confused with the trust organizations refenjed to so frequently in the newspapers, such as the tobacco trust, the liquor trust, or the steel trust. The trust company here re- ferred to is a banking institution. It differs from a commercial bank in that it does not usually handle checking accounts, but deals principally in time de- posits and long-time investments. It performs, how- ever, the services of a bank in bringing together the BUSINESS ORGANIZATION 8l borrower and the lender, cind in lending its name, reputation, and credit. Usually a trust company is appointed to represent the lenders, to act in the nature of a^ trustee, though this function may be performed by other institutions or by a private individual. The duties of the trustee are to hold the mortgage, which in the case of a bond issue is usually called a deed of trust, to see to it that no bonds are issued in excess of the value of the loan to be consummated, and to protect the interests of the bondholders. From this it might be inferred that the trustee is appointed by the bondholders. This is not usually the case. In the case of corporation bonds the trust company is, as a rule, appointed by the corporation. Closed and Open Mortgages. Usually, when selling bonds secured by a mortgage, the amount to be sold is publicly announced, and it is agreed that even though the value of the property may far exceed the "amoimt of the loan, no additional bonds shall be issued under the same mortgage. This is called a closed mortgage. Sometimes, however, in order to leave an opening for raising funds in the future on the same 'security, the amount to be issued is not definitely limited and may be increased at a later time. This is called an open mortgage. Railroads sometimes issue bonds in this way and limit the amount to be issued by a fixed 82 BUSINESS ORGANIZATION rate per mile of track. Such open mortgages may lead to many abuses. Once a bond issue has been sold against a closed mortgage on a piece of property, it is possible to use that same security again for the same purpose. The right to a first claim on the security, however, can- not be taken away from the original bondholders; they hold the first mortgage bonds, while later issues based on the same security will be known as second, third, or even fourth mortgage bonds. The later issues do not in this case affect the rights of the pre- ceding ones. Equipment Trust Bonds. A mortgage or deed of trust on immovable property is but one of several ways of oflfering security to the bondholders. Equip- ment trust bond^ are bonds based upon the security of equipment, such as machinery, railroad cars, street cars, or locomotives. Such bonds usually arise as follows: Suppose a street car company needs new cars but has no available funds. It must then borrow the money. A trustee is appointed to buy the cars, to issue bonds to finance the purchase, and to lease these cars to the street car company. The trustee may be a trust company or may be a corporation formed solely for this purpose. The cars remain the property of the trustee and are merely leased to the company in order to protect the bondholders. The yearly rental to be paid by the company must cover the interest due to bondholders, expenses of adminis- BUSINESS ORGANIZATION 83 tration, and enough more to accumulate within the period of life of the cars, a fund sufficient to pay off the principal of the debt. Collateral Trust Bonds. Another type of bonds exists which bears very close resemblance to the promissory notes discussed in the preceding chapter. These are the collateral trust bonds. They are issued against a deposit of collateral. This method of issu- ing bonds is often used by public utility companies. Many railroad systems are composed of a number of branch lines. In order to concentrate and sometimes in order to acquire the ownership of the obligations of these subsidiary lines, railroad companies fre- quently place the bonds of these lines in the hands of a trust company, and issue new bonds against them as security. The well-known credit of the large or parent com- pany frequently causes these collateral trust bonds to sell for a higher price than the value of the collat- eral would justify. The Income Bond. What makes bonds secured by the methods just; described attractive as an invest- ment, is the fact that they hold out guarantees both in regard to the regularity of income and to the ulti- mate repayment of the principal. Income bonds, though secured as to the principal, hold out no promise of a regular rate. They receive their income only if it is earned. In so far they are no better than a share of stock, except for the mortgage lien. As a 84 BUSINESS ORG ^NIZATION matter of fact, the income bond is a good deal less desirable than a share of stock, for the stockholders will postpone payment of interest on these bonds as long as they can, either until the bonds mature, or until enough has accumulated to allow the stock- holders to share in the division of income. The bond may wait a long time for a return and does not hold out the possibilities of a large return in the future. A stockholder as part-owner, shares in the profits,, a bondholder can never get more than the interest promised him in the bond. The Debenture Bond. While the income bond gives no certainty in regard to income, the debenture bond fails to give the certainty in regard to principal which other bonds offer. A debenture bond is no other than a promise to pay a certain amount of money at a certain time and to pay interest for its use. In most cases the debenture bond is protected by some special right or power which is intended to guarantee regular payment of income. Usually a clause is in- serted in the bond stating that the principal becomes due automatically upon default in payment of the interest. The Life of Bonds. The life of bonds varies greatly. Some are issued for short periods of five or ten years and others for fifty years or longer. As a rule, indus- trial companies do not issue bonds for longer than about twenty-five or thirty years. In many cases, companies will refund their bonds at maturity. BUSINESS ORGANIZATION 85 When a favorable interest rate can be secured the company may prefer not to withdraw the money from business, but to pay off the old loan with the proceeds of a new bond issue. This process is called refunding a loan. The total debt represented by bonds is called the funded or permanent debt. Short-term loans may be referred to as unfunded. The only difference be- tween these two classes of liabilities is the length of the period for which the loan is made. The Price of Bonds. Suppose that in order to raise $100,000 a thousand bonds of $ioo each are issued; how much interest must be promised in order to sell these bonds for $ioo each? That depends first of all upon the interest which other loans like it are offer- ing, and also upon the confidence which the public, or the small group of possible investors, has in the security offered. The less confidence they have in it, the higher the interest rate that must be offered in order to persuade them to pay $ioo for the bonds. This $100 is called the face value of the bonds be- cause it is the amount printed on the face of the cer- tificate. When a bond sells for its face value we say that it sells at par. Many bonds sell below par. This may result from a combination of causes. In most cases it will indi- cate that at the same rate of interest other and safer security can be found. It is interesting to note that to the company which issues the bonds, selling below 86 BUSINESS ORGANIZATION par is quite as expensive as promising a highfer rate of interest. That the company sells below par rather than raises the interest rate may be merely the result of miscalculation. Suppose that the issue referred to above of one thousand bonds of $ioo each would sell at par when promising 6 per cent. Then it is certain that the price would decline below par if only 5 per cent were offered. How much below cannot be determined un- til we know the life of the bond. The reasoning of the lender of money, i. e., the investor who buys the bonds, is as follows: "I can get 6 per cent on my money on perfectly good security, as good as of any issue like it promising 6 per cent. I am, therefore, interested in investing in this bond issue, but only on condition that I can make 6 per cent on my money. Suppose now that the investment were for- ever, that the bonds never matured, then I have only my yearly rate to consider, I want 6 per cent, or $6 on every $100. One of these bonds pays $5 a year; that means an equivalent of 6 per cent on $83.33. Leaving the question of the principal out of consideration, therefore, as far as yearly income is concerned, that bond is worth $83.33." He can afford to pay more, however, because when he buys the bond he not only buys income, but also ^loo sometime in the future. In other words, he buys an addition of ^16.67 to his invested capital. The sooner this event takes place, the more he will be BUSINESS ORGANIZATION 87 willing to pay for the bond. Bond buyers will, therefore, increase the amount they are willing to pay with regard to the date of maturity of the bonds. In buying bonds the investor considers, therefore, two things: First of all the rate, that is, the rate of interest promised ; but of most direct interest to him is the yield. This is the actual rate of interest earned by the money invested in the bond when bought at the current market price. The yield consists of two factors: First, the yearly return on the investment resulting from the regular interest pajments; and second, the difference between the price paid for the bond and the par value, expressed in terms of a yearly payment for the period ending at the date of maturity of the bonds. In order to figure this yield it is necessary to use difficult algebraic formulas and we shall not enter into that question here. For the use of investors.and bankers many bond tables are available from which one may read off quickly the net yield of bonds of almost any market price, rate, and maturity. When bonds are selling above par the yield may be calcu- lated in a similar way. This yield will then be less than the promised rate of interest. The Repayment oj Bonds. Upon the borrower rest two responsibilities. He must pay the interest regu- larly and he must be prepared to pay off the principal when the bonds fall due. Many corporations are compelled to refimd their bonds because they have 88 BUSINESS ORGANIZATION made no adequate preparation for paying off their debt at maturity. When the security upon which the bond issue rests remains unimpaired or increases in value, failure to provide for redemption is not a very serious matter though it may lead to difficulties. A railroad keeps up its roadbed by constant repairs and renewals, while the right to use the roadbed, i. e., the fran- chise, is usually perpetual and increases in value year by year. A mortgage on a roadbed is, there- fore, excellent security and refunding, can take place comparatively easily. The situation becomes different when the security consists of assets which decline in value. Declining or 'depreciating values are : rolling stock of a railroad or street-car line, mining property, forest lands, houses, and machinery. Where such security is offered as collateral, two conditions must be fulfilled: first, the bonds must not have a longer life than the estimated life of the assets; second, during the life of the bond a fund must be accumulated which will make redemption at maturity certain. Such a fund is called an amortization fund and the process of accumulation is called amortization. Here again, compound interest calculations must be used to determine what yearly sum shall be set aside to accomplish the desired end. Summary. The problem of securing the necessary funds for permanent investments, i. e., capital in- BUSINESS ORGANIZATION 89 vestments, is also important. These funds may be secured by talcing in new partners, which means an increase in the claimants when profits are to be divided, or by borrowing on long time. The latter is often to be preferred. It may be necessary to give security. A mortgage is such security. Where large amounts are needed a bond issue may be floated. There are various types of bonds. They differ according to the security offered for the payment of interest or for the ultimate redemption of the loan. The life of bonds varies but is usually more than ten years. The factors which influence the price at which bonds will sell are: condition of the money market, rate of interest and kind of security offered, and life of the bonds. REFERENCES The same as the preceding chapters. QUESTIONS FOR FURTHER STUDY 1. What various methods are open by which capital funds may be increased? Reference: Lough. Part III, chapter IX. Cleveland. Chapter VIII. 2. Enumerate and explain the character of the various kinds of long-time paper. Reference: Cleveland. Chapter VIII. 3. What are the chief advantages of entrusting the administration of bond issues to a trust company? Reference: Cleveland. Chapter XIII. 90 BUSINESS O RGANIZATION TEST QUESTIONS 1. What is the chief disadvantage of borrowing on long time? 2. Describe what documents make up what is usually called a mortgage? 3. What is a trust company? 4. Enumerate and explain the character of the dif- ferent types of bonds mentioned in this chapter. 5. What factors determine the price of bonds? 6. What will be the effect of an increase in the average rate of interest upon the price of bonds? BUSINESS ORGANIZATION 9I CHAPTER VI FINANCIAL INSTITUTIONS The Bank. Many institutions and business under- takings place their resources and financial experience at the disposal of the business men and aid them in financing their business. Among these institutions the banks have a first claim to our attention. There are two classes of banks: commercial and non- commercial. Commercial banks are of the greatest interest to business men. These are banks which confine themselves largely to short-term transactions. They logically become the depository for accounts subject to check, and aid in the financing of domestic and foreign business transactions by discounting commercial paper. There are a large number of fineincial institutions which are classified as non-commercial banks. These are: 1. Loan and trust companies 2. Savings banks 3. Insurance companies The Commercial Banks. The relations of the commercial banks to the business world have been discussed in the chapter on Working Capital. Their main function is to aid business by their credit 92 BUSINESS ORGANIZATION facilities, to mobilize the financial resources of the community, and to receive on deposit funds mo- mentarily idle. It is very important that business men should understand the essentials of the operation of a bank. Commercial banks may be national, state, or private. National banks operate under a national charter, state banks under a state charter, while private banks are unincorporated. The large private banks are engaged mostly in the promoting and financing of enterprises and either do not carry on any com- mercial banking business or do so only incidentally. Large commercial banks consist of many depart- ments. One prominent New York City bank is composed of the following departments: New York City accounts, out of town accounts, credit, new business, foreign business, securities, operation, and auditing departments. The chief executive officers are usually a president with a number of vice-presidents. They direct the policy of the bank and constitute the link between the outside world and the bank proper. The opera- tion of the bank is entrusted to a cashier and a number of assistant cashiers. They are assisted by a large number of clerks and tellers. The Making of a Deposit. When a new customer presents himself at the bank and desires to make a deposit, i. e., to open an account, he is directed to the cashier, assistant cashier, or one of the vice-presidents. BUSINESS ORGANIZATION 93 whichever one of these Is in charge of new customers. He must be properly introduced by a customer in good standing. The bank looks upon each customer as a potential borrower, and it is therefore important that none but reliable people be allowed to open accounts. The depositor has a right to issue checks. Since the handling of such checks and the keeping of the customers' accounts requires the time of the bank's employees, and is therefore costly, banks usually require a minimum deposit. In case accounts are allowed to fall below this minimum, a charge is made for the services of the bank. Such a minimum may be as low as $25, but in some banks is as high as $5,000. The banks figure that unless the deposit is large the interest which the bank can earn by using this money as a basis for loans does not offset the cost of handling the account. The depositor now makes out a signature card which is "kept as a record in the bank to enable the tellers to compare it with the signature appearing on the checks. If the bank does not use "due care and diligence" in making payment, and it should pay a check with a forged signature, the bank would have to bear the loss. The next step is to make the deposit. The cus- tomer must fill out ar deposit slip upon which the various kinds of cash items which may be deposited are listed separately. He inserts his name and the 94 BUSINESS ORGANIZATION date ajid presents the slip at the receiving teller's window with the money, checks, or coupons which he intends to deposit. This deposit slip is a valuable record which the bank keeps as evidence that a certain amount was deposited. Should any difficulty arise, the slip made out by the customer himself and accepted as correct by the bank would quickly settle the question. The customer receives as his receipt a pass book. Formerly this pass book was presented at the bank once a month, or less frequently in order to enable the bookkeeper to enter the withdrawals and to balance the book. Practically all banks now use the statement which is a monthly account of deposits and withdrawals, and which is sent to each customer with the canceled checks for comparison. The pass book continues to serve as a receipt for deposits. In case the depositor expects to leave the deposit undisturbed for a long period, he may notify the receiving teller that he does not want to open an accoimt "subject to check," but desires to make a time deposit. The bank agrees to pay interest on such deposits and issues a receipt called certificate of deposit. It is usually understood that no interest is to be paid unless the money remains undisturbed for a period of three months. Interest is sacrificed on all withdrawals made before the end of that period. In case the depositor desires to use the deposit with the bank to pay a debt in another city and he BUSINESS ORGANIZATION 95 fears that his own check will not be acceptable there, he may ask for a cashier's check for the amount, or he may write a,check himself and have it certified by the cashier. In both cases the amount of the check is charged to his account as a withdrawal and the check becomes a direct obligation of the bank. The Receiving Teller. The receiving teller sends the deposit slips to the individual bookkeeper at the end of the day, or in blocks or batches at stated inter- vals during the day, but first he makes a record of these slips to enable him to make out at the end of the day a receiving teller's proof. This is a sheet upon which are listed the different kinds of items received ; cash, notes, checks, etc. Their aggregate amount must of course be the same as the total of all the slips. If any of the items have been sent on to other departments of the bank, the total amounts received by these departments plus what is left in the teller's cage must equal the amount of the deposit slips. The Individual Bookkeeper. The individual book- keeper receives the deposit slips and uses them to make entries on the individual accounts. These are accounts with depositors or individuals, hence the term individual bookkeeper. He also receives all checks drawn by customers of the bank; these are called own checks. In all cases, therefore, a pajmaent made by check between two depositors in the same bank results merely in two bookkeeping entries in the individual bookkeeper's department. One entry 96 B U S I N ESS ORGANIZATION to decrease the balance on the account of the cus- tomer by whom the check was drawn, the other to increase the deposits of the customer in whose favor the check was made out. In large banks there are many such individual bookkeepers, and to facilitate their work the individual ledgers are made of loose leaves and split into a number of ledgers of con- venient size. The Paying Teller. The paying teller pays checks drawn by customers of the bank against their accounts. He also cashes many other items, such as bond coupons, as an accommodation to customers. His is a very difficult position, for once a payment is made, mistakes are not easily corrected. It is different with a receiving teller who may correct a mistaJce discovered after the depositor leaves the bank. It is therefore considered a promotion for a receiving teller to be made paying teller. The paying teller starts the day with a certain amount of cash in his cage. As he makes his pay- ments throughout the day and his cash dwindles he replenishes it from the vault or from the cash which the receiving teller sends him. At the end of the day the paying teller makes out the paying teller's proof. In his case all canceled checks and other items upon which he has made payment must show a total equal to the amount of cash which has disappeared from the cage. BUSINESS ORGANIZATION 97 The canceled items are sent to the individual book- keeper in so far as they represent payments made on account of* depositors of the bank; other items are sent to the various departments where they belong. If they are checks drawn on banks of the same town and members of the clearing house, they are sent to the clearing house desk; if drawn on other banks of the same town the items go to the collection depart- ment; if drawn on out-of-to-wn banks the mail desk or mail teller takes care of them. The paying teller must constantly be on the alert that payment is not made for the wrong amount or to the wrong person. His work is complicated by the fact that he has to watch for checks upon which he has received a stop payment order from the drawer. As soon as an order not to pay a check previously issued is received, a card is filled out giving all information and also the reason for the stop payment, such as "check stolen," "check lost," etc. This card is constantly before the eyes of the paying teller near the cage window. The Note Teller. The note teller is in charge of the notes. He aids in the preparation of notes and super- vises the collection of interest and principal. In case collateral is deposited he inspects the collateral, and keeps himself informed of any changes which may occur in its market value. Notes are always discounted for less than the market value of the collateral. The difference between tlje actual value of a collateral and the amount of the loan is called the 98 BUSINESS ORGANIZATION margin. The note teller must not allow this margin to be wiped out by a sharp decline in the market. Should the margin be in danger then he must call for additional collateral. The note teller keeps a note register which is a list of all the notes held by the bank. He also keeps a direct liability and an indirect liability register. In a direct liability register the loans made and the notes discounted are recorded under the name of the customer directly liable. This enables the bank to tell at a glance whether it is safe to allow the custo- mer to borrow an additional amount. The indirect liability register shows how many notes each custo- mer has indorsed. Such indirect or contingent lia- bility may at any time become a real liability should the person directly liable fail to live up to his financial obligations. A large indirect liability may, therefore, prevent a person from borrowing any more himself. The Clearing House. In the course of a day's busi- ness a bank receives from its customers a number of checks drawn on other banks. The items on out-of- town banks are sent out by the mail desk or out-of- town department to one of the bank's correspondents for collection. Such a correspondent is a bank in another town with which the bank carries on a reciprocal business. The checks drawn upon other banks in the same town or city must be collected by the bank itself. The likelihood exists that the other banks in town BUSINESS ORGANIZATION 99 will in turn have received from their customers and from out-of-town correspondents, checks drawn upon most of the other banks in that city. In order to save each bank the trouble of sending out runners to collect the checks and to carry the money back with them to their banks, a clearing house is estab- lished. This is a large room where representatives of the banks gather, each at his own desk, and where they exchange their checks. Only the differences or balances are then settled in money. This saves much time and means also a great economy in the use of money. To give an example: Suppose bank A has checks drawn on bank B for $5,000, while bank B has checks drawn on bank A for $4,500. If each bank sent out a runner to collect these items these men would pass each other on the street, one carrying $5,000, the other $4,500 of cash, a total of $9,500. If these men meet at the clearing house, bank B pays bank A for the $5,000 worth of checks with its $4,500 worth of checks and still owes $500. This is a simple case. ^ In most clearing houses there are a large number of banks, some twenty or thirty. Each of these banks sends clerks to collect checks on other banks and to pay checks presented, but no actual payments take place. The whole question of payments is re- duced to a bookkeeping transaction, a question of debit and credit. Every bank brings claims in the form of checks and receives evidence of money lOO BUSINESS ORGANIZATION which it owes to the other, i. e., to all banks repre- sented in the clearing house. The difference be- tween these two claims forms a balance to be paid, or a balance to be received. This is a balance not with any one bank but with all the banks, in other words, with the clearing house. The balance is, therefore, paid to, or received from, the clearing house. Millions of dollars in checks brought by banks into the clearing house may be thus settled by a payment of balances amounting to very small sums. Safety Deposit Department. Many banks main- tain a safety deposit vault and rent boxes to those who want a safe place to keep valuable papers. Usually these' boxes are kept in a large vault which is closed at night, and each box is locked with two in- dependent and different locks. The key to one lock is given to the renter, the key to the other lock is held by an official of the bank who must identify the customer before admitting him to the vault. Other Departments of a Commercial Bank. The de- partments and officials discussed are the ones with whom a business man most frequently comes in touch. Importers sind exporters deal with the foreign exchange department, which handles all drafts and other financial documents drawn by or upon foreign banks or firms. In the larger banks a foreign trade department is matntained which advises customers who are buying or selling in foreign markets, keeps BUSINESS ORGANIZAT ION lOI them informed of market conditions, and often brings them in touch Avith reliable firms who can act as their foreign representatives. The larger banks in New York, such as the National City Bank, the Irv- ing National Bank, and the Guaranty Trust Com- pany, publish pamphlets and weekly or daily lists containing financial or trade information, and dis- tribute them free among their customers. In all banks are found, moreover, a collection de- partment which collects all local items, and an accounting department of which the individual book- keepers are a part. Loan and Trust Companies. Among non-com- mercial banking institutions the trust companies are of most vital interest to business men. As a rule such companies do not handle short-term transac- tions though some of them combine a commercial banking business with their loan and trust business, and many of them maintain a separate banking department. The trust companies, because they do not deal in demand obligations, can safely invest in real estate and loans on inactive securities for long periods. They perform, as the name indicates, prin- cipally trust functions. They act as mortgagees in trust for bondholders; they administer estates; col- lateral, mortgage, and equipment trusts; and act as fiscal agents for corporations. A fiscal agent is a duly appointed agent who receives and pays out funds. In this capacity they pay the bond principal 102 BUSINESS ORGANIZATION at maturity or pay the interest when due. The work of transfer agents and registrars is usually intrusted to a trust company. They also administer under- writing syndicates, and in case of reorganization or dissolution they act as receivers, looking after the interests of the bondholders. Many of these functions could be performed and are not infrequently performed by individuals, but there are advantages attached to intrusting these duties to a trust company. The principal advan- tages are that trust companies are permanent, they are experienced, they have regular business hours, their transactions are coniidentid, and they are in close touch with the financial world, and, therefore, better informed than most individuals. In former days trust companies carried on an insurance busi- ness along with their other activities, but this is no Jonger customary. Trust companies all operate tra- der state laws and legal requirements differ widely in the various states. Savings Banks. In the ordinary course of iDUsiness a business man will have little occasion to deal with savings banks. These are a class of non-commercial banks which are primarily organized to afford a safe cind moderately profitable means of investing small savings. These banks appeal to the working classes and to persons of moderate incomes who accumulate slowly by small weekly or monthly installments. Safety, and a fairly good return, are the ideals for BUSINESS ORGANIZATION IO3 which the management of such banks strive. In order to attain these ideals they invest only in safe and tried securities, based upon real estate or issued by municipal, state, or federal governments, or by industrial concerns of proven stability. Conse- quently, such banks cannot be expected to pay their depositors upon demand. Investments such as they make are safe, but cannot be quickly turned into cash in large quantities. Savings banks, therefore, do not favor demand withdrawals. They either require notice a certain number of days before withdrawal will be permitted, or they limit the amount which may be withdrawn at one time. The fact that interest is only paid on deposits which remain with the bank for a certain minimum period, usually three months, acts as an inducement to allow the deposits to remain imdisturbed. The surplus money which must be kept available for withdrawals from day to day is usually deposited with commercial banks who pay the savings banks a small amount of interest on such deposits. Savings bank accounts, since they are not subject to demand, are not active. This means that the em- ployees of the bank must use double care not to make payments to anyone not entitled to receive it. Tellers quickly learn to recognize the signatures of active depositors, but no one can remember a cus- tomer or his signature if the depositor presents him- self at the bank only a few times a year. Such banks, I04 BUSINESS ORGANIZATION therefore, refuse payment except upon presentation of the pass book. Savings banks in the eastern states are frequently charitable institutions operated with no thought of profit. All earnings are then divided among the de- positors or members. In the middle western and western states, savings banks are organized as cor- porations like commercial beuiks. They promise a regular rate of interest and the net earnings are paid out as dividends to the stockholders. As buyers of fiscal bonds and mortgages, savings banks form an important channel through which the small savings of the masses find productive employment. Insurance Companies. Insurance companies serve the business world in two ways. First, they aid in solving the problem of risks which every business faces, and second, they absorb large quantities of securities, and thus supply to commerce and industry the working and capital funds needed. This needs further explanation. Life is full of uncertainty. No one knows when death will call him, or when some disease or accident will render him temporarily and permanently unable to work. Fire may destroy without warning the savings of a lifetime, and even in a bank's fireproof vaults, thieves may break in and make away with the valuable contents. It is inter- esting that these uncertainties may be reduced to certainty. The number of houses that bum each year in any one city or in the entire United Statf^ BUSINESS ORGANIZATION IO5 varies but little. Every year about the same number of people pass away, except, of course, in time of war or epidemic. The number of automobile accidents is a fairly constant figure and so is the number of thefts. This means that it is possible to predict, not which particular house will bum next year, but with a fair degree of certainty how many houses are likely to be destroyed in New York during that same period, and with even greater certainty how many will be burned in the United States as a whole. The larger the territory covered the less local con- ditions will influence our figures. One incendiary may cause the fire loss in a country town to rise far above normal, but his work will have little effect upon the figures of the country as a whole. The same reasoning holds true of the death, sickness, ac- cident, and theft statistics. Reducing Uncertainty to Certainty. If in a town of a hundred thousand houses, one hundred houses bum every year, the house owners may agree to establish a fund by regular contributions from which all fire losses would be paid. This fund would not need to be larger than to rebuild one hundred houses a year. Every house-owner would, therefore, be called upon to pay one one-thousandth of the value of a house each year. But in return he would have the promise that should his house bum it would be rebuilt from the general fund. This is the principle upon which all insurance is based. I06 BUSINESS ORGANIZATION By forming a sufficiently large club of people all facing the same risks, and by studying carefully the experience in the past of such risks — the longer the period the better — ^it is possible in almost every case to arrive at a figure which will indicate what may reasonably be expected in the future. Some fluctu- ation will occur, but if studied over a long enough period, even this fluctuation will be discovered to take place with regularity. If each business man had to face his own risks, commerce would be much hampered, if not Impos- sible. Who, indeed, would dare stock his warehouse full of expensive goods, investing not only all that he possessed but funds borrowed from others as well, when a carelessly dropped match of some minor em- ployee might start a fire. Such a fire would bring ruin to the owner and would destroy the means of paying those from whom he borrowed. Insurance makes it possible for him to protect himself against this uncertainty. A comparatively small yearly pay- ment in the common fund buys him certainty. He may now expand his business, tie up all his funds, and borrow from others. The risk of fire is no great cause of worry, to him. Insurance as. a Business. Sometimes such funds are administered co-operatively. Such insurance or- ganizations are called mutuals. Most of the insurance is in the hands of companies which make a business of writing insurance and the stockholders of which BUSINESS ORGANIZATION I07 reap the benefit of the difference between losses paid and earnings. These earnings are derived from pre- miums or the periodic payments of the people in- sured, and also from the income of the investments made. Every insurance company must set aside a reserve, and is frequently compelled by law to do» so. From this reserve, unexpected fluctuations in losses are met. The funds of this reserve are in- vested in bonds and stocks and yield a substantial income. Different Types of Insurance. Many risks have iiL this way been reduced to regular payments. It is possible to insure against sickness, accidents, un- employment, and death. Caruso was insured against loss of his voice, while Paderewski insures his fingers. The business man finds it possible to insure against fire, against loss of goods at sea, against losses result- ing from dishonesty of employees, or from faulty titles to real estate. He may protect himself in the same way against storms, hail, and frost. He may insiu-e his goods, his building, his- furniture, or his plate glass windows. ' Fire Insurance. Besides considering the actual normal risk from fire, a fire insurance company must also consider the moral risk. It is not difficult to see that after a piece of property has been insured, the owner is likely to be a little more careless with it. He says to himself, "It is insured, anyhow, so I don't care." He may even go so far as to destroy it inten- I08 BUSINE^SS ORGAN I Z AT I O N tionally in order to collect the insurance. This is a problem to be reckoned with in all insurance, but most of all in property insurance ; for it is not likely that Paderewski would deliberately put his hand against a band saw or that a man would commit suicide to collect the insurance. In fire insurance, the moral risk is a real risk. The policy, which is the contract between the insurance company and the insured, "always is careful in stating that the amount which will be paid by the company will not exceed the cash value of the property destroyed. The actual loss must be determined after the fire occurred. This clause is intended to limit the moral risk, for if pay- ment were made for the face value of the policy re- gardless of the value of the property at the time of the fire, having fires might become a profitable line of business. Many states, however, have passed valued policy laws under which the insurance com- pany is compelled to pay the face value of the policy in case of total loss, even though the actual loss is far less than that. In order to bring uniformity in the insurance busi- ness many companies have by mutual agreement adopted a standard policy. This policy is a formid- able document. The principal features are the fol- lowing: In the first place, the policy insures only against "direct loss or damage by fire," but this must be interpreted to mean fire which has escaped from its proper receptacle. No damages can be collected BUSINESS ORGANIZATION IO9 on a coat scorched by being hung near a red-hot stove. Loss resulting from lightning is, therefore, not covered unless special mention is made of it; neither does the contract offer protection against theft in the process of removing goods from a burning building. If goods insured are spoken of in a contract as in one building, they are no longer protected if removed from this building. When a fire has occurred the insured must give immediate notice in writing and he must send in a statement of the amount of his loss, accompanied by a statement of a notary public that he regards the claim to be honest. Usually there is a clause in the policy which provides for the appointing -of ap- praisers who are to pass upon the justice of the claim. The rate which must be paid for fire protection is determined to a large degree by the kind of risk offered for insurance. A wooden building standing near a wooden garage is more in danger of being totally destroyed than a concrete fireproof structure in the middle of a field. The wooden building would, therefore, have to pay a higher price for the insur- ance protection. The following factors influence the cost of insurance : 1. The type of building; whether wood, stone, or con- cre1;e. 2. The use to which it is gut. An ice storage plant runs less danger of fire than a garage. no BUSINESS ORGANIZATION 3. The fire prevention measures taken. A store with a sprinkler system, that is, a system of water pipes which automatically spray water into the store when heated to a certain temperature, pays a low rate. 4. The surrounding buildings. A good building may have to pay a high premium or annual payment because surrounded by poor risks. 5. The condition of the street and of the fire fighting equipment of the town. A wide, well-paved street makes it possible for the apparatus to reach the building quickly. A greater loss is likely to result where fire has to be fought with a low pressure municipal water supply than where a special high pressure system has been installed for fire fighting. Marine Insurance. When goods are shipped by water it becomes necessary to insure them against losses resulting from the "perils of the sea" as well as from fire. These risks are covered by marine insur- ance. Much of the marine insurance business in this country is handled by foreign companies, among which English companies are the most important. The English marine insurance is centered in Lloyd's. This is a corporation of which marine in- surance companies are members and which has as its piupose to protect the interests of its members, to collect and to distribute information in regard to shipping, and to conduct an insurance business. The agents of Lloyd's are found'in every important ship- BUSINESS ORGANIZATION III ping center. Tiiey are charged with collecting infor- mation regarding ships, inspecting vessels, reporting upon losses, and with aiding in collecting evidence. An important publication published by an affil- iated organization, is Lloyd's Register of British and Foreign Shipping, which is a catalogue of all Engli^ ships of over one hundred tons and of a large number of foreign ships. A detailed description of the ship is given, and the vessel is rated on the basis of a regu- lar inspection. This rating determines the rates charged for insurance. Lloyd's Corporation of Underwriters makes it pos- sible for many companies to -underwrite large risks together. This is called underwriting, because each company signs or underwrites the policy. The total risk is thereby divided over a large number of com- panies, sometimes as many as fifty. This means a wide distribution of risk for each company, and it lessens the effect which the sinking of a large, expen- sive ship would have on the finances of an individual insurance company. A large number of diiferent policies are issued, some covering the ship, and others the cargo; some protecting against damage from the "perils of the sea," and others against theft or lighterage accidents. Usually polides issued for goods carry the "F. P. A." clause (free from particular average). Average means damage. This clause indicates that the insur- ance company does not undertake to protect the 112 BUSINESS ORGANIZATION shipper against partial losses or damage. The policy covers, in such cases, only a total loss resulting from the destruction of the ship, and also general average. ' Any charges made against ship and cargo to cover damages .incurred by a particular shipment in order to save the ship, such as throwing it overboard to lighten the vessel, are called general average and are, therefore, covered by the policy. It is possible to insure goods 'W. P. A." (with particular average), if the shipper desires it. Credit Insurance. Every business man who sells goods on credit faces the risk of not being able to collect. Under normal conditions and when due care is used in extending credit, these losses run fairly even. This normal loss is different in every kind of business ; in some it is one per cent of sales ; in others as high as four per cent. As long as these credit losses remain normal the business man is nottro"ubled. He will merely charge that much more for his goods, counting his credit loss as part of his cost of doing business. What does cause him worry is the possi- bility of an unexpected and unusual loss. Against this unexpected loss he can insure himself with a credit insurance company. The normal or initial loss he must bear himself. A credit insurance company will not insure against all abnormal losses, but limits its payments to a cer- tain percentage of the capital rating which the firm has received in Dun's or Bradstreet's credit reports. BUSINESS ORGANIZATION II3 If a customer is rated at $50,000, then the credit in- surance will cover a loss not exceeding, say 25 per cent of this, or $12,500. In addition to this, the insurance company will limit the amount which will be paid on any one account. This is known as the single account limit. Suppose that the single account limit in the case given was $10,000, then the payment upon this account, notwithstanding the high capital rating, could never exceed $10,000. The merchant would have to face the remaining loss. In most cases only accounts with firms which are classified in the first two classes of credit by Dun and Bradstreet can be insured. In Dun's classification only high and good credit risks are insurable. In addition to all these limitations the insurance company will limit its total liability to a fixed sum. No matter what the losses are, the company can never be called upon to pay more than that sum upon the policy issued. Credit insurance is still comparatively new, but manufacturers and whole- salers are increasingly making use of the protection it offers. Fidelity Insurance. When an employer hires a new employee, places him in a responsible position, allows him to handle large sums of money or to collect bills from customers, he is taking a risk. The employer ■will, therefore, require that the employee offer some security by which he may be reimbursed in case of a loss. The employee may ask some of his friends to 114 BUSINESS ORGANIZATION "go bond" for him, that is, to promise his employer that they will make good any loss resulting from dis- honesty. But not everyone has rich friends who are willing to do this, nor is everyone willing to -bother his friends with such requests. The fidelity insurance company takes the place of these friends and in return for a fee, paid by the em- ployee or the employer, undertakes to protect the employer, after a careful investigation has been made of the trustworthiness of the new employee. The employer is protected more securely than when friends undertake to protect him, for the company is more likely to live up to its obligations. The pre- mium is determined by the statistics of risk, and also by the actual amount of money which it will be possible for the employee to misappropriate. In order to limit this amount the insurance company will frequently require certain internal checks. This usually means that the making of payments and the authorization for payment are placed in the hands of different employees. Frequently such companies require checks to be signed by two officials, while pay- ments in cash must be reported at the end of each day to some other official or employee. Companies undertaking this kind of insurance are called fidelity, guaranty, and bonding companies. The Stock Exchange. The stock exchange.provides a market or meeting place for buyers and sellers of stocks or .bonds. Such exchanges are found in many BUSINESS ORGANIZA TION II5 large cities. In New York three such maxkets exist, the New York Stock Exchange, the Consolidated Stock Exchange, and the Curb. Each of these stock markets is an association of men who make a profes- sion of buying and selling securities. Trading on these exchanges is limited to its members. There is a good reason for this. The exchange is established . not only in order to provide a place where trading may be done, but also to regulate this trading. The rules of the exchange are very strict and any one vio- lating them faces the danger of losing his seat. The New York Stock Exchange is stricter in its regulations than the other two mentioned, both in the supervision of trading and in its requirements imposed upon the companies which are anxious to have their securities admitted to the exchange. Its rules for membership are exceedingly strict and the number of members is limited. The stocks and bonds which satisfy the require- ments of the New York Stock Exchange are listed and are spoken of as listed stocks or listed bonds. In order to have its securities listed, a company must submit detailed information regarding assets, lia- bilities, the number of shares authorized, a list of the officers and directors, and the addresses and names of the transfer agent and the registrar. Moreover, the Exchange requires that annual reports containing telance sheet, profit and loss statement, and operat- ing statistics be sent to the stockholders. The New Il6 BUSINESS ORGANIZATION York Stock Exchange also allows dealings in se- curities which are unlisted, but tTiese, too, must satisfy certain requirements before being admitted to this privilege. Banks will lend more readily upon listed than upon the unlisted securities when pre- sented as collateral. Stocks and bonds not admitted to the New York Stock Exchange are bought and sold on the Consoli- dated Stock Exchange cuid on the Curb. The latter is an exchange held in the open air a short distance from the New York Stock Exchange building. The Brokers. A broker is a person who buys or sells goods for others. The pay received for this service is called commission. A broker dealing in stocks and bonds is called a stock broker or bond broker. Not all brokers are members of an exchange; they may deal through others who are members. In the New York Stock Exchange the membership is limited to 1,100, and seats are sold at high prices by members who wish to retire. The prices paid vary, but as much as $80,000 has been paid. The buyer must have the approval of the membership com- mittee. The members all charge the same rate of commission, which in the case of transactions for outsiders is no less than one-eighth of one per cent on the par value of securities. How Stocks and Bonds Are Sold. The brokers and the stock exchanges perform very important services to the business world. Without this financial ma- BUSINESS ORGANIZ ATION II7 chinery, corporations would have great difficulty in finding a market for their securities. Through the- exchanges investors are enabled to buy large varieties, of securities, and they are constantly on the alert for those which promise not only a fair return, but also> a possible rise in price. Right here a word may be said about investment, and speculation. If one buys securities with the in- tention of keeping them, and largely because they promise a good return on the purchase price, then, this may be called making an investment. It is differ- ent when one buys securities with the intention of selling them soon and to make profit on the change- in price. This is speculation. The line is difficult tch draw — it is largely a matter of intention. Securities bought for investment are almost always . paid for in cash. The reason they are wanted is bie- cause someone has a cash surplus. Stocks bought for speculation are almost always purchased with funds obtained by borrowing from the banks. Suppose a speculator desires to purchase $10,000 worth of stocks. He may go to a bank and borrow enough to i make this possible. Usually a broker will do this, for him. The bank is willing to lend the necessary funds on condition that the securities be placed in its vault as collateral. Naturally a bank will not lend up to the market value of the stocks or bonds but will require a margin. This may be 10 per cent of the market. Il8 BUSINESS ORGAN IZATION price or more, as the case may be, depending upon the class of security offered, and upon the market price. The speculator will have to supply the re- mainder. By this method a man with $i,ooo may speculate upon the possible rise in value of $10,000 worth of stock. The bank cannot lose as long as the market price of the stock does not fall below the amount of the loan. The buyer must pay the bank interest on the loan and must pay a commission to the broker. Should the market price fall, the bank will call upon him to increase his collateral or to supply more margin. If he is unable to furnish either, then the bank will sell out and he must face his loss. The fear of losing the investment often drives such speculators to mis- appropriate funds to satisfy the demands for more margin. They always hope that a sudden change in the market will enable them to sell with a profit and to cover up their dishonesty. The market for stocks and bonds is extremely sen- sitive to all financial, economic, and political changes. Every national Eind international event has its effect. Those dealing in securities must, therefore, keep a close watch upon prices, and study world conditions constantly. The optimism in some quarters is reflected in the bulls, that is, those who buy with the expectation that prices will go up ; while pessimism in the future of prices leads to bear dealings. The bear sells stock BUSINESS ORGANIZATION II9 for future delivery, say a week later, and hopes that the price will have declined sufficiently to allow him to buy at a lower price than the one for which he has contracted to deliver. This is short selling, while a bull is long of the market. These two opposing camps are constantly contending and keep the market active. The stock exchange performs, therefore, several important functions in the business world. It pro- vides a regular and regulated market for securities, as well as strict supervision over its members. Regular dealings make it possible for investors to invest their money with the knowledge that they can turn their investment into cash at any time in the future. The exchange also makes it possible for. the banks to find a profitable market for some of their funds which otherwise would lie idle, by lending on collateral. Without stock exchanges corporations could not easily find a market for their securities, and industry would depend for its expansion largely upon local funds. Summary. Many institutions offer aid to the business man in the solving of his financial problems. The banks, loan and trust companies, insurance com- panies, and the stock exchanges are the most impor- tant financial institutions. The commercial banks aid in supplying the current needs of business, the non-commercial institutions are largely active in offering opportunities for the expansion of permanent I20 BUSINESS ORGANIZATION capital funds. Insurance is a great aid in the financ- ing of business. By means of it uncertainty is re- duced to certainty. The stock exchanges provide a ready market for the sale of securities. The brokers are the officially recognized traders on these ex- changes. REFERENCES Banks R. S. Harris. Practical Banking. Houghton Mifflin Company. A. K. Fiske. The Modern Bank. D. Appleton and Com- pany. W. H. Kniffin. The Practical Work of a Bank. The Bankers Publishing Company. H. Parker Willis. American Banking. La Salle Exten- sion University. Trust Companies F. B. Kirkbride and J. E. Sterrett. The Modern Trust Company. The Macmillan Company. Savings Banks W. H. Kniffin. The Savings Bank and Its Practical Work. The Bankers Publishing Company. Insurance S. S. Huebner. Property Insurance. D. Appleton and Company. BUSINESS ORGANIZATION 121 Stock Exchanges Conway and Atwood. Investment and Speculation. Alexander Hamilton Institute. S. S. Pratt. The Work of Wall Street. D. Appleton and Company. W. H. Lough. Business Finance. The Ronald Press. Company. QXJESTIONS FOR FURTHER STUDY Banks 1. What departments are found in the bank with which you are best acquainted? Reference: Interview with some official of the bank.. 2. What system is used in that bank to keep its. depositors informed of the condition of their accounts? Reference: Interview with some official of the bank. 3. Is "paying and receiving" done by one teller, or by two, or by several? Or are the two combined in several- windows? Can you discover the reason for the arrange- ment that exists? Reference: (a) Harris. Chapters V, VI. (&) Interview with paying or receiv- ing teller of the bank. 4. What type of savings bank exists in your city? Reference: (a) Interview with official of the bank.. (b) The banking law of the state. 5. What does the law in your state say in regard to the carrying on of a banking business by a trust company?" Do you see a good reason for the regulation? 122 BUSINESS ORGANIZATION Reference: (a) The banking law of the state. (6) Kirkbride and Sterrett. Chapters I, II, IV. Insurance 1. How are insurance rates determined? Reference: Huebner. Chapters XVI, XVII. 2. What may a business man do to lower his insurance rates? Reference: Huebner. Chapter XX. 3. What causes have contributed to give England prominence in marine insurance? Reference: Huebner. Chapter XXII. Stock Exchanges 1. What is meant by call loans? Reference: Conway and Atwood. Chapter IV. 2. What are the requirements for admission of stocks to the list? Reference: Ibid, Chapter IV. 3. What is the New York Stock Exchange clearing house? Reference: Pratt. Chapter IX. 4. What is a subscription right, and how is its value determined? Reference: Lough. Part III, Chapter XIII. 5. Describe how a brokerage house handles an issue of stock. Reference: Lough. Part III, Chapter XIV. B U S I NE SS ORGANIZATION 123 TEST QUESTIONS 1 . Describe how a deposit is made. 2. What are the duties of the individual bookkeeper? 3. How does the clegiring house operate? 4. What factors determine the rate to be paid for fire insurance? 5. What is meant by "average"? 6. What kind of protection is offered by a credit insurance company? 7. What is a stock broker? 8. What is meant by short selling? 9. Distinguish between speculation and investment. 124 BUSINESS ORGANIZATION CHAPTER VII MANAGEMENT The Problems of Management. The management of a concern may be in the hands of the owner, or in the case of a partnership, in the hands of one of the part- ners. In corporate enterprises and frequently in un- incorporated undertakings a manager is appointed to supervise and direct the enterprise. Such a manager usually has full control over the buying, manufactur- ing, and selling, though he is responsible for his work to the owners. In some corporations an executive committee is appointed to confer frequently with the manager and no important decision can be taken without its consent. The manager brings together the raw material, the tools and machinery, the working force, and directs the processes of production. His aim should be to combine these elements in the most effective way so that he may obtain the greatest net result. The man- ager's position is a very difhcult one and one which demands wide knowledge and deep insight. He must know a good deal of the methods of production, of tools and their correct use ; he must be something of an engineer. He must not only know the physical plant, he must also understand the financial prob- BUSINESS ORGANIZATION , 125 lems that affect a concern. Not only large output but output at competitive cost should be his aim. He must, therefore, understand the buying and selling market ; he must be something of a business man. In order to be able to interpret the records of the con- cern, he should have some knowledge of accounting. Finally, he should know not only how to get results in respect to volume and cost of output, he should be able to get these favorable results without sacrificing the human element in the business. Success in out- put should go hand in hand with making better, stronger, happier men and women out of the working force. A business concern which attains material success at the expense of those who work within its walls is a social menace. The manager, therefore, faces no small problem. The Manager as a Jack of All Trades. As long as the business unit is small and the workmen few in number, and as long as these workmen are largely skilled experts in their own line the manager will be able to oversee all details of the business himself. He relies to a large extent upon the knowledge and skill of his workmen for the efficient execution of the work. He also relies upon his personal contact with them to settle any difficulty or friction. He usually has climbed up from the ranks and is sufficiently ac- quainted with the processes to be able tfa supervise tiiem and even to instruct the workmen. To be sure he does not show equal efficiency in all the various 126 BUSINESS ORGANIZATION functions he is called upon to perform, but he is in no worse shape than his competitors who are facing the same important and unrelated duties. This type of one-man organization is still found quite generally; it is the typical organization of a small concern. The owner or manager attends to everything and is usually very jealous of his powers of control. Feeling that no one can perform these various functions as well as he, he is afraid of del- egating authority to others. When the business grows large it becomes humanly impossible for one man to look after every detail. It is, therefore, necessary to appoint assistants. When it is decided to take this step some definite plan of dividing the duties and the authority of those ap- pointed must be outlined. The division of work which first suggests itself is that into production, sales, and administration or office departments. In addition to a general manager, three submanagers who are directly responsible to the general manager will be appointed. The various clerks and working- men in these departments remain the same, the only difference is that they are from now on responsible to the production manager (or factory superinten- dent), the sales manager, or the office manager, as the case may be, and not directly to the general manager. There are certain fundamental principles which must be observed in this and every type of business organization, for these principles are basic: BUSINESS ORGANIZATION 127 1. The men and women in the organization should be selected with due regard to their fitness for the work that is expected of them. 2. The work and duties of every member of the organiza- tion should be sharply defined so that responsibility can be readily located. 3. Orders should be standardized, so that no feeling may , be created that the order is unreasonable and unfair as between different employees. 4. Orders from executives down the line to workers and reports from workers back to executives should all be in written form as far as possible to avoid mis- understandings and disputes. 5. Every member of the organization should be made to feel that he is getting a "square deal," should be made to realize that only teamwork can produce results. His interest in the success of the firm and in his own work should be awakened. 6. Once authority hias been delegated the executive should never interfere with the work. He should hold his subordinates responsible for results, but should encourage them to exercise fearlessly initia- tive and control. Nothing has such a disintegrating effect upon the organization as executive inter- ference. The Line Organization. As the number of workers increases in the production department, the super- vision may be still further divided, and foremen ap- pointed who are directly responsible to the production manager or superintendent. 128 BUSINESS ORGANIZATION >- DC ■ 111 a. o LJ to EC hi < to a. o \- o UJ O < o 111 9 to UJ q: a CE UJ _i _i o ■ oa ■ I- Q. o O > o I- !2g B8a