Ha.U CfioUegc of AsritttUurc At ajocncU ImuerBttB Cornell University Library HF 5550.R4 Financing a business 3 1924 013 722 339 IS^^^I Cornell University Library The original of tiiis book is in tine Cornell University Library. There are no known copyright restrictions in the United States on the use of the text. http://www.archive.org/details/cu31924013722339 BUSINESS ADMINISTRATION The texts listed on this page form the basic material for the organ- ized Business Administration Course and service of the LaSalle Extension University. They constitute a library of standard practice in all the important divisions of business management. TiOes Authors 1 BUSINESS PSYCHOLOGY Hugo Munsterberg, Ph.D., M.D., LL.D. | PERSONAL EFFICIENCY, AP- PLIED SALESMANSHIP, AND SALES ADMINISTRA- TION Irving R. Allen Sales CouHsdar BUSINESS LAW I . 1 Samuel D. Hirschl, S.B., J. D. BUSINESS LAW II. BUSINESS ENGLISH . Edwin Herbert Lewis, Ph.D., LL.D. . Lewis Institute Chicago BUSINESS ECONOMICS Ernest Luolow Bogart, Ph.D. University of IlUtiais INDUSTRIAL ORGANIZA- TION AND MANAGEMENT Hugo Diemer, M.E. Winehesler Repeating Arms Co. AMERICAN BANKING Henry Parker Willis, Ph.D. Columbia University INVESTMENTS AND SPECU- LATION Louis Guenther Editor, "Financial World" ORGANISING A BUSINESS . . Maurice H. Robinson, Ph.D. University of Illinois FINANCING A BUSINESS . . Joseph M. Regan Editor, "Bankers' Monthly" ADVERTISING. E. H. Kastor H. W. Kastor 6* Sons RETAIL MERCHANDISING Paul Nystrom, Ph.D. International Magaiiae Co., N. Y. 'Edward M. Skinner CREDITS AND COLLEC- TIONS ■ Uanager, Wilson Bros. R. S. White American Steel &• Wire Co. Ji. E. Kramer THE TRAFFIC FIELD J. W. Cobey NatiomA Cosh Register Co. OCEAN TRAFFIC AND TRADE B. Olney Hough Editor, "American Exporter" PRINCIPLES OF ACCOUNT- ING.. Stephen Gilman, B. Sc., C.PJ^. OFFICE ORGANIZATION AND MANAGEMENT. . . . C. C. Parsons M-anuger, Skaw-Walker Co. LaSalle Extension University FINANCING A BUSINESS JOSEPH M. REGAN Editor-in-Chief, The Shaw Banking Series, and Editor of The Bankers' Monthly, Chicago, HI. LiSalk Extension Uniyer»tjr 1920 Copyright, 1920 LaSalib Extension Untvebsitt All RightB Besened in All CautHria A PEACTICAL PURPOSE This bpok is not an abstract treatise on finance but is rather a presentation of sound and dependable methods ba§ed on exhaustive researeli that will assist the business man to a fuller understanding of the financial side of his business and at the same time enable him to simplify the problems and to avoid the pitfalls that are arising con- stantly. No matter how big or how little a business may be, a concise knowledge of its financial requirements will con- tribute directly to its income. It is important, therefore, to control every financial tendency in order that, the busi- ness may be safeg^iarded and profits sustained. You will find described many plans that can be fitted easily to your own needs. Tour business, no matter what it may be, is not different, because underlying all business are certain fundamental principles which can be adapted to distinct individual requirements. The chapters cover the practical aspects of financing a business. You will find described methods that have helped to plan and to start the new business, to determine the amount of capital needed in the business, and to enlist the favorable recognition of outside investors. You will find simple and helpful plans relating to the selling of stock and to the significance of bonds and mortgages. Important also are the chapters dealing with the rela- tions between the business man and his banker, because they cover descriptions of the routine for handling a phase of finance that is sometimes misunderstood and often neglected. iii iv 'preface The constantly increasing use of the trade acceptance and the banker's acceptance is exerting a profound in- fluence on the financial management of business, and every business man will find the description of th'ese credit in- struments and the methods of using them a source of inspiration and value. Nor are we unmindful of the financial burden that de- volves upon the American business man in developing overseas markets. The war made us the great creditor nation. We must arrange to handle exports and imports ou a bigger scale and the description of the financial meth- ods that are usually employed will enable the business executive to approach this new field of activity with greater assurance. From the many constructive methods offered here, you should be able to draw many ideas of direct doUars-and- cents value. The incidents related are based on the tried- out and demonstrated practice of business concerns in all parts of the country. The emphasis thruout is on the practical everyday problems of financial management in a going business concern. J. M. E. CONTENTS I. Getting the Eight Viewpoint on FmANcmG Fmaacing Not Simply Banking 1 "What Financing Involves 2 Importance of Sound Management 4 Size Immaterial in Financing 5 Financing Is Simple 7 II. Planistinq and Staeting the New Business Comprehensive Grasp Necessary. 10 Value of Preliminary Planning . . ; 11 Investigation of SubjecJt 12 Form of the Organization 15 The Individual Proprietorship 18 The Partnership 19 The Corporation 21 Plan of Capitalization 27 The Banker as a Business Adviser 35 The Public Accountant as an Adviser 37 Different Classes of Corporate Capital 39 III. How MuoH Capital. Will You Need Complete Knowledge of Costs Essential 49 The Needs for Capital 50 Organization Expense 51 Fixed Capital ^ 52 Working Capital 54 rv. Intebestinq Capital in Tour Concern Questions That Capital Will Ask 68 The Backing Behind the Stock Offering 69 Selling and Distribution Methods 70 Attracting Investors 71 vi Contents Classes of Persons to Be Interested 71 Setting the Par Valued ; 74 Setting Terms of Sale 74 General Conditions 79 V. Seujng the Stock Disposing of Stock to "Insiders" 83 Selling Thru the Professional Salesman 83 Selling Stock Thru Advertising 84 Selling Thru the Mails 86 Selling Thru Investment Bankers or Brokers ... 88 Underwriters 89 Other Ways of Floating Stock 89 Selling Methods Compared 90 When Established Concerns Sell Stock 92 VI. The Use of Bonds in Financing The Mortgage 95 The Indenture 96 Open vs. Closed Mortgages 98 Denomination or Size of the Individual Bond. . 99 What Shall Be the Term of the Bond? 100 Fixing the Interest Payments 101 What Class Of Bond to Use 102 Mortgage Bonds 103 Guaranteed Bonds 107 Collateral Trust Bonds 108 Bonds Secured by Lease 108 Debenture Bonds 109 Income Bonds 110 Provision for Repayment Ill Increased Popularity of Bonds Ill VII. Meeting Additional Capital Needs in a Going Concern Consult Your Banker Early 114 Estimating Additional Capital Requirements. . 115 Contents vii Selling Securities — Accumulating a Surplus . . . 116 Increasing the Capital Stock 116 Making a Bond Issue 118 Borrowing on Private Collateral 118 Accumulating a Reserve 119 Conversion of Working Assets into Cash 119 Protecting the Business Against Depression . . 120 Vlll. Making the Eight Choice of a Banker Services of a Bank 125 The Function of Lending Money 126 Carrying Your Checkirlg Account 132 Business Standing of the Bank 133 Personnel of the Bank Officers 133 The Deposit Required 134 Location of Your Bank 135 Financial Strength of Your Bank 135 Savings Accounts 137 / Cooperation Between Banker and Depositor. . 138 Kinds of Banks 139 IX. Will Youk Financial Statement Pass Muster ? Danger Signals 145 Financial Unsoundness 146 Incomplete Statements 152 A Lack of Frankness. ,. 153 Essential Facts Omitted 154 Putting the House in Order 154 Approaching the Banker 156 The Personality of the Borrower 157 Maintaining a Proper Balance. . -. 158 Collateral Loans , 158 X. How TO Borrow Prokitablt When It Is Good Business to Borrow 160 The Good Will of the Banker 161 Conditions Affecting a Loas 162 viii Contents Time Factors in Securing Loans 163 The Source of the Loan 165 Effect of Location 166 Type of Business 167 The Specific Purpose of the Loan 169 The Risk Factor 170 Miscellaneous Influences 172 , XI. How TO Use the Trade Aooeptanoe Trade A,cceptance Defined 174 Banker's Acceptance Defined 176 Pros and Cons of Acceptances 176 Introducing the Trade Acceptance 178 Relation of Acceptances to Notes and Drafts. . 180 Credit Standing an Important Factor 183 Practices That Violate the Principle of the Trade Acceptance 184 Opposition to the Use of Trade Acceptances. . . 186 Some Typical Uses 189 Use in Financing Imports 189 Use in Financing Exports 195 U^e in Financing the Shipper 198 Accounting for Trade Acceptances 204 XII. Additional SouRCfES of Funds The Note Broker 308 Suppliers 214 Insurance 220 Personal Investments 220 Credit Companies 221 Loans on Fixed Assets 222 Sale of Property 222 By Sale of City Lots 222 Warehouse Receipts — Chattel Mortgages 223 Aid from City Associations 225 Customers 225 Character Loans 225 Contents ix XIII. Everyday Financing That Pays Success Factors in Everyday Financing 228 Definite Purpose 229 Direct Supervision 231 Proper Location 232 Planning Ahead 233 Taking of Discounts 235 Increased Turnover 286 Keeping Funds at Work , 237 Borrowing Profitably , 238 Attention to Important Details 238 Cost Analysis 239 How a Cost System Helps Financing 240 A Cost System May Atm^ Disaster 243 A Flexible System Needed 245 A Cost System in Bela-tion to General Ac- counting 245 Keeping Track of Stoek 251 The Fundamentals of Costs 252 Getting Full Use of 9^ce 256 Personality 257 Harmony in the OrgaaniBation 257 XIV. How TO CUBTATL, BOEROWING Don't Overbuy 260 Don't Carry Too Big a Stock 262 Don't Let Expensas Mount Too High 264 Don't Neglect Collections 266 XV. Helps TO Successpui. Financinq Personal Factors in Financing 271 Managerial Factors in Financing 274 The Customer a Factor in Financing 278 XVI. Making Finances Kbhp Pace with Business Gbowth Planning Ahead 282 X Contents Avoiding Abnormal Expansion 283 Leaving Part of the Profits in the Business. . . . 284 Cultivate Good WiU of Stockholders 285 Paying Debts Before Dividends 286 Proper Location and Leases 286 A Grasp of the Labor Problem 287 A Budget Plan , 287 XVII. Financing Exports and Imports Foreign Trade Similar to Domestic 292 Proper Information and Quotations 293 Various Quotations Compared 296 Importance of Definite Quotations 298 Cash with Order 300 -Cash on Delivery 300 The Confirmed Order 300 Letters of Credit 300^ Sales on Open Account 303 Drafts 305 Clean and Documentary Drafts 306 Instructions with Disafts 306 How Banks Handle the Drafts 309 Local Customs 311 Foreign Exchange 312 Relative Value of Coins as Bullion ^ , . . 312 Law of Supply and Demand 313 Financial Status of a Country 315 XVIII. Peotectivb and Emekgenot Measuees Importance of Maintaining a Reputation for Integrity 319 Training Others for Management 319 Desirability of Expert Advice 320 Building a Surplus 321 Sufficient Capital \a 322 Insuring the Executives 322 Obtaining Widely Diversified Markets 323 Contents xi Making Customers Stockholders 324 Definite Business Standards 324 Emergency Measures 325 Open Dealing with Creditors 327 Eeducing the Overhead 327 Borrowing on Accounts Receivable 329 XIX. What to Do with Youe Surplus Dividends '. 331 Reserves 333 ' What Is Surplus? 333 Making Use of the Surplus 336 Investing the Surplus 337 Using a Surplus in the Business 348 Uses of Ready Money 360 Statistical Financial Analysis 353 Gouolading Observations 357 UST OF FORMS AND ILLUSTRATIONS Mg. 1. The Scope of Pinaneing 3 Fig. 2. Tour Business Is Like You 6 Fig. 3. Forms of Organization Compared. ; 16-17 Fig. 4. Formalities of Organization 22-25 Fig. 5. Kinds of Short-Term Borrowing 32 Fig. &. Chart of Capital Stock... 40 Fig. 7. a. Stock Certificate and Stub (face) 42 b. Stock Certificate and Stub (back) 43 Fig. 8. Cost Factors and Working Capital 54 Fig. 9. Time Factors and Working Capital 55 Fig. 10. Volume Factors and "Vyorking Capital 55 Fig. 11. The Working Capital Cube 56 Fig. 12. Chart of the Turnover 58 Fig. 13. Terms of Sale in Typical Industries 64 Fig. 14. Outlets for Selling Stock 82 Fig. 15. Advertisement for Sale of Capital Stock 85 Fig. 16. Prospectus of Stock Offering 86-87 Fig. 17. Forms of Paper Used in Business and Finance. . 91 Fig. 18. a. A Bond Form (face) 104 b. A Bond Form (back) — Coupon Inserted 105 Fig. 19. Sources of Additional Capital for a Going Con- cern 117 Fig. 20. Punotioins and Services Beodered by ttie Modiem City Bank 126 How to CSiooBe Your Bank 128 Boles by Whioh Oramm'eroial Banks Lend Money. . 130 Kiads otf Banks from Borroweac's Viieiwptxbt 140 Banker^ QoeeOJcmB to One ^ekirig a Line of Oradit 14?-151 Form foar Profit asod Irass Account Facing 152 Form of Balance Sheet Facing 163 Factors Affecting Cost of Loans 164 xiii Pig. 21. Fig. 22. Pig. 28. P%. 24. FigL 35. Pig. 26. Fig. 27. xiv List of Forms and Illustrations Fig. 28. Non-Negotiable Warehouse Receipt Form 170 Fig. 29. Negotiable Warehouse Receipt Form 171 Fig. 30, Trade Acceptance 175 Fig. 31. How Trade Acceptance Originated '. 181 Fig. 32. Route of Trade Acceptance in a Domestic Trans- action 190 Fig. 33. Financing Imports with Acceptances 191 Fig. 34. Bank Acceptance .'. 193 Fig. 35. Use of Banker's Acceptance in Financing Exports 194 Fig. 36. Bank Acceptance 195 Fig. 37. SteplinFinancingExport Shipment of Cotton. . 196 Fig. 38. Step 2 j^ Financing Export Shipment of Cotton. . 197 Fig. 39. Bank Acceptance 199 Fig. 40. Bank Acceptance 201 Fig. 41. Financing the Shipper in a Domestic Shipment. . 202 Fig. 42. Commercial Letter of Credit Payable in Dollars. 203 Fig. 43. Tabulation Showing the Settlements for Differ- ent Periods When Acceptances Are Used 205 Fig. 44. Trade Aoceptanoe Register 206 Fig. 45. Characteristics of Note Broker 209 Fig. 46. Where to Find Funds or Credit 212 Fig. 47. Ways to Raise Beady Money. '. 217-218 Fig. 48. Form of Judgment Note 224 Fig. 49. Acid Test of Successful Everyday Financing 230 Fig. 50. Rules for Mark-up 247-248 Fig. 51. Comparative Cost of Operation in Panel Mill 250 ng. 52. Distribution di the Sales Dollar 256 Fig. 53. Getting the Same Work out of Less Stock 263 Fig. 54; Split the Profitable from the Unprofitable Prac- tices ,. 267 Fig. 55. Factors Making Financing Easier 272 Fig. 56. Blackboard Efeoord of Sales 276 Fig. 57. Budget CShart 288 Jig. SS. How to Figui© Quotations on Goods for Export. . ^5 Fig. 69. An Unconfirmed Export Credit. 301 Fig. 60. Confirmed Export Credit 302 Fig. 61. .Export Trust Receipt 304 List of Forms and Illustrations xv / Pig. 62. Time Draft Original and Duplicate 307 Fig. 63. Ways of Financing Foreign Shipments 310 Fig. 64. The Net Income and How It May Be Divided 334 Pig. 65. The Prosperity Cycle 341 Fig. 66. Division of a Sdes Dollar 354 Pig. 67. Allowances of Two Firms Compared 354 Pig. 68. The Operating Ratio 356 CHAPTER I GETTING THE RIGHT VIEWPOINT ON FINANCING What does the word "finance" usually conjure up inthe mind of a man who is preparing to go into business ? If he is honest, he will probably tell you that he thinks instantly of banks, of Wall Street, and of anything except the all- inclusive answer: "Day-to-day financial management." Newspaper stories of "high finance" have rudely dis- torted the real meaning of finance. In fact, when you talk to anyone about financing a proposition, you are likely to stir up unsavory thoughts of clever manipula- tions of funds, of honest men being mulcted of legitimate profits, of "Blue Sky" enterprises started and smashed, and so on. This is unfortunate, and it is time all men visualized finance for what it is. Financing Not Simply Banking The man who rushes to the bank to get help in financ- ing his business is only glimpsing one small phase of the problem. On the other hand, the man who succeeds brilliantly in selling goods and nonchalantly waits for the money to roll in is just as far off the track. Nor do you actually finance an enterprise when you get a lot of your friends to buy stock. That is only a start. It is like getting into a rowboat to reach the other side of the pond. Unless you row, you'll not get anywhere. 1 2 Financing a Business Similarly, financing is a day-to-day affair. It means constant planning and watchfulness. It touches every point in the conduct of a business, from organizing it to meeting everyday working capital needs. Let us turn our attention, then, from Wall Street and the banks ta all the other important features of financing. As one banker says : "It is astonishing how misunder- stood the term finance is. We constantly have to turn down applications for loans from concerns which need no money whatever. They simply need to know how to run their affairs. Our representatives frequently look over business houses which beg us for financial help, and find that a change in the buying policy, a better' grasp of the man-handling problem, or a closer w^tch on their collec- tions, is the solution of their difficulty — not additional loans from us." When concerns, large aAd small, learn to keep th^r house in order financially, they will find they have learned to finance. Of course, this does hot mean that banks are not highly important factors in affording temporary cap- ital to business. TheiT money-balancing influence is in- dispensable. Yet, financing runs the whole gamut of business activity. What Fikancing Involves In the correct sense of the term, then, you only start to finance your business when you get together the cap- ital to establish it. You must still further plan ahead to make a profit, you must buy right, sell on a mark-up to make a profit and still meet competition, have funds to pay workers on schedule, and collect and pay your ac- counts promptly. Sufficient working capital is also vital — in fact, you must know your business. Then, when a The Popular Notion The Field of Financi activity c £ oo rompt^..':f VH:'.V -.'-•■< - ,f^er§ '' us? iSbmbetltively y fW^ — ^:i?i$?s'-='^ ^ rit^g Ahead-- a P^^jj?rrig Capital Fig. 1. — The Scope of Financing 4 Financing a Business temporary need arises, you can obtain the assistance you require from the bank. Many a man who says, "I know my business from top to bottom," is deceiving himself. He may know very well the inner workings of his concern, market conditions as affecting his line, his customers, and the thousand and one details of the daily business routine; but until he has visualized his position and the position of his con- cern and of his line of business in the world of business activity as a whole, and until he understands the rela- tionship of his individual concern to the primary func- tions of production, distribution, and administration, he cannot truthfully say that he knows his business inside out, or possesses the breadth of vision essential to ex- pansion and sound financial management. Importance op Sound Management Many a concern has suffered failure because of poor financing, not at the start, but as the business ran aiong. Westinghouse and other brilliant men furnish striking examples of the ability to start an enterprise with plenty of money and yet make a failure of it, because they failed to recognize the everyday financial demands of the busi- ness. That is why definite and complete accounting and cost methods are essential to business success today. Under the complex general condition of trade and com- merce, even the smallest retail merchant cannot take the risk of guessing. He has to know. So all along — ^the manufacturer, the steel, corporation, the railroad execu- tive — each must know the facts of his business in order to finance it. This knowledge extends to so-called "small details." For instance, one great business enterprise actually The Right Viewpoint 6 makes its profits from its discounts — an item somQ men absolutely overlook. A middle-western retail store was forced to close its doors because its trade fell off. And what was the cause of such falling off? Simply that the owner allowed the store to become shabby ia appearance. Competitors gradually lured his trade away. People sought thei bright, shiny counters, the gayly lighted win- dows, and the fresh-looking s^ock of other stores. This man might have saved his business with practically no additional expense if he had devoted a few moments each day to tidying up. This is perhaps a far cry from the ordinary thought of financing. Yet the arrangement and appearance of that store were just as vital as^ — ^yes, more so than — getting a $1,000 loan from the bank. Not that it is bad business to borrow, altho it may he a sign of danger. What borrowing you should do will depend largely on the line of business you are in. Con- cerns having seasonal fluctuations may find it best to de- pend oh their banks to take care of these demands. This enables them to keep their funds working. It is not a sign of the best financing to have too large an idle bank account. A poorly managed business is likely to have trouble in borrowing, regardless of whether it is mak- ing money or not. Size Immaterial in Financing No business is too small to finance itself on the proper basis. Every man, whether he represents a $500 business or a $5,000,000 one, should know the principles and methods of finance. The man who says he has not time, or that his business is too small, to consider details, is usually headed straighlf toward financial trouble. This has been proved by investigation of many businesses. Your Business Islike You Fio. 2— Your Business Is Like You. The Right Viewpomi' 7 Financing one's business is exactly the same in prin- ciple as handling one's private affairs. If a man receives a salary of $200 a month, he has to live within that Wm. He must arrange his purchases, his household require- ments, and his personal expenses to meet his income. If he borrows money to keep going without the assurance of an increase in salary, he must have some plan of pay- ing back his loan. Otherwise he is bound to get in deeper until, theoretlically, he fails. Financing Is Simple Financing is simple if the underlying principles are known. Any man can learn these principles if he deter- mines to do so. The mysteries of financing ascribed to the manipulations of Wall Street speculators and clever promoters, fade away when one attempts sincerely to analyze his market, to investigate sources of capital, and to plan a real business organization. For, after all, the same fundamentals that' apply to the big concern apply equally to the small business. Financing in its principles is not variable, not an uncertain will-o'-the-wisp factor in operating a concern. It is definite, certain, depend- able, and tangible. One has only to see it in its com- pleteness to understand its application to business. In the following chapters, therefore, will be set forth in detail the methods of financing a business, from secur- ing the <^apital and planning the enterprise to conducting its everyday affairs and protecting its progress. All thru the study of the wor^ however, the comparative simplic- ity of financing should be kept in mind. It covers many points, of course, but it should not be difificxdt for any- one to grasp the essentials to the extent of operating a buskiess successfully. 8 Financing a Business SELF-TEST QUJpSTIONS 1. THE DIFFERENCE. Distinguish between "financing" and "banking." 2. SUCCESSFUL BUSINESS MAN. Why is he usually a goo4 financier? 3. FINANCIAL MANAGEMENT. What are fiie principal factors in successful financial management? 4. BIG BUSINESS. Explain how its financing is similar to an individual's daily affairs. CHAPTER n PLANNING AND STARTING THE NEW BUSINESS Two brothers, who were left $5,000 apiece by their father, launched forth in the mail-order business some years ago and now own a million dollar concern, doing an enormous annual business. Both were trained sales- men, and at the start their available funds amounted to little more than the $10,000. But they had a clear, well- defined plan before starting out, and they knew their field and their goods. At the outset the timid man would have hesitated to attempt the step taken by these brothers because mail- order competition was already keen, and a number of companies in this line had grown to awe-inspiring pro- portions. But since they had at their command all Of the equipnient necessary to build on a sure foundation, their success was inevitable. Here is one example of the importance of starting a business on absolute knowledge, and not on guesswork. This chapter, therefore, will take up the essential require- ments in planning and starting a new business, giving proved examples of how others have wisely shaped their business course. The old ada^e, "Train up a child in the way he should go, and when he is old he will not de- part from it," is just as applicable to a business as to a human being. Get an enterprise started right and suc- cess is ordinarily two-thirds assured. 9 ID Financing a Business OOMPEBHENSIVE GeASP NeCESSABY Much depends upon the method by which the problems of the new enterprise are approached. There is one best way to do everything. That way is often sacrificed for the sake of humoring a personal whim or sentiment of some executive, many times resulting disastrously. ' An eastern manufacturer's business had been founded by his father years before. Expansion, necessitating new buildings and equipment, had become imperative. The manufacturer was urged by his aids to move to a nearby industrial center, where the labor and raw material markets were better, and transportation facilities much more favorable. But on account of fhe sentiment at- tached to the old home town, he would not move. From occupying the position of a leader in his line, Be was, in a few years, forced out of business. A mechanic learns to operate and repair an automobile engine most quickly by taking it apart, studying each piece of mechanism in its relation to the other parts and to the engine as a whole. The same is true in solving business problems. If the executive, in approaching the problem, picks it to pieces, he will discover why each proc- ess or department is carried on as it is. He will be bet- ter able to detect any lost motion or unnecessary detail, and, on the other hand, he may see plainly that the ad- dition of some det^l will simplify the operation as a whole, the solution of the big problem resting on some minor factor. Often, in analyzing a complex situation, it is difficult to remember the details which niake up the whole. If these factors are listed, you will have them before you in black and white, where they cannot get away, allowing yoxi to spend your entire energy in weighing them aaainst Planning and Starting 11 each other, checking them off one by one, until the point upon which the whole problem hinges is found and solved. A vice-president of one of the biggest surety com- panies in America received his early training in big busi- ness with the largest department store in Chicago. He says that every helpful suggestion, he made while em- ployed in that store was due to his "glorious fund of inexperience." This is only another way of saying that he was able to see the shortcomings of the store because he approached the problems as if they had never been solved. The mere fact that a thing was being done with a fair degree of efficiency, and had always been done in a certain way, did not mean to him that it could not be done better in some other way. This approach to a prob- lem as if it is an entirely new one, gives the executive a chance to use his initiative and to get an entirely new slant on the problem. Open-mindedness, then, is a most important thing in approaching a business problem. Value of Pkeliminaby Planking To return to the case of the two brothers. In the first place their sense of the value of their $10,000 was keen. They realized it must be put to the best possible use. So, instead of hiring elaborate warerooms and offices, they rented a $15-a-month loft and then took hold themselves. Their reputation as salesmen was good and they capital- ized it in getting started. To explain : They knew that to interest customers they must have a special appeal somewhat different from that employed by the old estab- lished houses. They therefore decided that if it were possible, they would sell on the instalment plan. To accomplish this purpose, the two men appealed to their manufacturer, explaining their desire to obtain 12 Financing a Business longer terms of credit than usual, in order to sell on time. The plan was minutely worked out, showing the credit needed from the date of purchase to the dates of repay- ment by customers who bought on instalments. They showed the analysis of their field and the probabilities ,f or future growth. The manufacturer, greatly impressed by the careful planning of the young men, agreed to supply a reasonable amount of goods to start them. The brothers did not stop here, but, realizing that their success would depend largely on the volume of their sales, laid their plans before an advertising agency with the result that a large share of their $10,000 was con- tracted for in advertising. Not that this would be at all advisable in many businesses, but they acted accord- ing to the nature of their undertaking. ^ Orders came in beyond their most liberal estimates. I As fast as possible they discounted their bills and thus were able to secure the maximum profit. The wisdom of their planning was quickly proved. Today they stand without a peer in their chosen field. Contrast this case with the case of men who want to have their own business, but who fail to analyze or plan intelligently. Is it any wonder the banker turns them down! Definiteness of aim, then, with details as far as possible worked out in advance, are necessary to in- terest either the banker or the investor. First Step — Investigation of Subject On this basis, what is the first logical step to takef Ordinarily it is the thoro investigation of all factors vital to it. These include: 1. The market Planning and Starting 13 2. The competition 3. The prices ' 4. The cost of production or selling, or both 5. The location ' 6. The condition of the materials and labor markets 7. The status of the money market 8. The permanency of demand. Inquiry into the subject indicates that often there is woeful neglect of one or more or all of these factors in planning the new business. For instance, an inventor may be so enthusiastic over his own cireation that he may fail to see that production expense would be too great to meet competition. Or a location may be chosen too far from the right labor market or where freight rates may be prohibitive. The status of the money mar- ket must also be carefully considered. Foi^ example, the cheapness of the dollar as well as the unprecedented i i expansion of trade were important factors for business to contemplate during the period just following the World War. High building costs made it impossible for some concerns to proceed with their plans, while on the other hand the cheapness of the dollar, together with other considerations, made the time propitious for some lines to reach out after attractive profits. This was the case with concerns which had large quantities of work- ing assets on hand. These assets were acquired at a low price before the close of the war and could be disposed of at a great profit afterwards. Probably more necessary to know than all other points enumerated for investigation is that of costs. Altho of late years great strides have been made in this direction, still many who seek to go into business have a startling misconception of the costs of doing business. This point 14 Financing a Business should never be neglected, no matter how irksome its investigation may be. The man who does not know his costs today is lost. An automobile manufacturer thought that he was making $300 on each machine that left his plant. After he failed, a cost expert was called in. He found that there had been a loss of $175 on each machine. It pays to know. Location is not always given proper consideration. Take, for instance, the experience of a middle-western tractor concenL The proposed capital was largely sub- scribed and a building was erected. When the affairs of the company had reached this stage it was found that the plant was too far not only from the labor market but from the sources of raw material as well. Here the delay occasioned by a thoro investigation would have been offset by a saving of several thousand dollars. Even a retail store needs to analyze the character of the neighborhood, the possibilities of the field, and so on. It negds to determine what is the per capita wealth, the nature of the buying habits of the majority of the people, the density of the population, and the nature of the oom- petition. A wholesale house similarly has to consider closely the scope of its territory, the character of its dealers and of the competition, while manufacturing concerns must watch such factors as proximity to raw supplies, trans- portation facilities, the question of agency or direct sell- ing, the skilled or unskilled labor market, and all other in- fluences covered in the broad term, "location." The importance of this is indicated by the emphasis placed upon it by some of the most successful firms in the business world. For example, see the care with which the United Cigar Stores Company, the Woolworth stores, and the packing companies choose their locations. Planning and Starting 15 As everyone knows, the retail corporations count "noses" of passers-by and use every test at their command to prove the worth of a location. The packing companies locate one type of plant where the greatest^ cattle receipts are assured, another type where a great fruit market is at their doors, and so on. Whether a business is planned on a large or small scale, these factors should be given the deepest study and thought. If a concern is to make use of the products of the farm, proximity to farm territory is desirable. At the same time the need of ample financing is apparent, in order to permit of dealing with farmers and of buy- ing crops right. Here the need for adequate banking connections is obvious. It may be that a seasonal time for launching the enter- prise should also be considered, especially if the enter- prise is of a sort subject to fluctuation, to dull and busy periods, etc. Second Step — Form of the Organisation After all of the preliminary investigations have been made, it is then time to consider the forming of the or- ganization — ^just how large, its type, and so on. The usual forms of organization are classed as fol- lows: 1. The individual proprietorship 2. The partnership 3. The corporation. How these various types are legally organized and what steps are taken to make them effective is pointed out in the summary on pages 22-25. It is worth while here to take up each of these forms with their variations in a somewhat comprehensive Which Form Shall U Be? Is the oriheCbrpor^ion SOLE PROPRIETORSHIP Applicable to Small businesses of all kinds. Physicians, and others giving a dis- tinctly personal service. Men of great wealth whose busi- ness is the invest- ment and manage- ment of their funds. Advantages Easy to start. Simple in opera- tion. Economical for small businesses. Free from legal restrictions. Gives opportu- nity to learn all phases of business and to develop all- round business qualities. Disadvantages Limited capital Limited manage- ment. Unlimited liabil- ity for debts. Limited life. Fio. 3. — Forms of Organization Compared PARTNERSHIP Applicable to Advantages Disadvantages Lawyers. Accountants. Engineers. Stock and bond brokers. Underwriters. Easy to start. Simple in opera- tion. Few legal restric- tions. High-quality men can be attracted to share in manage- ment. Limited capital. Unlimited liabil- ity. Danger of unde- sirable partners. Danger to busi- ness on death or withdrawal of a partner. CORPORATION Applicable to Advantages Disadvantages Nearly all me- dium- and large- sized organizations — social, govern- mental, or busi- ness. Limited liability. Ability to get high - grade m a n- agement independ- ent of capital needs. Ease in borrow- ing and in increas- ing the capital. Ease in transfer- ring property rights or in changing management. Business not af- fected by death or withdrawal of mem- bers. Powers limited by law. Governmental re- strictions. Tendency for small investor to have no word in the management Temptation to management to dis- regard interests of investor. Heavier taxation. Fia. 3. — Forms of Organizaticn Compared (concluded) 18 Financing a Business manner, for much depends sometimes on the right sort of organization to meet the exigencies that may arise. THE INDIVIDTTAL PBOPEIETOKSHIP Starting with the individual proprietorship, we have the simplest type of business — that which is owned by one man. It has its advantages and disadvantages, which doubtless are readily apparent. Advantages. — The individual can enter and retire from any business field he desires with little formality. Any field which promises large business profits can be en- tered by the individual. He can reap the rewards of the pioneer and then withdraw to take up the development of some new industry, when the field becomes crowded. This tends to keep different lines of endeavor evenly developed. When emergencies arise, the individual proprietor can act at once, without consulting anyone else. The possi- bility of prompt action may save many dollars. The in- dividual proprietor can also keep his business secrets from the rest of the world more effectively. Drawbacks. — The sole owner is truly an independent business entity. He bears alone the responsibility for the success or failure of the enterprise, and is thus cir- cumscribed in his activities. As his business grows he may find difficulty in inducing men whom he has devel- oped to remain with him, inasmuch as they can expect no part of ownership in the enterprise. There are other drawbacks to a one-man business which always should be borne in mind when contemplat- ing launching any commercial activity. One of these is the question of its perpetuation in ease of the owner's death. Experience shows that many difficulties may arise Planning and Starting 19 from this exigency which may seriously threaten the life of the business. Investigation has proved that many promising one-man businesses have been closed out be- cause it was not possible to find a successor satisfactory to all the heirs and relatives concerned. Another point to consider is the temporary absence of the owner. Has someone been trained to perform his duties and been made to realize properly the responsi- bility? An eastern manufacturer who was called to Europe on business, one day received a cable urging his immediate return. Prior to his absence, the business had been under his sole direction and domination. During his absence, friction and questionings arose which threatened general disaster. He arrived home just in time to pull the organization together. Seeing his mis- take, he proceeded to change his concern into a corpora- tion, so that responsibilities could be more readily placed on others. Often, too, the one-man business is restricted in its growth. It lacks the counsel of a number of men vitaUy interested in it, and thus may suffer from the lack of attention to the detaUs necessary to expansion. On the other hand, however, the individual proprietorship means undivided control, and thus appeals to a large number of men who look forward to an independent business career. THE PAKTNBESHIP The second type of business is the partnership. At the outset it is essential for those intending to form a partnership to have a very definite, not to say intimate, knowledge of their colleagues. Partnerships impose heavy obligations on each member, for each one is liable for all of the indebtedness of the firm. An instance of 20 Financing a Business the penalties attached to a partnership is to be found in the case of a Missouri man who went into a stone busi- ness with one whom he supposed to be his best friend. He invested heavily of his means and traveled much of his time, selling goods and building up the business. His partner stayed at home and managed the enterprise, having had considerable experience in this line. One day the traveling partner returned from a trip to find that his work had been futile. The concern was insol- vent thru the mismanagement by the other partner. This man spent years of his later life squaring up the obliga- tions incurred by his colleague and for which he was legally responsible. The fact that a partnership is dissolved by operation of law upon the death of one of the partners is also a great disadvantage, for the perpetuity of a business or- ganization is one of its most desirable attributes. A partnership is a personal relationship,, and a partner cannot sell his interest without the consent of all the other partners. The partnership is not a legal entity in the eyes of the law. When it is sued, the suit is entered against all of the partners as individuals and not against the partner- ship itself. The liability of one partner is the liability of a^. Of course a partnership has the advantage over the individual proprietorship in that it usually represents a greater source from which to draw capital and more men directly and vitally interested in the welfare of the organization. In England and Canada, "limited" partnerships have proved satisfactory in many instances. Among the part- ners may be some who have invested their money but who take no active part in it. In the United States in- Planning and Starting 21 active partners are taken into the partnership for their financial assistance only. They take no part in the man- agement and are liable only for the amount of their in- vestment. Their liability, in other words, is "limited." This freedom from liability for the debts of the partner- ship is secured only by accurate compliance with very strict statutory laws. Many men who have gone into limited partnerships as inactive partners have found themselves lial^le for the debts incurred by the general partners, on account of their failure to comply with all the requirements of the law. It is almost as difficult to form a limited partnership as it is to form a corpora- tion. In spite of its many disadvantages, the partnership has proved a satisfactory form of organization with many successful concerns. The present-day tendency, however, is away from the partnership form of organization. THE COEPORATION/ The third general type of business is the corporation, and this at present is by far the most popular of all be- cause it is a legal entity and because of its continuity, flexibility, centralized control, and the limited liability of the investors. A corporation has the same standing in the eyes of the law as an individual. It can sue and be sued, sign contracts, and carry on transactions in the same manner as can an individual. This is a great advantage over the partnership. A corporation, con- sisting as it does of several stockholders, who are usually liable only for i;heir individual investment, ap- peals to people with money to invest, and its perpetuity of existence safeguards the future of the business. The directors, "vs^ho are all interested as owners, naturally 22 Financing tf Business FORMALITIES OF ORGANIZATION What the Law Requires in the Formation of Partnerships, Trusts, Joint Stock Companies, and Corporations Partnership The formation of a partnership requires no legal proceed- ings. The partners merely agree to do business together. While it is better to have the definite written articles^ of partnership drawn up, this is not necessary. Limited Partnership Here it is necessary to go thru legal proceedings to secure the limited liability. Such a partnership is unknown to the common law and depends upon statute. While these stat- utes vary in their minor details, according to the jurisdic- tion, yet the following may be taken as a good example: 1. Two or more persons desiring to form a liniited part- nership shall: (a) Sign and swear to a certificate, which shall state, I. The name of the partnership, II. The character of the business, III. The location of the principal place of business, IV. The name and place of residence of each member, general and limited partners being respectively designated, V. The term for which the partnership is to exist, VI. The amoimt of cash and a description of and the agreed value of the other property contributed by each lim- ited partner, VII. The additional contributions, if any, agreed to be made by each limited partner, and the times at which Or events on the happening of which they shall be made, Vm. The time, if agreed upon, when the contribution of each limited partner is to be returned, IX. The share of the profits or the other compensation by way of income which each limited partner shall receive by reason of his contribution. X. The right, if given, of a limited partner to substitute an assignee as contributor in his place, and the terms and conditions of the substitution, XI. The right, if given, of the partners to admit additional limited partners. Fig. 4. — Formalities of Organization Planning and Starting 23 XII. The right, i^ given, of one or more of the limited partners to priority over other limited partners, as to con- tributions or as to compensation by way of income, and the nature of such priority, XIII. The right, if given, of the remaining general partner or partners to continue tiie business on the death, retire- ment, or insanity of a general partner, and XIV. The right, if given, of a limited partner to demand and receive property other than cash in return for his con- tribution, (b) File for record the certificate in the office of the re- corder of deeds of the county where the principal office of such limited partnership is located. 2. A limited partnership is formed if there has. been sub- stantial compliance in good faith with the requirements of paragraph 1. Such a certificate must be acknowledged in the same man- ner as a deed, and filed with the clerk of the coimty where the principal place of business is located. If the business is to be carried on in more than one county, copies of cer- tificate must be filed in those other counties. At the same time when the certificate is filed, an afiidavit of one or more of the general partners must be filed in the same office with the certificate. This affidavit must state the amount of money or property furnished by each part- ner. If property is furnished, the affidavit should show the actual cash value of the property. It should also show that the money or property specified in these certificates has been contributed to the common stock by each of the spe- cial partners, and has been in good feuth applied to the same. Besides this, the terms Of the partnership must be published in some newspaper of general circulation for a period of six weeks beginning immediately after the filing of the certificate and affidavit. Proof of publication must be filed with the clerk with whom the certificate was filed. This proof of publication is simply an affidavit of the pub- lication of the newspaper that the notice was published for the required six weeks. A copy of the notice is attached to the affidavit. The names of the limited partners cannot be used in iJie firm name. Trusts As trusts depend upon common law, there are no legal for- malities excepting the drawing up of the trust deed which establishes the trust. This of itself does not need to be recorded, but may involve other things, such as conveyance of real estate, which will require its being recorded. Fio. 4. — Formalities of Organization (continued) 24 ' Financing a Business. Joint Stock Companies These are modifications of partnerships and can usually be formed Without the necessity of filing any legal papers. A few jurisdictions, however, require the fUing of the agree- ment under which the company is organized. In such cases the statutes must be comphed with. Corporations "* Corporations depend for their powers entirely upon statutes. The statutes vary with the different jurisdictions. Ordinar- ily a statement of incorporation is required to be signed, sealed, and acknowledged. This statement is usually re- quired to contain the following: 1. The names and post-office addresses of the incorporators ; 2. The name of the proposed corporation; 3. A clear and definite statement of the object or objects for which it is formed; 4. The period of duration; 5. The location of its principal office in this state, g^iving town, or city, street, and number if any; 6. The number of shares into which the capital stock is to be divided, whether all or part of the same shall have a par value, and if so the par value thereof, which shall not be less than five dollars nor more than one hundred dollars per share, and whether all or part of the same shall have no par value, and if there is to be more than one class of stock created, a description of the different classes, the number of shares in each class, and the relative rights, interests, and preferences each class shall represent; 7. The names and addresses, giving street and number, of the original subscribers to the capital stock, and the amount subscribed by each; 8. The total amoimt of authorized capital stock; 9. The amount of such stock which it is proposed to issue at once, which shall not be less than one thousand dollars; 10. The payment of at least one-half pi the capital stock having a par value, and of not less than fiive dollars per share for each share of capital stock having no par value, which it is proposed to issue at once, with a description of the nature and value of property, if any, paid for such capi- tal stock; 11. The number, names and post-office addresses of the directors^ by street and number, at least one of whom shall be a resident of this state, and the term for which elected; Fio. 4. — Formalities of Organization (continued) Planning and Starting 25 12. In the case of a building corporation, a specific and definite description of the site for such building; 13. Any other provisions, not inconsistent with law, for the regulation of the business and the conduct of the affairs of . the corporation, and any provisions creating, defining, limit- ing, and regulating the powers of the corporation, the di- rectors, and the stockholders, or any class or classes of stockholders. Such statement shall be filed in duplicate in the office of the Secretary of State, on forms prescribed and furnished by the Secretary of State. The Secretary of State then issues a certificate of incorpora- tions. In some cases it is necessary for preliminary papers to be filed before subscription books for stock can be opened. Copies of the law in regard to corporations can usually be obtained from the Secretary of State in the proper jurisdic- tion. Fio. 4. — Formalities of Organization (concluded) take a keen personal interest in the corporation's affairs, and each one is more or less familiar with the -.enterprise. In theory, at lea^, each one is fitted to take an active share in the management whenever necessity de- mands it. A corporation need never stop because of the passing of the chief executive. It may continue as before with a duly appointed successor in charge. In this sense it is subject to none of the limitations of the partner- ship, or of the individual enterprise. Restrictive features. — Because of the abuse of this easy form of raising capital by means of selling stock in the corporation, many of the staties have what is known as a "Blue Sky" law, making it necessary for a new company to undergo a rigid test of responsibility, of its soundness, and of its purposes and aims before it is permitted to offer its stock for sale. The securities it proposes to offer for sale are usually the subject of a rigid examination, and the assets behind the securities 26 Financing a Business "Blue Skt" Laws At the tftne of the publication of this book, "Blue Sky" laws to protect investors had been passed by a majority of the states. A fair example of some of the provisions of these laws is found in the Ohio statute, in effect since 1917, the provisions of which, among others, are as follows: It regulates dealers in securities, their agents, and the type of securities sold. The latter include any stock, bonds, debentures, col- lateral, stock or trust certificates, or other similar instrom^it evi- dencing title to or interest in property. Valid conveyances of real estate and mortgage bonds and notes secured by mortgage on real estate, securities of quasi-public corporations authorized by the state imblic service commission, and stocks or obligations of national and state banks and trust companies subject to examination by the state authorities, are exempt. All infomiation having to do with the proposed sale of securities must be filed with the Commissioner of Securities and application must be made to him for a license to sell. The filing fee is $5. The penalty for failing to fpUow the provisions of the act is fine and imprisonment. Besides a filing fee, an annual fee of $50 and an agent's annual registration fee of $5 are assessed. Note. — ^This r6sum6 is given merely as informational illustration of the foregoing discussion. No person should attempt to sell stock in a newly organized corporation without conferring with a competent attorney in the state in which it is proposed to engage in such selling operations. are required to be disclosed with more or less definite- ness. A spectacular example of the mushroom type of organ- ization which "Blue Sky" laws are designed to prevent was the Pan Motors Company of St. Cloud, Minnesota. It was extremely successful in its efforts to interest cap- ital. Country bankers and others were induced to buy stock in order to obtain the prestige afforded by the use of their names. The company was soon accused of mis- management and of defrauding the public who had pur- Plcmmng and Starting 27 chased stock. A court in Chicago found the^ promoters guilty of a number of the charges made against them. Notwithstanding examples of this Mnd, however, the public frequently is inveigled into investing in "fly-by- night" schemes. As is often the case, a worthy enter- prise finds it difficult to secure the interest of the in- vestor simply because of the manipulations of unscrupu- lous promoters. It is well, then, before taking final steps to launch a corporation, to consider carefully and exhaustively the restrictions attending an enterprise of this character, as well as the drawbacks to be encountered, and to weigh them thoroly against the advantages accruing from this form of organization, It is obviously of little encour- agement to men starting in a small 'way to have before their mind's eye only the rosily painted stories of the spectacular success of great corporation^ without taking equally into account the burdens as well as the risks they assume. Third Step — Plan of Capitalisation When once the type of business is determined upon, then tlie plan of capitalization must be taken up. BASES OF CAPITALIZATION The nature of the business into which the young busi- ness man is about to enter will determine to a great extent the capitalization of his organization. Most businesses are of the type which have standard- ized production. For instance, a desk factory puts out four different styles of desks. The manager knows just how much material it takes to make a desk, how much labor, and what the overhead cost averages. These items 28 Financing a Business are fixed, but what about his market and his sales? He must determine in advance what his sales are to be and then the basis of his knowledge of costs of production, determine his capital needs. In this class of concern the sales policy is the fundamental item on which capital needs are founded. The terms of sales, the rate of turnover, the purchase price and credit terms on raw material, and soi fprth, interpreted in the light of predetermined sales shoulSi be the basis for determining the amount of working capital needed. The amount of sales, or, in other words, the possible size of the market, will also determine the money needed for fixed assets. Many firms have gone down to ruin because they have made the mistake of figuring from the production rather than from a sales or market basis, when they were planning to put out a standard product. They have overestimated the size of their market. These items are discussed more fully in the next chapter. On the other hand there are enterprises, such as ma- chine shops doing job work, whose production is limited to sjjecial orders. The cpst of these orders must be esti- mated separately as they come in, and the managers must detennine which class of work is more profitable. Each case must have individual consideration as to cost of pro- duction, credit standing of the customers, terms of pay- ment, and the promptness with which the customer pays. All of the^ points affect the profitableness of the order. The amount of sales does not play the important part in financing this business that it does in* a concern which is on a basis 6i standardized production. Thus we see that liie new business must estimate its bases of capitalization, but the older biisineBS, altho affected somewhat by the same factors, has definite quan- Planning and Starting 29 titles with which to work ; it has its own past experience as a gnide. There are three methods of determining the method of capitalizing a business organization. The first considers the net worth of the concern as the proper amount a^ which to capitalize. By net worth is meant the value of the investment plus any aecmnulation of ^ earnings such as is shown in the surplus, or profit and loss accounts. Secondly, the cost of replacement of the property of the company may be taken as a basis for capitalization. The books show the property at its original cost, but a change in financial conditions may make that property much more valuable than the so-called "book value." The third basis for computation is the capitalization of the earning power. Earning power is the real meas- ure of success by which any business may be appraised. It is possible, and often happens, that two concerns have physical assets having the same original and replace- ment cost, but one earns a great deal more than the other. In such a case it is clearly fairer to estimate the proper capitalization on the basis of earning power rather than on either net worth or replacement value. In taking the earning power as the basis of capitaliza- tion, careful consideration should be devoted to a de- termination that the estimated earning power is not assessed on the basis of unusual causes. It should also be decided how the new management's policies will affect the earning power of the organization. Owned and Borrowed Capital. — ^In considering any plan of capitalizaticn, distinction must be made between owned and borrowed capital. This distinction is easily recog- nized in tiie csase of th6 individual proprietorship or the partnership. The total value of the assets of such con- cerns is offset on the liability side of the balance sheet 30 Financing a Business by obligations to persons outside the firm, borrowed capital, and by proprietorship which includes any sur- plus which may have been accumulated. In the case of the corporation it is not so easy to draw an absolute line between owned and borrowed capital. For instance, (there is a very slight difference between preferred stock of some kinds and debenture bonds. All of the accounts on the liability side of the balance sheet are obligations of the corporation as a legal entity. The stock represents the obligation of the corporation to the stockholders. However, the capital represented by stock is considered as owned by the corporation, because in several respects the advantages and disadvantages accru- ing to the stockholders and partners are comparable. That is, the stockholders take a greater risk of loss of^ capital in exchange for the possibilities of higher returns on their investment, than is the case with the holders of debenture bonds or other fixed forms of evidence of indebtedness. Methods of Borrowing Capital.— When an individual finds that he needs more capital he will usually have to take in a partner, or in the case of an existing partner- ship, to add another partner. In both cases control is parted with to some extent. In the case of a corporation the lenders take a low return and no direct control, in exchange for the highest degree of safety possible. Thus the corporation, when raising money thru an issue of bonds to be sold to the general public, has the advantage over the partnership, since it does not, by such an act, throw any individual liability on its stockholders, nor does it part with any control over its affairs. In this sense, it is cheaper to effect corporate borrowing than to secure one or more partners. The corporation, for instance, can issue bonds returning 4, 5, or 6 per cent Planning and Starting 31 instead of issuing preferred stock paying 6, 7, or 8 per cent. Year by year it becomes easier to borrow thru an issue of corporation bonds offered for sale to the general pub- lie because people are trying more and more to make themselves independent in their old age. To do this they are willing to forego large returns for increased safety and sure return. As this class is growing all the time, it is creating a large market for bonds and other securities of this type. Short-Term Borrowing. — ^AU borrowing is classified as short or long term. Short-term borrowing is done by means of notes, acceptances, and accounts receivable. The notes may be classified as (1) merchandise notes, (2) notes discounted at the bank, and (3) notes sold to the public. 1. Merchandise notes are those given to the seller by the buyer and usually run from thirty to ninety days according to the custom of the particular business. Mer- chandise notes are very closely allied with pure accounts receivable, for the notes are often given to cover the accounts. Many, it would almost be safe to say a ma- jority of small businesses are conducted to a large degree on this class of financing. The wholesaler will allow his customer the choice of two terms of settlement. Either the buyer may pay the full amount of the invoice for the goods at the end of thirty, sixty, or ninety days, the time depending on the length of time necessary for the buyer to put the purchased goods into salable form, dispose of them, and obtain cash ; or the seller may allow the buyer to deduct a specified sum from the bill for the payment of cash soon after the day of purchase. You can see from this that the credit extended by whole- salers, jobbers, or manufacturers is one form of ii il 4°" Sit £& J Si2 St3(3 Eagis si? :1s lit i II ills 1, 1} I it lilt S « o S &o_S in III e « v 5-53 ill 1 g « -SSE o o a QO •ii: iluH If BM is III llfll ■Sj! ft 3" BJi-ss..* Illllll llll 51 IIP 2 2 a 11^ a o ■ II i I Planning and Starting 33 borrowed capital as surely as if notes or other specific evidence of indebtedness were involved. 2. Notes discounted at the bank are used for three general purposes: (a) to finance a temporary shortage of funds, as in the case of a fire, or extraordinary de- mand for cash due to seasonable buying, as in the grain business; (b) to buy salable goods, the income from which will pay off the notes; (c) to finance a business during the period of credit extended to a customer. 3. Some large firms that need sums of cash to carry on their business most advantageously, make out notes which they sell to note brokers, who in turn seU them to bankers thruout the country. This form of financing has been widely and somewhat loosely used in the past. Latterly, however, the banks have demanded statements of the financial condition of the companies or firms issu- ing the notes. The thing to be guarded against is the issuing of notes to brokers and to the home banks at the same time, thus cutting off any chance of financing in a crisis. Notes sold to the public are of an entirely different nature from the merchandise notes and notes discounted by bankers and sold thru note brokers. These short-term notes which are sold to the public are usually issued as a forerunner of an issue of long-term bonds, in the hope that the money rate may be more favoraWe at the time of the issue of the long-time obli- gations. They may also be issued for the financing of some new branch of an established business, which it is hoped will prove sufficiently profitable to enable the com- pany to pay off the notes at maturity. This class of securities is handled by regular stock and bond brokers and usually matures in from one to five years. 34 Financing a Bueiness Short-terjn borrowing should be resorted to only for the purpose of obtaining working assets, which are those to be liquidated in the usual course of business, thus creating funds with which to pay the debt. This phase of financing is elaborated in Chapter X. Long-Term Borrowing. — ^Long-term borrowing is usu- ally backed by some fixed asset as security. This has led to the practice of speaking of this class of obligation as a "funded debt." A great variety of assets is used as the basis for such security in business today. Eeal estate, buildings, machinery, and equipment, stocks and bonds; these and many other types of fixed assets serve as security for long-term borrowing. The use of a mortgage on fixed assets is the basis, in some form or other, on which most long-time borrowing is done. In case a person or firm desires only a small amount, someone can usually be found who will be will- ing to supply the whole amount needed. In case a large amount is needed, say $10^000,000, it is highly improb- able that one person could be found who would be willing to furnish the whole sum. There are two parts to a mortgage which affect the procedure of borrowing money. One is the part which conveys the property to the person who loans the money, or to a trustee who rep- resents him. The other is the part which "bonds" the borrower to repay the lender. In case the borrower fails to repay or fulfil other requirements stated in the mortgage, such as payment of interest, the lender is given the right of "foreclosure" in some form on the property conveyed, to repay him for the money loaned. The usual method when large amounts are needed is to create a trustee, usually a trust company, which holds the title to the property mortgaged in behalf of the bond- holders. The bonds can then be issued and will have a Planning and Starting 35' proportionate lien on the property held in trust, accord- ing to their size. The borrowing of an amount for a longer time than five years is spoken of as "long-term" borrowing. Most long-time borrowing is done thru the agency of bonds. The word "bond" covers a wide field of securities. A working knowledge of bonds and their use is essential to the modern business executive. The different kinds are discussed in detail in another chapter. THE BANKER AS A BUSINESS ADVISEB So much for the different methods of raising capital. But before a final method is determined upon, indeed before any of the financial steps are decided, it is usually wise to discuss the subject in more or less detail with a banker. The choice of a banker is taken lip in detail in a later chapter, so that here need be discussed only the general advisability of having a banker for your busi- ness friend. There was a time not so far distant when most men would have shaken their heads dubiously over this recommendation, and even now there are evidences that the old traditional dislike of the banker still obtains among young men trying to get a business start. This dislike is largely the result of the conservative attitude of bankers toward young men just getting a start in business. Formerly, the man who succeeded in getting a loan from the old-time banker usually had to have money already back of him, and his concern had to be a going one. That type of banker did not realize that those young men who came to him for help were all possible means of future revenue for the bank. He did not see that with his advice and financial support he would build up a valuable clientele. The fact that the modem banker 36 Financing a Business realizes his opportunity is illustrated by the motto of a prominent Chicago bank, "Built on the Success of the Young Men We Have Helped." Such banks as these have surrounded themselves with a staff of business ex- perts whose knowledge and experience is available to the customers of the bank. But even granting that your banker can see in your proposition no present basis of credit, he may be able to help you plan your enterprise so that you may later be entitled to a line of credit. Competition, progress, and a better understanding of service have combined greatly to transform the old type of bankej, against whom so many young men have seemed embittered, into an officer desirous of extending the fullest co-operation. A num- ber of successful young men who have been interviewed, point out the folly of approaching a banker with a "chip on your shoulder." It doesn't pay. Even if a line of credit is not forthcoming, it is weU to discuss freely with the banker your plans and financial needs. Estab- lish a banking connection and, once satisfied with it, keep in frequent touch with one or more of the officers. Their service is naturally circumscribed by the banking laws, but notwithstanding tradition, you will most likely find them interested in your success, for bankers are also business men. For example, a large gum manufacturer early in his career appealed for financial help to the vice-president of a middle-western bank. Under strict banking rules the banker could lend the applicant no money, but he was so impressed with the enterprise that he himself fur- nished sufficient capital for his client to go ahead. To- day that manufacturer is a director in the same bank. Many, other instances show the wisdom of keeping close to your banker on all your business moves. Often he Planning and Starting .37 can help you determine the proper plan of capitaliza- tion and how much you will need. THE PUBLIC ACCOUNTANT AS AN ADVISEE Another business expert whom you would do well to consult, is the public accountant. Accounting organiza- tions accumulate a vast fund of knowledge and experi- ence along all business lines, making them a valuable aid to the promoters of a new business. They have found in the course of their investigations just where are the strong and weak points of almost every business. There- fore they are possible sources of advice that should not be overlooked. The necessity of correct costs Has been mentioned. It will pay to get a certified public account- ant to install a complete cost finding and accounting system. This class of business men are business doctors and can be used advantageously for preventive as well as curative purposes. The old saying, "An ounce of pre- vention is worth a pound of cure," is equally as true in business life as in any other direction. Capitalizing the Individual Proprietorship The capitalizaction of a business to be conducted under individual proprietorship is a comparatively simple mat- ter, as the proprietor is himself the one thru whom all the capital is provided. As a rule, such concerns cannot grow to very large proportions with any great degree of success because their capital is rarely adequate to enable them to rival the operations of capital combinations. Fur- thermore, the risk of crushing liability which faces the individual proprietor is usually an obstacle in the way of successful expansion beyond reasonable limits. 38 Financing a Business Capitalizing a Partnership If the concern is to be a partnership, each partner contributes toward the assets of the partnership what- ever is agreeable to all. Sometimes it may be expert counsel or property, rather than actual money. These points are determined by mutual agreement of the part- ners for 'the best interests of the business, and are set forth in the articles of partnership agreement. Here a banker of the right sort can be of value to the principals in helping to work out their problems. The amount of the investment to be made must be determined by the amount of business it is estimated will be done, the re- quirements of the particular business, and the initial scale of operations. Capitalising a Corporation In planning the capitalization of a corporation, many serious problems are likely to arise, usually requiring the assistance not only of a banker but of a lawyer. If it is desired to guide the policy of the company as well as to control it, the incorporators should make sure that there is no possible way for outsiders to gain control. In most cases the majority of the stock is kept in the hands of the men who have organized the corporation. The original agreement of theories as to policies, which brought them together, will usually make it unnecessary to take any such precautionary steps looking to a retain- ing of control. One method frequently followed, how- ever, is to buy for or have donated to the treasury of the company enough of its own stock to insure control of the company even if some of the heavy stockholders should sell out to minority interests. Such stock is termed "Treasury Stock." Plcmning and Starting \ 39 It would not be within the scope of this book to go specifically into the broad field covered by the subject of capitalization, because each new concern is necessarily affected by the special circumstances existing in each case. It cannot, however, be too strongly urged that in cases where it is desired to provide for future control, the most careful guidance should actuate every move. capitaIj may demand conteol Any jeopardizing of control may be a serious draw- back, yet sometimes it is necessary to relinquish it in order to obtain the capital with which to launch an en- terprise. For instance, the inventor of a valuable patent in connection with the oil business tried unsuccessfully to organize his own company. No one dared to join him because of his doubtful business ability. Finally, he ap- pealed to a banker in his home town. The banker agreed to finance him on the condition that he be allowed to hold 62 per cent of the capital stock. He convinced the inventor that only in this way could there be assurance of proper business management. The company was finally launched on this basis with business men in control, and aU, including the inventor, received a splendid profit from the prosperous regime that followed. DIFFEBENT CLASSES OF COEPOEATE CAPITAL The capital of a corporation is represented by stocks, by bonds, and by the surplus it owns. Stock certificates are, in theory at least, the paper evidence of the capital which the corporation owns. The bonds are evidences of the indebtedness of the corporation and represent borrowed capital, the repayment of which is promised at 3 <» 73 6 6 i Planning and Starting 41 a fixed time. The "surplus" may be funds subscribed by the stockholders before the corporation is launched, or it may represent profits earned by the corporation and retained as working capital, instead of being distributed to the stockholders. The stocks and bonds of each cor- poration have distinctive features as set forth in their --charter and by-laws. We shall confine ourselves in this chapter to a brief discussion of the various kinds of cor- poration stocks. The most popular kii^ds of stock are the common and preferred, in their many forms. The reason for having different kinds of shares is to attract different types of investors. Preferred shares, or preferred stock, are de- signed to attract the investor who is a little more daring than the one who invests in bonds which have a lien on the property, but does not wish to risk investing in com- mon stock. Common stock gives up the first rights to assets and dividends on the chance of gaining larger dividends after the other classes of security holders have been paid. Preferred stock is that stock which is described as being preferred both as to dividends and assets, that is, this class of stock must receive dividends at the rate stated on the stock certificate before the other share- holders are entitled to anything. In addition, preferred stock shares in the division of assets, in case of the dis- solution of the corporation, up to its par value, and it has a priority right to this ahead of the common stock. There are two common kinds of preferred stock: the regular and the cumulative. Tlie dividends are payable on certain dates and at fixed rates in both cases, but in the casd of the cumulative, dividends accrued in the past must all be declared and paid before any are paid to the regular preferred. As distinguished from the s C3 <3 4 ^ a ■J3 T Kn6>— I 11 44 Financing a Business cumulative preferred, when a dividend on the regular preferred stocks is "passed" without the directors de- claring a dividend, that dividend is lost to the regular preferred. On the cumulative preferred it "accumu- lates" until paid. Hence the name "cumulative." Common stock is entitled to dividends and to share in the division of assets upon dissolution of the corpora- tion only after the bondholders and preferred share- holders have been paid what is due them. Investors who buy common stock do so because they believe that there will be enough profit left after the, other security hold- ers have been paid the fixed amount due thei!n to pay the common stock holders more than has been received by the others. They give up security of income and capital in return for larger possible income. Also, as a rule, the voting power is restricted to the common stock, thus giving control of the enterprise to the holders of com- mon shares. Founders' Stock. — ^Recently there has been a new type of stock introduced by several American corporations, called "founders' stock." The purpose of issuing this stock is to attract to the organization brains and ability obtainable otherwise only at spectacular figures. These so-called founders' or managers' shares are really only another form of profit sharing by means of super-pre- ferred stock, usually held conditionally by those who promote the business,' manage it, or are employed in it — by the business builders, in short, as opposed to the mere investors. In cases such as this, the regular and cwmuJatiTe preferred stock is not affected as to rate of diridends, but the chance of very large returns to the holders of common is eliminated. In a recent flotation $15,000,000 of common was issued and 100,000 founders' shares at Planning and Starting 45 $5 per share. But the by-laws provided that the holders of founders' shares should receive the same amount, not the same percentage on the investment, as the holders of the common stock. If the company declared an 8 per cent dividend on the common stock, it would amount to $1,200,000, and a like amount would have to be paid to the holders of the founders' shares. This would mean that the holders of founders' shares would receive 240 per cent on their investment, which would tend to keep the surplus so low that there would be no chance of a stock dividend. These shares also frequently permit of considerable disproportionate control, each founders' share, in the case just cited, having the same voting power as ten shares of the common. The par values of stocks may vary in common prac- tice from $1 to $100, according to the class of investor the promoters wish to reach. The $100 and $10 par value stock are probably the most popular, altho $50, $5, and $1 shares are frequently issued. The smaller de- nominations are used in popular and speculative issues of stocks intended for a wide distribution. It makes it easier for the small investor to participate, and psycho- logically there seems to be more to ten $10 shares than ito one $100 share. Old corporations, with large accu- mulations of surplus and seasoned dividend records, whose stocks have reached a high maxket value fre- quently break these shares up into smaller denomina- . tions to popularize the stock in the market. As a rule, the combined market value of the smaller shares will be larger than the combined value of the previous high- priced shares. The explanation for this lies in the wider market and increased opportunity for speculative operations that the larger number of shares makes 46 ' Financing a Business possible. This, of course, applies only where there is active trading in the shares. A method of avoiding the whole question of amount of capitalization and the relation between the value of assets and the amount of stock issued is that of issuing common stock without any par value. The tendency seems to be for this practice to increase, and many large corporations have adopted the plan. Its chief recom- mendation is that all appearance of over-capitalization or "stock watering" is avoided. Moreover, the confusion arising in some instances out of existing variations be- tween the market value and the par value of stocks is eliminated. At the same time, there need be no misapprehension as to the book value of each share if the number of shares outstanding is known, since the excess of assets over liabilities to outsiders, as indicated by the balance sheet, represents the total value of the stockholders' equity in the corporation. How much capital is needed to start the enterprise, the importance of a budget plan for day-to-day needs, and the relation of sales and general operations to cap- ital, wiU be taken up in later chapters. It need only be emphasized that the right foundational start, as outlined in this chapter, is ordinarily essential to the satisfactory and permanent progress of the enterprise. SELF-TEST QUESTIONS 1. OPEN-MINDEDNESS. Why is it so significant in the han- dling of business problems? 2. CHIEF CHARACTERISTICS OF SUCCESS. What did the two brothers with the $10,000 manifest in this respect? 3. INDIVIDUAL PROPRIETORSHIP. Why is it losing its popularity? Planning and Starting 47 4. PARTNERSHIP. When may this fotm of organization be used to best advantage? '^ 5. CORPORATION. Explain its relation with the "Blue Sky" laws. 6. CAPITALIZATION. What are the various bases for capitali- zation? 7. SHORT-TERM BORROWING. When is it expedient? 8. LONG-TERM BORROWING. What are its salient features? 9. THE BANKER. Is his good will to be cultivated, and why? 10. THE PUBLIC ACCOUNTANT. Why is he an important ad- viser? CHAPTfeE III HOW MUCH CAPITAL WILL YOU NEED? Ask any banker or experienced business man the reason for nine out of ten of the failures of new enter- prises and you will probably receive the time-worn but illuminating answer, "Lack of capital." As a matter of fact, the first big question in starting a business after all preliminary investigations and plans have been made is, "How much capital is required?" Since the war, the changes in the value of the dollar have added to the com- plexities of the question. It would obviously be difficult to lay down inflexible rules to govern each particular case that might come up, yet it is possible to indicate the general requirements of financing a new business. Eight here, let it be said that investigation points to the fact that too many men jump haphazard into a prop- osition, giving it little or no analysis. Enthusiasm is a great factor with successful men, yet you will find that the large and powerful business houses that started on the proverlDial "shoe-string" have usually attained to their commanding position as the result of early analysis of their vital problems by their promoters. When Swift, the elder, came west to Chicago to estab- lish the packing industry, he had already visualized the whole proposition. He saw that a central plant would obviate not only waste in the neighborhood slaughtering houses, but the unsanitary methods as well. Having a 48 How Much Capital Will You Need? ' 49 clear conception of his business and his field, he was able to estimate his capital requirements and to con- vince others of the wisdom of his undertaking. Complete Knowledge of Costs Essential One of the serious influences opposed to sound busi- ness today is the lack on the part of many business men of a complete knowledge of costs. Without this, as pointed out in a later chapter, it is useless to try to de- termine capital requirements accurately. A small manufacturer in the West who had met with unusual success during his first two years, showed that his progress from the start was largely due to his close analysis of costs. He had little ready money, but owned a valuable farm. Going to his banker, he presented his plan, and obtained a loan on this property. He spent most of his time in the factory, endeavoring to cut down his costs. Little by little he contrived new devices for his machinery to increase production without adding materially to his expense. His constant attention to costs at the start and his knowledge of prodilction ex- pense was one of the big factors in his initial success. He anticipated his capital requirements and proved to his banker that he was headed in the right direction. Admittedly, it is difficult to compile an accurate budget of expenses any great length of time in advance, but close analysis will ordinarily show the approximate needs of the business. In making this analysis it is always well to confer with your banker. If he is not receptive, analyze the project again and decide if the banker is justified in turning you down. If several bankers are unreceptive, it is almost sure that the proposition has something wrong. 50 Financing a Business If business men would follow this line of action regard- less of their personal prejudices one way or another, rather than wait till they are involved in financial trouble, there undoubtedly would be fewer failures. The Needs foe Capital In general, capital needs come under classifications somewhat as follows : I. Preliminary or Organization Expense. A. Investigation of the project. '• B. Assembling of parties who may be willing to participate. C. Canvass of territory to ascertain if sufficient business can be obtained. D. Preliminary engineering and legal advice on the proposi- tion. E. Estimate of the cost of plant and probable income. F. Incorporation of company. G. Expense of company organization during construction. H. Interest on capital tied up during construction. I. Taxes and insurance during construction. J. Financing, including bankers' commission, discount on bonds, and promoters' profits and expenses. K. Legal services. II. Initial Investment. A. Fixed capital. 1. Property. 2. Plant. 3. Equipment. 4. Other fixed assets. B. Acquiring or establishing the ,business. 1. Advertising. 2. Expense of canvassing for business. 3. Interest on investment until business becomes self-sup- porting. 4. Taxes and insurance during that time. 6. Cost of mistakes in construction, equipment, advertis- ing, etc. C. Purchasing of intangible assets. 1. Goodwill. 2. Patents, xopyrights. How Much Capital Will You Need? 51 D. Working capital. 1. Stores and supplies. 2. Capital sufficient to carry on business until the returns on sales are received. £. Funds for expansion (discussed in Chapter VII). Organization Expense The expenses listed under organization expenses are usually consolidated into one account in the general ledger, which is absorbed by the profits of the concern over a number of years. This is usually spoken of as "writing off" the organization expense. In some cases' these expenditures are considered as a cost of the busi- ness, just as much as plant and equipment. It is conse- quently capitalized, being included with the fixed capital assets. Promotional expense includes the compensation of the promoter who has charge of selhng the securities, advertising, office rent, and railroad fare and other ex- penses of the promoter and his staff. It takes much longer to get some kinds of organizations running than others. For instance, it may be several years between the time when the construction of a railway is started and the time the first revenue is received from operation. In- terest on the immense amount of capital tied up during this time must be provided for. Often the item of preliminary expense is compara- tively small, yet it has to be taken into consideration. The nature of the business, its contemplated size at the start, and its field govern the amount to be set aside for this purpose. It may be very inconsiderable for a small retail store, and of large proportions for a concern plan- ning the manufacture of some highly technical product. For example, a salesman for a western tailor decided to embark in the business for himself. He had held his 52 Financing a Business position for several years and knew tlie field, the desir- able locations for shops of that Mnd, and the friendly- attitude of many of his patrons. He knew labor costs, the prices of materials, and also the approximate rental values in the retail center. His preliminary expenses were therefore negligible. He was able to proceed with his equipment plans immediately. On the other hand, a company of men, formed to man- ufacture an imitation leather product, found it necessary to spend thousands of .dollars in order to get started. Many tests of the product by experts had to be made to assure prospective investors of its worth. Offices had to be rented for the purpose of carrying on preliminary details of the organization. Salary expenses of assist- ants, and so on, all came in to consume the capital of the company. It was a hard struggle, in fact, to get the enterprise on an initial small production basis. Initial Investment FIXED CAPITAL Initial investment in fixed assets usually can be fairly and readily determined. If property is rented or pur- chased, the investment is definitely determined. Equip- ment, such as machinery, furniture and fixtures, and so on, can be approximately estimated, provided that their costs have been thoroly gone into. Here, however, the tendency seems to be, as revealed by investigators for this volume, to plan more elaborately than necessary. It usually happens that extravagance has ta be guarded against. This is a highly important point to bear in mind. Pefore capital is invested in fixed assets the test should be applied: "Is this the most profitable way to invest this sum? "Will it earn more profits this way than How Much Capital Will You Need? 53 if iuvested in working assets!" You have seen some expensive display device in a retail store, which is not being used. The capital tied up in it could be used effi- ciently if working assets had been purchased. STAETING THE BUSINESS So it is in the other business activities. Expensive mahogany furnishings may not be required for the infant enterprise. A loft at cheap rent may fill the require- ments as well as an expensive individual building. The expenses listed in the financial statements of many new concerns under the class of "Cost of acquiring and establishing a business" are suggestive of the amount of initial capital needed to get a business under way with- out financial embarrassment. No matter how thoro the investigation of all phases of the starting of a new business may have been, it very rarely happens that the organizers have made perfect plans. The building and the arrangement of the ma- chines may have to be changed before the plant is started, for the sake of efficiency. This all involves a considerable loss which is really a preliminary expense. The product may have to be changed ; also it may be dis- covered that the advertising is not the right kind. All of these difficulties may arise in starting a business, and in estimating the capital needed, it is advisable to take them into consideration. INTANGIBLE ASSETS The value of intangible assets, such as patents, trade marks, and copyrights, can be estimated easily and with a fair degree of accuracy. The item of goodwill is more 54 Financing a Business intricate and the estimate of its value should be made very carefully and conservatively. One writer says, "Goodwill is the capitalization of that portion of the earning power of a business which is not credited to other assets." The average earning power for several years is taken as a basis on which to make the calcula- tions. A certain percentage on the actual capital in- vested is deducted from the average earnings. Other deductions should be made for estimated earnings due to unusual circumstances, such as extraordinarily favor- able contracts which cannot be renewed. After these deductions are made the remainder is capitalized at the percentage of calculated earnings. WORKING CAPITAL 'sy^j After all these points have been wisely settled, the question of working capital comes up. And this often is far from easy ^^1^* to determine. Working capital is invested Fig. 8.— Cost in cash, raw material, work in proccss, fin- Workin/ Capi- ^^^^^ product and accounts or notes re- tai ceivable. All working capital is being coft'°fIc"o^rs °in changed from one form to another thru a liTl^yil ^^^^^ «y*^^®' usually in the order illus- working cap!- tratcd ou page 58. The fact that the requ re . influences which affect the several elements of the cycle are constantly changing, makes it very difficult to estimate the amount of capital' needed for this part of the business. Fluctuating commodity and labor prices, unforeseen delays} credit problems, un- expected competition, possible flaws in the product that need correction, and changes in business conditions, all have to be borne in mind in determining the necessary working capital. How Much Capital Will You Needf 55 The amount of working capital needed in a business depends upon the three general factors of co^t, time, and volume of production, that is : cost of producing a unit, multiplied by the time consumed in producing a unit, multiplied by the volume of business done. The relation of these three general factors to the amount of working capital can readily be understood by studying the figure called Fio. 9.— Time Fac- tors and Work- ing Capital Showing' how time factors in a business may in- crease amount of w o r k i n ET capi- tal required, i 'The Fio. 10. — Vol- ume Factors and Working Capital Showing how volume factors in a business may increase amount of working capi- tal required. Working Capital Cube." However, it should be remem- bered that these three elements do not always increase in the proportions indicated by this figure. The general nature of the business will have a great influence, in determining which of these three general factors is most re- sponsible for the amount of working capi- tal needed. This is illustrated and ex- plained by the thumb-nail sketches shown on this and the preceding pages. Each one of these general factors will be influenced by other more specific factors which affect working capital and are listed below. Tie factors that affect working capital are: 1. Terms of purchase 2. Period of manufacture 3. Turnover 4. Terms of sale 5. Seasonal variations in business 6. Type of material handled (liquid) 7. Ease with which stock can be obtained. All of these factors have a different effect in each busi- ness upon the amount of working capital necessary, 56 Financing a Business according to whether they hasten or retard the movement of the capital thru the cycle mentioned above. The terms upon which purchases can be made are very COST FACTORS — The more costly and less liquid the raw ma- terials, and the more costly the processes of production, distribu- tion, collection, and administration, the greater the amount of work- ing capital required. TIME FACTORS— The longer the timp of the turnover, that is, the greater the period when money is tiled up in a transaction, the greater the amount of working capital required. VOLUME FACTORS— The greater the volume of the business, the greater the amount of working capital required. THE WORKING CAPITAL CUBE The amount of working capital required in a business is the re- sultant obtained by multiplying together the values governed by three sets of factors — Cost Factors, Time Factors, and Volume Fac- tors. Pio. 11.— The Working Capital Cube , How Much Capital Will You Need? 57 important to the business. If payment does not fall due until the purchases have been put in a salable form, sold, and the money collected on them, it is possible to oper- ate with a very small working capital. In some manufacturing industries the raw material is changed to the fiiiished product in a few hours, while in others it is months from the time the raw material enters the plant until it is ready for the market. In the great meat industries, the cattle are bought, killed, and made ready for the butcher within twenty-four hours. The hides from these same cattle are the raw material for the tanneries and are in process of .tanning from six to twelve months, causing a tie-up of a vast amount of working capital. It is self-evident that the shorter the time between the purchase of raw material and the sale of the finished product, the greater the speed with which the working capital revolves thru the cycle. The rate of turnover is obtained by dividing the amount of gross sales at cost price by the average amount of working assets at cost price. Increasing the turnover will result in several benefits. It increases the volume of sales, which means more profits; it revolves the working capital more rapidly; and the greater the speed the smaller the amount of working capital re- quired, because the capital is not tied up in stock so long. Jones and Smith are rival tobacconists. Jones is sat- isfied to let the trade come to him as it will, for he is making a good profit on his money. Smith is a hustler, a good mixer, and realizes the value of a quick turnover. Jones has a $500 stock of goods (cost price) which he turns over six times a year. He sells it at a net profit of $250 making a yearly net profit of $1,500. Smith's stock cost Eow Much Capital Will You Need? 59 $250. He turns it over twelve times in the course of a year, at a net profit of $100 each time. His net profit for the year is $1,200, or $300 less than Jones's. But on the basis of capital invested Smith has out-classed Jones, for he has made his capital back 4.8 times while Jones made his back only 3 times. Terms of sale have much to do with the amount of work- ing capital required. Long-time terms demand greater capital to carry the business along from the time the goods leave the establishment until they are paid for. Espe- cially is this true of selling on instalment. Capital is obviously tied up when long periods of credit are granted. The interest usually charged the customer, of course, covers the seller, so far as the profits are concerned, but the instalment house must prepare to finance itself over this period allowed its customers in which to pay. Instalment-Plan Selling. — The financing of a business Belling on the instalment plan is one that calls for the working out of a very careful financial policy. One diffi- culty of financing this kind of a business is that all of the expenses of the sale are incurred before the sale is made, but not all the cash from the sale is received for months afterward. This diflSculty is one of having working capital tied up in book accounts. The problem is to convert those book accounts into cash. One of the several ways is to sell or assign these accounts to financing corporations which make it their business to finance instalment houses. An- other is to obtain a loan from the banker, which may be advanced if the financial statement of the instalment house shows the proper relation between working assets and liabilities. Or at the time of sale, notes can be taken for the amount unpaid which can be discounted or sgld on the market. The trade acceptance is playing a larger and 60 Financing a Business larger part in financing such business, as is well illus- trated by the method for financing the automobile indus- try by credit or financing corporations. The loss from failure to carry out contracts will also amount to a large sum if the proper safeguards are not taken to protect the seller. These safeguards are the making of a contract with the buyer which will protect the seller from loss as far as possible. Altho the article pur- chased may be taken back, the expense of the sales and collection departments cannot be recovered. Part Played hy Credit Organizations. — ^The automobile industry presents a fine example of how business enter- prises can be financed by means of the extension of credit. This industry, from the viewpoints of production and distribution, is largely dependent upon credit corpora- tions. The^e credit corporations have been organized and developed mainly for the purpose of helping the auto- mobile manufacturer, distributor, and dealer finance their business. The distributor, whose credit standing has been estab- lished with the manufacturer, buys fifty cars, paying from 10 to 20 per cent in cash and giving trade acceptances for the balance. The credit corporations buy these aecept- a!nces after they have been indorsed by the manufacturer. The distributor may desire to store the cars in a public warehouse or upon his own floor. In the first case a nego- tiable warehouse receipt is issued to cover the car and is sent to ttie credit oorpora,tion. ' In the second ease a trust receipt is signed by the dis- tributor, and is turned over to the credit oerporation by the manufacturer. These trust receipts are sent to the local bank in the town in which the distributor is located. The credit corporation informs the distributor that the local bank holds the trust receipts and that the bank must Eow Much Capital Will You Need? 61 be paid before the cars can be delivered. The sale of cars to the dealer by the distributor is financed by the same kind of transactions as are used to finance the distributor. The phenomenal success of the credit corporations is due to the care with which they investigate the credit standing and the soundness of the financial character of the distributors, dealers, and the users who finally buy the cars for their own use. The user who desires to purchase a car on time fills out. a financial statement which is sent to the credit corpora- tion, and is checked up thru its local financial representa- tive, usually the bank. If the corporation gives its ap- proval the car can be sold. Usually 20 per cent is paid in cash, and notes with a chattel mortgage on the car as col- lateral are given for the remainder of the purchase price. These notes are indorsed by the dealer and sold to the cor- poration. Under times of money stress, as after the World "War, an initial payment of 50 per cent is required by some dealers. The time-selling price is slightly more than the cash price, the difference covering the expense of taking out insurance by the credit corporation to protect itself against any possible loss. When the notes are paid, the insurance policies are sent to the user, and he is protected until the expiration of the policies. These notes and acceptances and the supporting colla|;- eral are deposited with the credit corporation's bank, which acts as trustee. The bank investigates the worth of the collateral in order to make sure that everyone is prop- erly protected. For every $120,000 worth of collateral deposited by the credit corporation, the bank will under normal conditions certify the credit corporation's deben- ture notes or bonds to the amount of $100,000. These debentures which are issued m denominations of $500, 62 Financing a Business $1,000, $2,500, and $5,000 are sold to other bankers and investors to yield a return of 6 to 7 per cent, accorduig to maturities, which range from three months to a year. As fast as the corporation collects the instalment money on the notes it is turned over directly to the trus- tee who in turn pays off the debentures as they fair due and returns the canceled note to the purchaser of the car. Selling on Consignment. — The financing of a business which sells its product on consignment calls for an organ- ization with a very high financial standing; one that can keep going even tho a vast amount of capital is tied up in its product held by the distributors or dealers. Altho there is a very strong tendency to break away from it, the farm machinery industry probably is the best example of the business which sells a great amount of its product on consignment. For example, a binder is con- signed to the dealer who signs a contract which protects the manufacturer. The contract binds the dealer to pro- tect the machine from damage by weather and to take out insurance fully covering its value. The company holds the title to the implement to be sold until it is disposed of to the farmer, and usually has the right to recall the machine before its final sale, at any time it sees fit. The manufacturer fixes the price at which the imple- ment may be sold and the amount to be retained by the dealer as his profit for storing and selling. As soon as the binder is sold, the dealer must forward the manufac- turer his share of the selling price. In most cases this amount must be in cash. If notes or acceptances are taken by the dealer he must discount or sell them, if he should be too short of cash to pay the manufac1;urer his share. The fact that the manufacturer retains title to the im- plements sent to the dealer on consignment means that Eow Much Capital Will You Need? ' 63 there are no open accounts on his books. Goods shipped on consignment are considered a much safer and more liquid asset than an ordinary book account. Under such circumstances the manufacturer can borrow money on goods shipped on consignment either from a financing corporation organized for such a purpose, or from his banker. A resume of terms of sale of various lines of industry showing the length of periods requiring financing has been prepared by the Federal Eeserve Board, and is sum- marized in a chart on page 64. Seasonal variations in business may mean one of two things. First, sales are so much heavier at one season of the year than another that the manufacturer is forced to tie up large quantities of working capital in finished prod- ucts during the dull season in order to meet the heavy demand which comes later. The manufacturing of ready- to-wear clothing is a good example of this class. The second case is that of concerns using or dealing in a raw product, the year's supply of which is dumped on the market during a period of a few weeks. Sugar beet, can- ning, and grain businesses are good examples of this kind of seasonal industry. It is very easy to see that the con- cerns affected by seasonal variations must be able to com- mand a vast amount of capital once or twice a year, but must also be able to employ that capital profitably in some other way during the slack seasons. The stocks of material carried by some concerns can be converted into cash much more readily than others ; that is, some are more easily liquidated than others. The only way to guard against stocking up with unsalable stocks is to manufacture or buy so accurately in relation to the de- mand that the goods bought will be consumed by the demand for them. Goods that do not move at the •a CO pT o «> bo Net 20th Proximo Net 16th Proximo Coke, By-Products Bituminous Coal, By-products a. a •a!H 2%, 10 Da. I Proximo Rubber Soles and Heels Net 4 Mo. Cigars, Cheap Domestic 2% Cash. 90 Da., Net 3% 10 Da. 4 m. Net Arrival Dft.,B.ot L. "3„ no's in Green Coffee Tea, to Jobber Flour, Carload Lots PSNco ■OS S3 « 5a •a H« mam MM 20%, 7 da. •alter Arrival 2% Sight Dft.,B.ol L. Sugar to Wholesaler Canned Fruits and V^egetables Si 1S-B Op** OJHOl sis ►3 -S* - P. San ?45.8 5| S iH%.io Da., 30 Net Caimed Soups •3 •" GO'S •20 ,S 5^s (0 0) Pi 52 ss S-9S a> el a 3 -^^ « u u (a S 9 a &o V4 o >. S a-* a ji z* M at Sao lis S a . >Spi£ -I'd all ass Weekly Basis Fresh Meats •3 a *p4 i -i How Much Capital Will You Need? 65 accustomed rate of turnover should be sold at a sacrifice of profit in order to release the working capital for profitable use. The more liquid the working assets, the smaller the amount of working capital needed. Details Affecting Working Capital. — The ease with vhich the stock of material can be replenished affects the available amount of working capital. The ease of replen- ishment depends on whether the stock is of seasonal variety, the nearness of the market, and the transporta- tion facilities between the supplier and the user. In most businesses experience has taught what amount of stock it is most advantageous to carry. The fixing of maximum and minimum quantities to be carried in stock protects the concern against an over or under supply. In making estimates of working capital it is well to put the figures well above the probable amount required, for experience shows that frequently the amount is too small. Considered in the light of a reserve, this additional source of capital is a wise financial provision. Where the firm is a borrower on a line of credit, the in- terest charge must be considered in pro\iding sufficient working capital. Here, again, is a reason why costs should be so well worked out that the interest payments will be less than the margin of profit. If interest charges over- ride the difference between cost and sale price, then the planning has gone dangerously awry. Every detail of working capital should be weighed thoroly and taken up fully with your banker or other competent financial adviser. Broadly speaking, working capital must be sufficient to cover all expenses of a concern from the time the goods are bought and are manufactured or put on the shelves, until they are Sold and paid for. In other words, if a manufacturer today buys $1,000 worth of raw materials. 66 Financing a Business he must have money to pay for them by the day of dis- count and enough more to prepare them for sale, get them into the hands of customers, and bring in the money to pay for a new supply of raw material and finance the busi- ness fhru the rest of the cycle thru which working capital revolves. Relation of Capital to Volume of Business. — ^Altho there can be no definite rule laid down as to the relation of working capital to gross business, the general state- ment can be made that the amount of working capital re- quired varies directly with the volume of business. The tendency among manufacturing and trading com- panies is to have the capitalization fairly near the amount of annual sales. The securities of railroads and other public utilities are sought by investors on account of their safety. Therefore it is natural to expect that the ratio of gross earnings to capitalization is less than in indus- tries where the risk is greater. The relation of working to total capital depends to a great degree upon the nature of the business. Telephone, railroad, and water-power companies do not require a great amoimt of working capital. They receive most of their payment in advance for the service which they render. In the case of the manufacturing concerns, the greater part of the capital is invested in fixed assets, while in the trading establishments the fixed capital re- quired is negligible, the stock in trade being the item requiring the most capital. Every man, therefore, who contemplates starting an en- terprise should have a practical knowledge of scientific financing, which, after all, means exactness in handling an enterprise and in so far as possible foreseeing and being prepared for every contingency. Only by knowing can he be assured of going thru successfully. How Much Capital Will You Need? 67 SELF-TEST QUESTIONS 1. ENTHUSIASM., Why, without proper background, is enthu- siasm so fatal in business? 2. PRELIMINARY EXPENSES. Show how neglect of initial expense has caused the fall of many enterprises. 3. EXTRAVAGANCE. Explain how extravagance in initial fixed assets has handicapped success. 4. WORKING CAPITAL. What are the significant factors af- fecting it? 5. SELLING GOODS. What effect does the instalment method of selling have on capital requirements? 6. DISTRIBUTION. Why is the selling of goods on consignment not applicable to most businesses? 7. CREDIT. Why should the interest on borrowed money be care- fully considered? 8. CAPITAL NEEDS. What are the underlying principles that determine the amount of capital required? CHAPTER IV INTERESTING CAPITAL IN YOUR CONCERN A Michigan inventor started a one-man business to manufacture and sell an alarm apparatus. But he found his capital inadequate. Seeing the necessity of securing financial help, he appealed to a practical manager who be- came a partner with the definite understanding that the inventor would attend to the technical end of the business and develop it while the partner would assume the gen- eral managership. This arrangement not only brought in more capital but adapted the enterprise to the most prac- tical arrangement. Here was an attractive proposition for both men, and each was happy to become active where he could be of the most value. Thus it is comparatively easy to interest capital in an enterprise if it is sound and the most sensible plan for operating it is presented. It doesn't matter whether the concern is small or large or whether it is a partnership or corporation ; the same general fundamentals ordinarily apply. Questions That Capital "Will Ask If the individual seeks to interest capital, it is requisite at the outset to know whether he is an expert in his line. This question comprehends a number of important points. First of all, is the idea or basis for the undertaking sound? Is his invention, commodity, or plan meritori- ous? Next, has he proved himself a good business man? 68 Interesting Capital 69 Is he practical? If he is not, does he still insist on domi- nating the business management? These and possibly other questions come to the mind of the investor. He will hardly be interested unless all these basic questions can be answered favorably. Many a good article has lost a market because of poor business management, while many a mediocre commodity has continued in demand be- cause of wise financial control. At the same time these points are under consideration, it is well to investigate the individual's banking relations. Regardless of whether a line of credit has been secured or not, it is often of vital consequence to know how a man is looked upon in banldng circles. Has he a clean credit record? Does he pay his bills promptly? Is he steady? ' Do those who supply him with materials or goods regard him favorably? All of these questions are important, particularly because the individual may be restricted in his means and also because he may have no understijdy who could successfully succeed him. The Backing Behind the Stock Offeeing What, then, are the chief reqiiisites that a corporation should possess to enable it to dispose of its stock offer- ings successfully? First, the men behind the project should be known for their business integrity and judg- ment. Investors almost invariably insisj; on full informa- tion as to who is running the concern. They want to 'know, too, how the enterprise stands with the bank and, in fact, they demand answers to the whole list of ques- tions set forth earlier in the chapter regarding the indi- vidual owner. The appeal to investors will vary also with the type of product and its market, the freight rates, and the methods 70 Financing a Bitsiness of operating the business. For example, a manufacturer of underwear must understand his markets, making heavy garments for winter wear in the North, while pro- ducing thinner for the South. One new concern, before going ahead with its plans, made a complete analysis of its territory, finding out just which towns showed the great- est demand for similar products. Selling and Disteibution Methods Selling methods are an equally important subject to be presented concretely to the possible investor. Is the product sold direct, thru agencies, or in some other way? Which is cheaper? Facts such as these should be at the command of the prospective buyer of stock in the enter- prise. ' Failure to be alert to the tendencies of the times ren- ders an enterprise less capable of interesting capital. An instance of this was seen in the mistake of a new whole- sale millinery house. Tipped off to the story that ostrich feathers were to be "the rage," the manager bought up $30,000 worth. But the demand did not materialize. He therefore had his money tied up i^ goods he could not move. The error was a serious handicap to him in obtain- ing additional capital and nearly lost him control of the business. Another point often overlooked in starting a new con- cern is the problem of distribution. A warehouse full of goods with UQ reasonable way to move them is a serious situation. Before going to the public with an offering of stock the whole question of selling and distribution should be worked out completely. Again, what about patents, trademarks, goodwill, and so on? Are they properly protected? Also is there an assurance of plenty of labor? Interesting Capital 71 Attracting Investoes Sometimes a desirable shareholder is added to the list by giving him a voice in the management, perhaps as a di- rector. There are numerous ways in which to interest the right type of people in a meritorious enterprise. Ex- perience shows that one of the chief personal elements required in any new undertaking is patience. The interest of people must be secured, only after the most tireless planning and figuring have made the enterprise as nearly "fool-proof" as possible. In a few instances concerns with patented commodities have gained working capital by leasing their product at a stipulated rental, often pay- able each month in advance. Other methods for gaining the attention and money of investors are resorted to, but it is the intention here to indicate particularly how the small concern can get a start. There are many treatises on the organization and methods of some of the huge national corporatioiis, but in most cases the ramifications of such immense enter- prises are too intricate to be readily applicable to the or- dinary type of business. Here, then, are set forth some pjans that have helped new concerns meet their capital requirements. Classes of Persons to Be Interested In organizing a business it is necessary to consider the different classes of persons to whom the appeal for cap- ital is to be made and just what may be expected from them. These may be : 1. Insiders 2. Friends 3. Employees 72 Financing a Business 4. Municipal, real estate, and civic organizations 5. The public at large a. Investors b. Speculators By the term "insiders" is meant those directly inter- ested in the concern itself. For instance, let us suppose rA, B, and C, after looking the ground over thoroly, decide to establish a department storey They are the insiders and may furnish all the capital required. However, they may not have icnough money. They may desire to incor- porate and then induce their friends to join in the enter- prise. This brings us to the second group. If the con- cern is small or the friends wealthy, this may be very sat- isfactory. It may be felt also that the employees should be given an opportunity to take a proprietary interest in the business, and so some stock may be sold to them. This plan, of course, disposes at most of only a small amount of stock. It may be better, however, especially if the concern is a large one, to depend on the general public to purchase the capital stock, or a considerable portion of it. In this con- nection we should not lose sight of the possibility of dis- posing of stock to residents of the locality where the busi- ness is well and favorably Icaown. It is in attempting to dispose of stock to the general public that two classes, the investors and the speculators, are met with. The investor depends on the security offered rather than on the return for his money, while the speculator is looking primarily at the ^return. Those looking primarily at the security are individuals and corporations with money to invest, such as savings banks, life insurance companies, colleges, etc. Those looking simply at the returns are usually indi- viduals. It is needless to say that the terms "investor" Interesting Capital 73 and "speculator" apply to the two extremes of the public rather than to certain definite classes, for there are people who consider the security carefully, but are will- ing nevertheless to take some chance for a higher return. Each class of stockholders may be of advantage to the business. The first keeps the business entirely in the hands of those most interested, and involves no sales ex- pense in selling stock. The second has the same advan- tages tho to^ a less degree, but makes it possible to raise more capital. The third will tend to promote the success- ful career of the business as well as furnish capital. The fourth source of capital, while occasionally available, is apt to be undesirable because of burdensome restrictions. The fifth source is most commonly made use of, particu- larly by the larger corporations. Its chief disadvantage is the possible loss of control of management of the enter- prise. In deciding on the proper course to take, the organ- izers must be sure that course will leave them in control of the business. Forms of Organisations We have seen in Chapter II the advantages and disad- vantages of the various forms of business organization — the individual proprietorship, the partnership, and the corporation. These advantages and disadvantages are bound to be considered carefully by prospective investors in the busi- ness, for they have a very direct bearing upon the risk in- volved. Thus the corporate form of organization, because of its attractive features of perpetuity and limited liabil- ity, will generally appeal to the largest number of in- vestors ; while a concern that is an individual proprietor- ship is compelled in seeking capital to rely almost wholly upon investors who are personally acquainted with the 74 Financing a Business proprietor. This is undoubtedly a very strong reason for the modern tendentjy among business concerns to adopt the corporate form of organization. Setting the Par Value Having decided to what class the appeal for money shall be made and that it is best to incorporate, the or- ganizers must decide what form of stock shall be issued, ~ what rights it shall have, and what the par value shall be. If it is desirable to sell to individua,ls of relatively small means, it is best to put the par value low, so that many can invest a small amount. This is specially true where the appeal is to be made to the local community. On the other hand, if the investors are intended to be either few in number, or those of considerable means, the par value of each share may be high. Setting Terms of Sale The terms and conditions of the sale of a stock issue are very important. If an appeal is to be made to many in- vestors with small means, especially if they are salaried men, the payments may be in instalments. This may not be any disadvantage to the corporation, for it usually does not need the money all at once but simply as it has to pay for its buildings, plant, etc. The idea of getting something big for a small outlay at the moment has a strong appeal to many. Sometimes common stock is given away as a premium for purchasing preferred stock. This premium may be share for share, with equal par values, or it may not be so large. Here the purchaser feels that he is getting something extra that he does not have to pay for. Also stocks are often given as a bonus in the sale of bonds. Interesting Capital 75 Frequently this stock that is given as a premium con- sists of treasury stock ; that is, shares that have once been issued and re-purchased by the corporation or donated to it by the stockholders. Occasionally the promoters of a corporation donate to the corporation a part of the stock received in compensation for their services, so it may be resold to secure additional capital. Where this is not the case, but new stock is given as a bonus, careful investors will inquire into the extent of their liability on this "free stock" since it is coming to be commonly held by the courts that the acceptance of stock given as a bonus implies a promise to make payment for it in full, if called upon to do so. In this event, much de- pends on whether the stock is sold by the corporation direct, or thru the agency of bankers or brokers who un- derwrite the issue ; since, in the latter case, while the stock may appear to have been given away it was in reality issued in compensation for the services of the under- writers and is therefore "fully paid." This question does not arise in connection with stocks given away as a bonus in the sale of bonds, since there is no law or statute that forbids the issue of bonds at a dis- count, and it is assumed that the stock is paid for in full and that the bonds are issued at a discount.^ It is a common practice among successful corporations, whose stock is selling above par, to secure new capital thru the sale of additional stock to their existing stock- holders. The method adopted is the granting of "rights" to existing stockholders which entitle them to purchase new stock in the corporation at less than the market price, frequently at par, tho of course not lower than par. As these "rights" are assignable, they possess great attrac- tiveness for the stockholders, and are freely dealt in on the exchanges. 76 Financing a Business Preferred and Common Stock Compared Ordinarily an incorporated company sells two kinds of stock, preferred and common. In wMcli is the prospec- tive investor more likely to be interested? Preferred stocks seem to have grown in popularity, especially since the World War. This is probably in part due to the great stimulus given to individual investing by the Liberty Loan campaigns as well as to new safeguards placed about the stock. Preferred stock, of course, gives a defi- nite yield and has preference in the distribution of assets and profits. The speculative quality is practically negli- gible in the better and 'more stable issues. Unlike the common stock, therefore, it makes a conservative, attrac- tive investment. In this connection it is interesting to note that, until a few years ago, tl;e only advantages that the holder of preferred stock had over the holder of common stock was priority of assets in liquidation, and preference over the common stock in the payment of dividends. The preferred holder was really in an anomalous position, as he was neither a full shareholder (as his income was restricted to a specified dividend rate) nor was he a creditor. Of late years, however, bankers have brought about a material change in the position of the preferred stock- holder, which to all intents and purposes makes him a creditor, thus 'strengthening his position without reducing his income. This change applies even where bonds are outstanding ahead of the preferred stock, but is espe- cially marked when the company has no bonds against it. In the case of a majority of preferred stocks issued dur- ing the past fifty years it has been possible to issue prac- tically an unlimited amount of bonds or additional pre- ferred stock either ahead of or on a parity with the then Interesting Capital 11 outstanding preferred stock without the consent of the owners. Furthermore, little consideration was given to the amount of assets and earnings of preferred stocks, many issues actually having less assets than the outstand- ing stock, and average earnings of only IV^ times the dividend requirements. For these and similar reasons, the more conservative form of investor naturally pre- ferred to invest his money in bonds. The position of preferred stocky has now been almost entirely changed. In fact, the number of safeguarding provisions which have been thrown around them has im- proved their position so materially as to constitute virtu- ally a new, class of security. One investment house enumerates the various safe- guards of the better class of preferred stocks as follows : 1. No bonds or lien may be issued without the consent of the holders of three-fourths of the preferred stock. 2. No preferred stock may be created having priority over or parity with the then outstanding preferred stock. 3. The preferred stock is a closed issue. In other words, no addi- tional preferred stock may be issued without obtaining the consent of the holders of three-fourths of the outstanding preferred stock. If the company fails to obtain this consent, it is forced to redeem the outstanding preferred Stock at a substantial premium. 4. The company is required to provide a cumulative sinking f imd for a substantial reduction of the outstanding preferred stock an- nually. This sinking fund may either be fixed in amount, or provide a definite percentage of the company's earnings, thus compelling the company in prosperous times when it is making a great deal of money to retire a correspondingly large amount of preferred stock instead of paying out all of its increased earnings in the form of dividends on the common stock. 5. Many of the largest issues of preferred stocks had only a small amount of assets applicable to the stock, and in many cases the issue was actually greater than the total assets. With the modem preferred stocks, however, this point is given careful attention, and a preferred stock is rarely issued without net tangible assets of at least two for one. Many of the issues recommended by us have net tangible assets of from $250 to $400 for every $100 of preferred stock outstanding. 78 Financing a Business 6. In order that companies may not sink too large a proportion of their capital resources in fixed assets leaving them without suiH- cient current assets in liquid form — always a dangerous situation — the modem preferred stock carries a provision that the company agrees at all times to maintain net quick assets of not less than from 100 to 200 per cent of the largest amount of preferred stock at any time out- standing. 7. The preferred stocks of years ago in most cases earned their dividend by a narrow margin only. The earnings record of the modem preferred stocks, after liberal depreciation, is very much greater and must show a successful record of many years instead of over- emphasizing the exceptionally large earning of the year in which the stock may have hsea. issued. Preferred stocks underwritten and offered by us have shown for the past five years or more, average net earnings of over four and one-guarter times the dividend requirements. The same issues in the last fisbal year showed earnings of over six and one-half times the dividend requirements^. Such provisions enable conservative investors to in- crease ^heir income materially without lessening the safety of their principal. Especially is this true where stock is offered below par. Thus in offering stock for sale it is worth while to consider these points. In determining the rights to be accorded to an issue of preferred stock, care must be taken not to bind the corpo- ration so that it will be debarred from raising money in the future, either by the sale of other stock, by giving a mortgage, or in any other way. Unless care is taken in this matter the concern may find it impossible in the future to borrow money at a time when it is badly needed. The various stock issues may be so arranged as to their amounts and rights that they will appeal to several groups of buyers. Thus the common stock appeals to those who are speculative, while preferred appeals more Nto the investor. There are also companies which issue stock without par value. .This cannot always be done, be- cause many states and countries require a par value for all stock issued. Such an issue has the advantage, how- Interesting Capital 79 ever, that it can be put on the market at any price the company sees fit. v General Conditions The person financing a business must also take into consideration the general situation, in reference both to the habits of the people and to business conditions. People are much more likely to put their money in a form of stock or other investment that they are accustomed to than one they do not know about even tho it is equally good. Investment styles have their seasons. At certain periods the preferred stock may be the popular f ortn ; at other periods long-term bonds or short-term notes maj* be in demand. There are also periodical preferences foi railroad, industrial, oil or mining securities. It may be easier to finance one's business by following the popular swing of the time. , Business conditions exercise a highly important bear- ing on stock issues. It is much better to sell on a bull than a bear market. People will not put their money into an enterprise when times are hard so readily as they wUl when things are booming and times are good. If stocks generally are below par it is much harder to sell a new stock at par even tho the security is very good. This may, of course, affect the question of the relative amounts of preferred and conamon stock to be issued, as preferred usually brings the better price. The cost of selling is also affected by existing condi- tions, whether the sales are made directly by the corpora- tion or thru brokers. When it is borne in mind that this selling cost has in some cases been 50 per cent of the value of the stock, we see it is important to reduce this as much as possible. 80 Financing a Business SELF-TEST QUESTIONS 1. MONEY. Why are investors so hesitant about putting money into a new enterprise? 2. DEPENDABLE MANAGEMENT. What is its relation to the sale of stock? 3. SOURCES OF CAPITAL. What &re some of them, and what are their respective merits? 4. PAR VALUE. What principles are involved in different par value issues? 5. PREFERRED STOCK. To what class of buyers does this ap- peal, and why? CHAPTER V SELLING THE STOCK Once your plans for interesting capital in your con- cern have been carefully outlined and approved, the ques- tion then arises : "How shall we get the stock into the hands of investors — thru advertising, thru brokers, thru professional promoters, thru our own efforts, or thru other possible channels?" This step frequently requires more study, tact, and vision than any other of the preliminary phases of financ- ing. On it may hinge the successful inauguration of the enterprise. Notwithstanding that the public seems ready to snap up any attractive proposition in stocks, in spite of having been so frequently mulcted and humbugged, yet after all it is a business all by itself to sell a stock isSue for a new enterprise. An old established concern may increase its capital with little effort; in fact, an over-subscription of such an offering is often noted. A new and unknown business, however, may have to resort to the hardest kind of per- suasion to place its stock and obtain the necessary funds to get started. For this reason every point connected with stock-selling should be taken up and studied before going ahead, assuming, of course, that no unusual circum- stances, such as the public backing of prominent finan- ciers, have already simplified the problem. The nature of the business has much to do with the question of a decision regarding the method of disposing of stock. If it comprehends making a product or selling a commodity of proved value and in public demand, it 81 Outlets for Selling Your Stock 1 Professional salesman il e. advertising 3 5^1 ling thru the Mails 4 Investment Banker OP Broker 5. Undert^t^''' JgnU:^ Inside f I To the ^ ' 0rg«"i2eri? ^ to Friends ^.To Rirties ^ Indirectly inte^pj -^ a. ProspedivfCiisiooifiy ''-- Ij^ Furnishers of I Fig. 14.— Outlets for Selling Stock Selling the Stock 83 may be that sufficient shares can be disposed of directly among friends. Much may depend on the amount of the^ capitalization and whether or not, as pointed out in the previous chapter, the stock is offered at par or below. Disposing op Stock to "Insidebs" Again, if no great amount of capital is needed, the orig- inators of the enterprise may be able to find someone who has money to invest. Thus some person living near may have sold a farm, or have money lying idle awaiting in- vestment. The aid of several such persons might be ob- tained and be sufficient to make up the necessary capital. Often parties indirectly interested in the business, as prospective customers, furnishers of raw materials, or the chamber of commerce for the town where the plant is to be located, may be induced! to take stock. In such a case as this several methods are usually tried at the same time. Thus friends will take some stock, cus- tomers some, the chamber of commerce will take some, and so on. Selling Thkit the Peofessional Salesman It frequently happens, however, that business organiz- ers are not good stock salesmen. The problem then arises how to dispose of the stock successfully, in case it is not taken up to a sufficient extent by "insiders," those origi- nally interested in forming the enterprise. There is a type of stock salesman who is admirably adapted to this work and who is occasionally quite successful in selling issues of companies just starting out. It is not intended here to include the "Blue Sky" salesmen who inveigle the public into purchasing shares of stock in "wild-cat" schemes, 84 Financing a Business but to give credit to those men who, honestly believing in the worth of a genuine undertaking, are able to in- terest "outsiders" in it. Hiring the work done, then, by which is meant, paying for the services of professional stock salesmen, is often a quick way of bringing in sufficient capital with which to start. Extreme care should be taken to select men who will properly represent the organization, for misstate- ments in the beginning might badly cripple or otherwise injure a likely undertaking. Despite legislative and other precautions, unfortunate stock-selling schemes do get before the people, and each loss makes it harder for the legitimate proposition to get a financial hearing. An Illinois publishing house, already organized but eager to expand, advertised the sale of 7 per cent preferred stock at par, offering to rebuy it any time after one year at a 25 per cent increase. The sale was exceedingly successful, but, following the sale, the management failed to proceed cautiously with its expan- sion, with the result that it was soon making use of the money received for stock for the purpose of paying divi- dehds. Three years later a reorganization became necessary. The old officers were deposed, and preferred stockholders were offered ten cents on the dollar for their shares. Here is only one instance of ill-advised stock- selling. The company had no financial vision and made promises that could not be fulfilled. Instances like this tend to bring distrust on firms offering high-class stock for sale. Selling Stock Theu Advertising That is one reason, no doubt, why so little advertising is attempted for a new company. Most people have to be Selling the Stock 85 convinced by word of mouth of the worth of the new un- dertaking. In fact, a great many newspapers will accept no advertising of an untried proposition which seeks to sell stock to the public. This is a fortunate development of recent years. W.L. DOUGLAS SHOE CO (MAS8A0HU5ETTS CORPORATION) 7% PREFERRED STOCK Cumpt frgiiKMomial FMaral Tax ASSETS OUTSTANDING PREFERRED AS TO DIVIDENDS .AND PAB VA1.tr $100.00. NON'ASSESSABI.Q CAPITAUZATION AUTHORIZED Js.soo.oao *3,soa,ooa 4,6«O|00O iltZOO.OOO- Dividends' hare been paid regularly for the past seventeen years. Payable .Taniukr; 1st and JllIy^lst■ There i»ao better 7 per cent investment in tlie Called Stfttea. If yon are looUnK'orasafeaitdpemiiUneDt Investment we believe this 7 percent stock wilt appeal toT'on. It Is an oM eatabUsbed baaloess. That the Preforrad Stock Is amply well protected is sbowa from I Uo fiact that the net eorDln-s available for dlvld.eods after the Federal tax and all ether taxes were paid durlas. the past four years have aTOraged nearly four times the dividends Anr the Preferred Stock oatstandlo*. The Common Stockholders propose to s^ve even greater jprotectioa to the Preferred Stock by leaving anaoaUy la the treasury a substantial part of the earnings of the Common Stock. W-L-Doaglos name ts kooTCnthronshont the world.- Tbe trade mark ts a vny valnable asset ivortit mlHlona of dollars, and* la the aroperty of the stockholdersJ tt la one of the most valnable trade marks la United States. Application wlf i. be made to have this stock listed npon tho stock oxchanse. •• This cornpanj owns and operates WI W.L.Doaetaa shoe stores located in the Urfre'citles. ^.Ii.DoagLis sboea are siso soil Ira' over 0000 stios dealers In, the United Stitoa. DarioE the pait fo^yesnoor shoos haTob - to? has Saved the wearers milUoos.ot doUaiSi aod gnacanteea them tho boat attoes in style, comfort and sorrice that can be prodoced tor the prices' ' . . * ' In the leading fotvlgri eoastries » gnat'domaDd for W. !•. DorSglss sboea «u eprnngop. Oardomostiaboslnosshasiacreaseil so that oar sales ^ave more than doablod in foorfean. In 1!115 Uie£aIeaweTBS8,060,e2Ml and in i9\^S21,WSfiQiAi The put six mooth's bQainesa was at the rate of over $24,000,000 per year. Id eommoD with other Riwit boatneiHS wemeed artdltinDfti capital to meet the oiMit requlTemonta o( iocrevJag domeatlo iinil forelEn trade. The new conilltlons of bnt^an fttso demand more CApftaL The cMt of labor uid noterlal hu nearly doubled a» that ■tvleo the STDountot capital naceiuryaadertheold boaloenooiullUaiwfipDfr required. Ton will mako no mistake to order at onco as many shares of t&ia stock as you can afford to bny, price 910O.O0 per shares U you CUCO for more partlcolars fill oat thecoupon nod mall at once. Send certified check, <»shlar'8 cheek. Post OfBoe BlOney Order W Express Order to W. I* DOUGLA3 SHOE CO^ Brockton, Mass. ■ COUPON. Tf.T. WWraUB aimC. ca, IroeSWTi W***. Plouoeend proBpcctu of thaW.jUiwtt. glu SboO OompanT and vpecfot option oortTtleitto entttlTog me to pnTchAse wiihln th[K7(lan...-.......^liareaoT^o7j>erccot prerorretock of tlie enmpitnf. It 1i oo- Fig. 16.— Advertisement for Sale of Capital Stock Advertisement in which the W. L. Douglas Shoe Company offers Its preferred stock direct to the investing- public. While an old, well-estab- lished house may do this successfully, most concerns make use of in- vestment bankers and stock brokers to advertise and sell their issues. 86 Financing a Business ^ The greater part of the advertisements for the sale of stock originate with the proved concerns which seek addi- tional capital for legitimate expansion purposes. Follow- ing the war this advertising grew tremendously, and often the stock thus offered proved to have been already over- subscribed. The offer by advertisement was made simply as a matter of record. Selling Thru the Mails Numerous stock-selling plans are advertised by circu- lar letters and printed matter sent thru the mails.^ Where The followinir Is a brief but comprehensive prospectus of a stock offering of the Armour L«ather Company. In accordance vrith the announcement of Mr. 3. Ogden Armour, Preudent of Armour and Company, made in this paptir yesterday, the Armour Leather Com> pany is offering its stock for public subscription. Allot- ments will be made iti the order of receipt of subscrip- tions, and as promptly as possible, after February 2Sth, 1920, after which date no subscriptions will be accepted. Til. ilaeic ia aff«r.d ubja.l to tha pri.iUf« of inbieriptioB ts Ihs baMeri af A» VnStmd •toek of Annour ond Compoor now ouUUndioK io tJio b«nda of tho publi^ ArxAour Leather Company (OF DELAWARE) $IG,OOO.OOD $10,500,000 7% Cumulative Preferred Stock Common Stock (Par Valuj; $100 per Share) (Par Value $15 par Shut) OMipai as Praranvd Stock RBr«t>l« quartarlr, Jmnuarr t, April I. JuU I, MadOets* bar I. Fint diWdand parablo 'April 1, ifO. wilt ba for month of Mar^b only. CalU> bUi at a vbale or in part, at tb* option of iha Company. *t IIS and acc^iad dlvidnadi. DIVIDENDS EXEMPT P^OM NORMAL FEDERAL INCOME TAX TRANSFER ACENTj RECISTftARi (Both Preferred and Common Stock) (Both Preferred and Coinnipn 5tMh> Cbunk— ital and Commarcial Tniit and Firil Truit and Sarinii Banlit 5»vtns* Bank. Cklcaie. Ill, Cbicago, 111. The Armour Leathei' Company has been organized under the Laws of the State of Delaware, and will acquire all of the tanning companies and leather assets now owned by Armour arid Company at figures 'which do not include any value for good will. JThe gross volume ctf business irr 1919 was approximately $90,000,000. Fig. 16.— Prospectus of Stock OfPering (Concluded on next page) AuUioriied •tandbic ^va^PK^Red-Stoek {$109 par>. . .Vfi5.00Q,l)00 SlumpM ^tock (¥15 pw) .*t5/M)0i06o •$15,000^00 'FaOndenf Stock (do par' valos) aharet • 100,000 tlOO,000 *$4,5D0,0(X} Common 5to(k Is reserved to ht ofTered to employees and ciutotncrs ot the Company. tThc Foundert' Stock trill be subscribed S6r and acqatreo Dy Armour and Company, wbo will pay $5 a share for aame. The Company will have no bonds oatktanding and covenknts not to permit &t areatioa B* any mortgaffea or Kant opon the present property of either the Company or the Com" panics whose stodc the Company. is khotot to acquire, without the consent of the holder* of two>thirds in>par valae of -the Preferred Stock oatstanding at the time, ,. Net assets^ baaed ^. Tolaations of Ndvember 1, 1919, will be (25,500,000, equal to $Z5S per share of Preferred Stock oatstani* at least three time*, the aoioant required for ^vidends on all Preferred Stock outstanding and the new stock to be issued. The Company agree* to maintain' at all times net assets equal to at least 200% and net qidck asset* equal \o.at 4east |2S% of the par valneof d) Prefenred Stock outstanding. Earainsa available for ifividends, after Federal taxes, daring the last Bscal year wera i$,\9SJi24; averc^ annual net earnings during the last four-year- period were $4,485,215. "thvif net earnings for the last fiscal year were over eight times, and average earnings ol the last four years were io excess (tf six, times dividend requirements on present issue of Preferred Stock. After prefcmd iSvidesds, the remuniog surplus earmngs shall be kvaitabiy for divt> 4eads on ^e Common and Fdonders* Stock, in equal aggregate amounts, For^a period of three yeaiv dividends on the Founders' Stock shall be limited if earnings ^e less than $4,000,000: After jirwn£ng for Avidmds on the Preferred Stock, the earnings for the lost fiscal year were equivalent to 18 j% on the Common Stock (this after deducting an equal aggre- gate amount oa the Founder^ Stodt). and the average annual net earnings during the four* year period were 12.6% on theXommon St^ on the same basis. ■ The officers and directors of the Company will be principally those who have been engaged in the operation of the ccmpanies now being acquired, and wbo have in a large measure been responsible for their growth and develo|mient, ■ APPUCATION WILL BE MADE TO UST BOTH THE PREFERRED AND COMMON STOCK ON THE CHICAGO STOCK EXCHANGE jIU legal proceedings approveA, by 'Messrs. Mayer, Mtyer. Austrian and Piatt, AttorHtyt^ Chicago; Balance Sheet and Earnings certified to by Price, I'/atcrhotise & Co., Chicago; A fpraiiala node by American Appraisal Co., MHvaUkee. i A< -.If ($100 pat value. Preferred, % Share) * ,- , - fnce-m block, I jjpg P value, <:omn.on.-7 Sharcf *200 per Uodf ■ (TUa fs •qnnlent to price of t9S {mt^Lh on Prefond Sto^ sod $15 per ihsrs oa tie Cobubod SimQ Subscriptions. acc ^ Fig. 16. — Prospectus of Stock Offering (conduded) 88 Financing a Business it is carefully gotten up, sucli a method may be found worth while. The statements presented must be rigidly checked fot accuracy, the personnel of the company set forth frankly, and the status of the organization and its purpose honestly explained. A return postcard or stamped envelope may help to secure a prospect. But all circularizing should be done only after careful analysis of the proposition. Sometimes it is preferred to enlist the support of numerous small investors, in the belief that this will make for the success of the enterprise. A middle- western department store was organized on this basis, customers and employees alike being given the opportu- nity to become shareholders. In this instance a carefully prepared circular did the work. Unless this plan can be followed with a prospect of success, it m9,y be found wiser to make a direct appeal to those at least partially ac- quainted with the merits of the project. Selling THKtr Investment Bankers oe Bkokeks Another alternative is to place the whole proposition in the hands of an investment banker or broker with in- structions to dispose of a certain amount of the stock. Whether you shall sell at par or below is a matter to con- sider carefully. From the standpoint of psychology it is sometimes considered better in selling stock to^offer more of it at a figure considerably below par than a smaller amount at par. For instance, some concerns have offered dollar shares of stock at 10 cents, and others have offered $10 shares at $2. The appeal to the public from the "bar- gain" standpoint is obvious. In selling stock belOw par, due regard must always be had for the law and for the purchaser's contingent liabil- ity for the unpaid balance in case the concern becomes Selling the Stock , 89 insolvent. At the same time the buying publife often dis- regards this liability. "Usually stock offered below par is in the form of treasury stock referred to in Chapter II. UjfDEEWEITBES Besides salesmen and brokers, the stock may be sold, or at least its sale guaranteed, by an underwriter. Usu- ally the underwriter is a syndicate composed of several banks, brokers, etc. In its narrowest sense, the under- writing of an issue of stock is simply a guaranty or insur- ance of its sale, or the sale of a certain portion of it, at not less than a certain price before a certain date. In case the stock is not sold, the underwriter takes over the un- sold portion of it at that date at the stipulated price. As most of the underwriting syndicates are well equipped for selling, they usually take over that function as well as the underwriting in its strict sense. The advantage of underwriting to the organizer of the corporation is that of insurance. Instead of having some- thing indefinite and uncertain, he knows what he can de- pend on, and can act accordingly. Usually only the larger issues of stocks are underwrit- ten, as these syndicates do not care to bother with making an investigation of the corporation's standing and busi- ness chances unless the issue is at least $250,000. Otheb Ways of Floating Stock In some cases the organizer of a corporation may be able to interest some business executive or financier to take the stock and then to re-sell it as a speculation or to keep it as an investment. There are numerous cases on record where engineer- ing companies have become stockholders in various 90 Financing a Business corporations. The engineering company would take stock in payment for its services in building the plant and then either hold the stock or sell it out later. It should not be disappointing to the promoters of a small company to find the stock-selling problem a diffi- cult one. Experience shows that most new ventures, un- less spectacular in nature, like oil or mining propositions, have had to grope slowly from the bottom. Each step of financial progress, as well as each claim made for the future, has to be proved before outsiders are willing to invest their in&ds for profit. Look back over the suc- cesses of some of the nation's greatest corporations and you will see that at the beginning they encountered the hardest kind of striiggle to get people to believe in the financial worth of the undertaking. Striking examples are found in the early years of the harvester industry, the Willys-Overland Company, the Ford Motor Com- pany, and so on. Selling Methods Compabed , Admittedly, it is beyond the scope of this book to spec- ify the exact type of stock-selling arrangement that a new concern ought to make. It is possible simply to indicate the experiences of others and to point out the favorable and unfavorable features of the various plans. As to ex- pense, investigation indicates that there is usually not much difference between direct selling and selling thru other agencies. This expense may be relatively large if skilled salesmen are used. As high as 50 per cent of the purchase price of the stock has sometimes been paid in commissions,. On points of this character, it is usually the part of wisdom to confer not only with your banker but with a reputable investment broker and a lawyer as 92 Financing a Business well. Perhaps your banker may have a securities depart- ment where you can obtain the best possible suggestions on how to proceed. If there is a "Blue Sky" law all rules must be complied with and a permit secured before the public can be approached in any way. When Established CoNCEBisrs Sell Stock After a concern has proved itself and then desires to expand, it is much easier to sell additional securities, either direct or thru an investment company. The problem, then, is simple, for a successful enterprise usu- ally has no difficulty in selling an additional issue of stock. Reputable investment houses are usually looking for op- portunities of this kind and assume aU the burden of "bringing in the money." The charges are not considered exorbitant. Well-known corporations such as Montgom- ery Ward & Company, Pacific Gas & Electric Company, and so on, find an eager market for their stock. The small, struggling concern, no matter how meritorious, frequently finds the effort to dispose of stock discourag- ing, but it should be remembered that most of the nation- ally known enterprises started with similar handicaps. Summiag up, the conditions in a new or growing busi- ness must be analyzed and weighed, and the stock-selling should be handled wisely on the basis considered most applicable to the specific need.« If the right method has happily been chosen, smooth sailing financially is assured. If not, the steps taken must be retraced until the task in hand is accomplished. Looking ahead carefully usually brings about a sufficient selling to permit of moving for- ward, at least to some extent. If the undertaking is meri- torious and good business judgment is exercised, sufficient funds for each step ordiaarily should be forthcoming. Selling the Stock ' 93 SELF-TEST QUESTIONS 1. INSIDERS. What points should be observed? 2. PROFESSIONAL SALESMEN. What are the qualifications of a good stock salesman? 3. USE OF MAILS. Why must care be exercised in this method ? 4. IN PAYMENT FOR SERVICES. How is this method of dis- tributing stock advantageously used? 5. "BLUE SKY" LAWS. How have these laws aflfected the sale of securities? 6. ESTABLISHED CONCERNS. Tyhat are the outstanding fea- tures in their selling additional stock? CHAPTER VI THE USE OF BONDS IN FINANCING "WTien a growing concern is faced with the problem of securing additional capital for investment in new build- ings, machinery, equipment, and other types of fixed as- sets, it meets face to face the problem of how that cap- ital is to be obtained. Even under the most prosperous conditions, surplus earnings are seldom sufficient to take care of these growing needs, and sound financial policy often dictates that it is unwise to put all the surplus back into the busiuess. To meet these needs, the financial manager is, there- fore, confronted with the choice of two general lines of policy. He may either increase the capital owned by the business, thru the sale of additional stock, or he may bor- row the amount necessary to meet requirements. In a preceding chapter we have seen the advantages and disadvantages of selling stock. It is sufficient to re- peat here that it is not always possible or desirable to increase the amount of capital stock outstanding. Also, if the nature of the business and its earnings permit long-term financing, there may be an opportunity to in- crease considerably the profits of existing stockholders by selling bonds instead of stock. For example, a hy- draulio-power plant, capitalized at $3,000,000, was able to pay 8 per cent regular dividends on the outstanding cap- ital stock. It had no bonded indebtedness and no common stock. New equipment was required involving about 94 The Use of Bonds 95 $1,000,000. The directors believed that the earning po'w'er would be increased proportionately, so that 8 per cent dividends could be paid upon the $4,000,000. This in- volved an annual dividend charge of $320,000, whereas the amount required on the $3,000,000 was only $240,000. The directors at that time found that they could float a million-dollar bond issue on the combined properties at 5% per cent. Their business was a very steady, non- fluctuating business. With a steady outlet for their prod- uct and assured earning power, they decided to float the bonds rather than issue new stock. The interest charge on this bond issue amounted to $55,000 a year, whereas the 8 per cent dividend would have required $80,000 — a saving of $25,0,00 to the business. The Mobtgagb Under these and similar conditions, recourse may be had to pledging some of the real estate, buildings, equip- ment, or other permanent assets of the company under a mortgage as security for a long-term loan. The mortgage secured by real estate is one of the oldest and best-known types of security. It is so carefully sur- rounded by the protecting laws of property rights as to make it a very safe investment, and is, consequently, popular with savings banks, trustees, and other conserva^ tive investors. A discussion of the legal technicalities of the mortgage would be out of place in a book of this nature, but it may be well to point out here that while technically the mort- gage is a deed of specific property given by the borrower to the lender, in practice it is regarded simply as a lien, and leaves the borrower in undisputed use of the pledged property so long as the interest is paid regularly, the 96 Financing a Business , property kept in reasonably good condition, and the other essential terms of the mortgage- complied with. This practice of treating the mortgage as a lien is an important point in financing, since it enables a business concern to borrow on the basis of a mortgage on part or all of its real and personal property without losing control of the operation and profits of ,the business, so long as the interest payments and other conditions of the mortgage are kept up. But the use of the simple mortgage is restricted to the borrowing of comparatively small sums,- siace it is im- practicable to split the security up among a number of money lenders ; and only in rare instances is a single indi- vidual or banker able or willing to lend the large sums frequently required by business concerns. This situation has given rise to the introduction of a third person, the trustee, into the borrowing transaction ; and this arrangement makes possible the issue and sale of bonds, thus dividing the loan up among a large number of investors of whom the trustee is the representative. The way this works out is that the concern desiring to float a bond issue has a mortgage prepared which pledges certain specific property as security, and conveys this mortgage by means of a deed of trust to some individual or trust company, who acts as trustee. In securing the services of a trustee, the borrowing concern must expect to undergo a very searching exami- nation of its affairs, for no responsible trustee will be found willing to undertake the responsibilities of his posi- tion without insisting upon such an examination. The Indentube In general practice the deed of trust, the mortgage, and all the particulars connected with the bond issue are The Use of Bonds 97 contained in one and the same instrmnent, called the in- denture. These corporate mortgages outlining the terms of a bond issue must, of course, be very carefully drawn ; and, ia the case of large issues particularly, the instru- ment is often a lengthy document. A good illustration is that of the Adjustment Income Mortgage securing the 5 per cent adjusttnent income bonds of the Hudson and Manhattan Eailroad Company, given to the Guaranty Trust Company of New York, trustee. This document runs into well over one hundred pages of printed text. Some idea of the subjects covered in it may be gained from the following heads: 1. Parties. 2. Eecitalsof: a. Purpose of the issue. b. Nature and amount of the issue. c. Authority given by the stockholders and di- rectors. d. General nature of the security (specified in detail later in the instrument). 3. Form for coupon bonds and coupons. 4. Form for registered bonds. \ 5. Form of trustee's certificate of validity of bonds. 6. Granting clause. 7. Detailed description of properties mortgaged. 8. Habendmn clause. 9. Declaration of trust. 10. Detailed specifications for the execution, issue, and registration of bonds. IJ. Covenant as to payment of principal and interest. 12. Particular covenants of the company, as to : a. Payment of underlying obligations. b. Maintenance of corporate existence. 98 Financing a Business c. Extension, renewal, or discharge of underlying obligations. d. Priority of lien. e. Maintenance and insurance of properties. 13. Provision for retention of possession. 14. Detailed provisions for return of ownership on repayment by the borrower. 15. Provisions in ca,se of failure to pay interest, 16. Privileges of the Trustee. 17. Provisions for redemption of bonds. 18. Miscellaneous" terms. 19. Signatures and corporate seals of the parties. While the detailed provisions of one such indenture usually differ materially from those of another, the sub- jects covered in the list above give a very good idea of the general provisions common to such instruments. Open vs. Closed Mobtgages One of the first things that the purchaser of bonds se^xired by a mortgage will be interested in, is the main- tenance of the security up to its original worth. Many indentures contain an "after acquired property" clause to insure the original worth. He will ask whether the mortgage is "open" or "closed" ; that is, whether further loans can be made, or bonds issued on the basis of a first lien on the same pledged property. Naturally, to do so would weaken the security from the bondholder's point of view, and open-end mortgages are unpopular and rare. Limited open-end mortgages are sometimes used to pro- tect both the security and the expanding financial require- ments of the business. On the other hand, the closed mortgage sets a definite The Use of Bonds 99 limit on the amoimt of the loan that the borrower can get on the basis of the same security. The difficulties which this limitation places in the way of the borrower can be avoided, it has been found, by making the original bond issue considerably larger than is immediately required. Various sorts of property may be pledged as security back of a bond issue, the chief requirements being that such property shall possess the qualifications of reason- able permanency of value and a broad general market which permits of relatively easy liquidation in the event of default of interest payments. Real estate most nearly meets these requirements; tho certain types of personal property, such as stocks and bonds, machinery and equip- ment, buildings, etc., also frequently furnish a good basis for security for a bond issue. Bond financing occupies a very important position with a large number of businesses, and for that reason the principal characteristics of bonds and bond financing are here outlined. Denomination or Size of the Individxtal Bond A bond is simply an interest-bearing debt certificate. These certificates have become pretty well standardized into two general types : 1. The registered bond. 2. The coupon bond. A registered bond may be registered either as to prin- cipal and interest or as to principal alone, and Vrhen registered in the name of the owner must be transferred on the books of the corporation similarly to a stock cer- tificate. Registered bonds are usually issued in multiples of $5,000. 100 Financing a Business > Coupon bonds are transferable from holder to holder without any registry formality. Interest-bearing coupons are attached to the bonds indicating the date when inter- est is payable and the amount payable. The holder of the bond simply clips the coupons and deposits them for payment Coupon bonds are usually issued ia denomiaations of $100, $500, or $1,000 each. There may be a tendency toward even smaller denominations where popular dis- tribution is desired. What Shall Be the Teem of the Bond? The corporation confronted with the problem of issu- ing bonds needs to analyze the term factor from various angles. All bonds issued against pledged property are affected by the life of that property. In the case of wast- ing assets, such as mines, sand pits, and quarries, as a rule only a short-temi issue can be raised; and certain special provisions for protecting the security or redeem- ing the bonds ia proportion to the consumption of the assets, are necessary. In the case of personal property and equipment pledged, such as rolling stock on railroads, obviously the term should ^ot be longer than the productive life of the asset. On the other hand, in the case of real estate, buildings, public utilities, etc., the life of the bond may be^ 50 or 100 years. The term of a bond issue is also vitally affected by a. The money market at the time. b. The credit condition of the company. In a period of high money rates and money stringency, short-term issues or short-term notes are usually resorted The Use of Bonds 101 to. An endeavor is made to time these notes so that they may be refunded at a time when money conditions are more favorable toward a long-term bond issue. For in- stance, a long-term bond issue meets greater public favor when money is easy jand investors are willing to part with their money for a long period. The interest rates are lower at a time like this and mean to a business a saving j of perhaps thousands of dollars during the course of sev- eral years. When money is hard to get, as in the years following the World War, business concerns have to offer attractive interest payments to obtain capital. How the credit condition of a company influences terms of issue is illustrated by a certain food-manufacturing corporation which in the earlier years of its life had not fully established its permanency and earning capacity in the financial markets. It became necessary to expand • the plant. In financing the property and new building, a five-year bond issue was agreed upon. At the maturity of these bonds the company had fully justified its expecta- tions. It had become a nationally recognized food con- cern. Its credit was established. It was then able to refund these bonds at a considerably lower rate of in- terest. Fixing the Inteeest Payments Provisions regarding interest payments group them- selves under four principal points : 1. The rate of interest. 2. Interest dates. 3. Place of payment. 4. Kind of money in which to pay. The fixing of interest rates is a very complex problem in which such questions as money conditions, credit of the 102 Financing a Business company, size of the issue, character of the bond, popu- larity of the bond, and a good many other factors, need to be considered. These interest rates are usually estab- lished in conference with the financial institution handling the sale of the issue. Interest payments are almost alwayis made semi-aimu- ally. The months o^ the year should be chosen with reference to the seasonal monetary requirements of the business if so affected. If, for example, a firm requires an extra amount of money in the spring and fall of the year for seasonal reiiuirements, the January 1 and July 1 interest dates woidd normally be more suitable than March 1 and September 1. > The place of payment and the kind of money in which it is to be made are obvious points. Often only the place of payment is specified. What Class op Bond to Use The variance in the nature of the security naturally means that bonds differ widely in character. Needless to say, the stronger the security, the lower the interest rate required to make a bond issue attractive from an investment point of view, granted, of course, that the earning power is present. For the average business man, the most useful classi- fication of the general types of bonds is that foxmded on the character of the security behind them. Viewed from this angle, we find that the most common kinds of bonds used in financing a business may be divided into two general classes : 1. Those secured by specific assets, such as land, buildings, securities, etc. The.Use of Bonds 103 2. Those secured only by the promise of repayment of prmcipal and interest of the, concern issuing them. Within these two general classes, tiie following types are commonly found : 1. Bonds secured by specific pr(!>perty. a. Mortgage bonds. b. Guaranteed bonds. c. Collateral trust bonds. d. Secured by lease (equipment trust bonds). 2. Bonds not secured by specific property. a. Debentures. b. Convertible debentures. c. Income bonds. While there are numerous other types of bonds oflFered under a variety of names, tliey will be found to correspond in most respects to the types listed. Because of the legal and financial technicalities involved in a bond issue, the average business man will do well to seek the advice of his lawyer, his banker, and a bond expert when planning to raise money thru the sale of bonds. MoKTGAGE Bonds As a general proposition, the type of bond issue most popular with investors is one backed by a first mortgage. In some cases, bonds are issued under a second mortgage, or even a third, fourth, and fifth mortgage. However, the second or other junior mortgage issues are not always so popular as the first mortgage because of the greater security attaching to the latter. On the other hand, a higher rate of interest is usually offered for the second ^ili^ ^'xSrrs ^aBi^ ^^p-^-. ..., 3Knmu AU-iSlm by llr'BF ^nands, tiiat«BfcfUi9fairafttriSitrpttnnim.KeorixH j Untion, otguized and cxliting under tbe lawi of the SUte o( Illinois, fot value Kcrived. tettbru ^romUeS to pay to bearer hereof, or if this bond i* regutered. then, to the regutered ovntr ti«rtdIjK , on Uie I5th d^/ o( February, h. D. 1924, the lum of One Hundred Dollars b gold coin of the UiiitedV btatea of Americ*, of or tautX to the pRseut standard of no'eht and Gneuess, and to pay interest oaV said sum until the same suU be paid, at tbe rate of six per wntum per annum in like gold cob on tbe 16t}) day of August and Pebniaty in each year b accordance with fod upon itRsentation and ■uncndcr ot the anncud in tercit coupons, as they severally btconedue. BathpTincipal oddblcrest o( this bond shall be payable at the olEce of CHICAGO TnXE AND THUST COMPANY, in the City of Chicago and Stata of Illinoli, vithout dedQcUoa of any tax or governmental charge nbich tbe Carporation may be retiuired to pay, cb rcglttratioo being noted hereon as provided b and by said Iruil deed and in oiul by soM coThilera) (rust agreement, after nhich no transfer of this bond ibsll be valid onlesi made o&said books by the rcf^tstercd avaeT iii person, or by b)s aUomcy duly autboriied, and aimiUrly noted on this bond, but this bond may be ditchargcd from regiMiY by b iung ia like manner transferred to bearer, nherenpoa transferability by deliveiy shall be restored, and this bond may agun. end from time to time, bo registered or trwsferrcd to hearer. Such rcjiiK- tratJon, bowever, shall not aSed the tnoti^uUty of the coupona but tbe same shall always be trouferoble by deHvefy and be payable to Dcaier. Thisjbond shall not become obtigalery for any pnipoie imtQ tbe tnute^s ootlSeste mdorAed (KieoB shall have been duly executed by said trustee ot its successor in trust- Bit SilnrBfl Sfjtrrof, the Corperatioa boa auied tbis bond to be etecnted b iU nanw, br its heaident. and has caused itsoocpar«t« seal to be heieiuito affixed and attested by iuSeciclaiy, and bas caused die bteiest coupons hereunto annrn-d to be autbcDticatel by lbs fo^mile of tno (uwtun of ill Tieuuref tbls Utb day of February. A, D. 1017. IPiiMdflt (SfmrtK^jSiirponitfut \^ ■>a^' '^ Fio. 18a.— A Bond Form (face) 1^ (FORM OF TRUSTEE'S CERTIFIOVTEi) WfiM tl to li^Ttat: tad boftds arc dvidad -into (uo Seriet. denspOded at "A" and "B" reapecUKiu- Serw "A" on qf th» dmomination of Fioe Bundred (tSOOXX)) DoUara each, and art numberad from 1 to 490 both indutise. taid Ssriet "B" on of the dmominalion of One Burtdrid {$100X10) jitOare toA, and ate nunbered'fnjm 1 to 660 both indutwe. The aggregate amount of said tteo Sam u Tkret Bimdrtd Tkoutand '($300,000.00) DoUan. CHICAGO TTILC ANB TRUST COMPANY, DATE OF REOSntV IN WHOSE NAME REG1STE51E0 Pom of CdupoD D«sd Mth thli Bead Fig. 18b. — A Bond Form (back) — Coupon Inserted 106 Financing a Business mortgage issue, which attracts investors when a concern finds it advisable to use this type of financing. The condition of the investment market should be, studied carefully, when a bond issue is being contem- plated. The type of security pledged and the interest rate must be carefully adjusted to the current demands of investors if the whole issue is to be sold at top prices. It is well to repeat here again the advisability of going into a question of this kind thoroly with one's banker. He often can bring to the surface valuable factors to be considered that otherwise might be overlooked to the financial disadvantage of the business. To illustrate, a middle- western firm grew so rapidly that it was unable, with its equipment, to handle all the incom- ing business. It decided to raise additional funds for ex- pansion by means of a bond issue of $500,000. The three heads of the concern laid the plan before their banker. They went over the whole situation, and he showed them how by shaving their costs more closely, by, buying mate- rials oftener'and in smaller quantities, and by borrowing wisely to discount bills, they could get along with a $200,- 000 bond issue. This enabled the firm to hold its interest payments to the minimum an(i still expand sufficiently to take care of increasing business. Then, too, there is always the question of the future. It is not always wise when business is booming, to put a lot of money into "bricks and mortar ' ' for possibly only temporary needs. A banker can often help a customer to visualize his requirements in fixed assets. Fixed interest charges sometimes become more burdensome than is anticipated at the time of issu- ing the bonds. The following experience of a manufacturing corpora- ( tion illustrates this danger. The concern decided to bor- row $500,000 on twenty-year bonds secured by a first The Use of Bonds 107 mortgage on the real estate and buildings which it owned, and bearing interest at 5 per cent. The security was excel- lent, but both stock and bond buyers, at the time these bonds were offered for sale, paid little attention to the issue. They were, just then, more interested in the high- dividend and interest-paying securities of some of the "War Brides, " or in Liberty bonds. The result was that the manufacturing corporation's bonds sold at 81; that is, a $1,000 bond would bring only $810 in the market, and the concern found itself pajdng an annual interest charge of $25,000, or slightly over 6 per cent on $405,000, the amount the whole block of bonds yielded. Underwriting The usual practice in floating bonds is to sell the entire issue at a fixed sum to some bond house or investment banker, who in turn sells the bonds to the public, usually at a higher price, the difference serving as the banker's commission. By this method, the borrowing concern is assured at once of a definite sum for the entire issue of bonds. Guaranteed Bonds Sometimes a large corporation which owns a number of subsidiary concerns, cannot float a new bond issue because of the limitations of the mortgage under which a former issue was sold. In this case, it may be possible to sell the bonds of the subsidiary companies, secured by their property and guaranteed by the better-known parent organization. The favor with which investors will regard such guar- anteed bonds depends partly upon the completeness of the guaranty, and partly upon the reputation for strength possessed by the guarantor. 108 Financing a Biisiness COLLATEBAL TbUST BoNDS A concern owning a considerable an^onnt of dividend- paying stocks and bonds of other companies, may use these securities as collateral for a mortgage under which bonds may be sold. Such bonds are called collateral trust bonds, and they have been used to a considerable extent in financing American railroads and holding com- panies. Where the borrowing concern is not dependent upon the dividends from the pledged securities for payment of interest on the bond issue, investors will be willing, as a rule, to pay a higher price for these collateral trust bonds than would be the case where the borrower relies largely upon the return from his stocks and bonds pledged as collateral to pay the interest. In the latter case, the price of the collateral trust bonds is likely to fluctuate with the market price of the pledged securities. Bonds Secueed by Lease As will be seen in a later chapter, the leases, instal- ment contracts, and mortgages held by concerns selling merchandise on the instalment plan, are frequently used as security for a bond issue. This method of financing has developed tremendously in recent years in connection with the automobile, talking machine, piano, washing- machine, and furniture industries; and several financial houses now specialize in acting as trustees and certifying bond issues backed by the paper of these industries. A similar method has long been in use in the financing of railroads. Here, cars and other railroad equipment, purchased by a syndicate and leased to the railroads, serve as security, thru the assignment of the lease to a trustee, for issue of car or equipment trust bonds. The Use of Bonds 109 Because of the excellent security and the high interest rates usually paid on equipment truSt bonds, they are generally popular with investors. Debenttteb Bonds A strong concern may employ its credit as the only security for long-term credit. Bonds issued under such conditions are called * ' debenture bonds. ' ' They ordinarily hold priority over all stock obligations of the company, and the interest must be paid before dividends on stock can be declared. Usually the interest payments on these debentures are cumulative. The type of document in cases of this kind permits drastic action to compel pay- ment of interest in the event of a default. Companies in popular favor, especially smaller concerns, sometimes are able to meet additional capital requirements thru this channel. Convertible Debentueb Bonds As a means of reaching bond buyers who desire a specu- lative opportunity to share in the future profits of the business, debenture bonds are issued with the privilege of converting them into the stock of the company at a fixed price. Usually this conversion privilege expires on a definite date before the bonds mature. From the point of view of the borrower, the sale of such convertible bonds is simply a deferred sale of stock, and frequently these bonds can be sold at a much higher price than the stock would bring at the time of the issue. The conversion privilege is not confined wholly to debenture bonds, but is sometimes a feature of other types of bond issue. Thus, the circular announcing the issue of $2,000,000 worth of ten-year 7 per cent bonds 110 Financing a Business by one manufacturing company, dated April 1, 1920, and secured by a closed mortgage on all the property of the company, provides that "the bonds are convertible after April 1, 1922, and until maturity, into 8 per cent cumu- lative preferred stock of the company, par for par, or when accompanied by warrants into common stock at $40 a share at any time after April 1, 1922, and to and includ- ing April 1, 1925, and thereafter at $50 a share, etc." Income Bonds Tl^e income bond has been used very little in recent years because it is not popular with investors. It pledges the payment of interest only when, in the judgment of the management of the borrowing concern, the income earned has been sufficient to permit payment, altho, like any other bond, the principal is payable at a definite date. It will be seen that such a bond possesses neither the virtues of stock nor of other types of bonds, and it is used mostly thru necessity due to reorganization or similar con- tingencies. CONSIDEK THE INVESTOR It must be clear from what has already been said that the financial manager must continually consider the pref- erence of investors when planning a bond issue. His task is to purchase money at the lowest cost to his concern, and that does not necessarily mean the lowest interest rate. The bonds must offer the greatest possible attraction to the purchaser. This attraction may lie in the security of the repayment of principal and the regu- larity of income, in which case most investors will accept a low interest rate. As the security of principal is weak- ened, the interest return demanded by purchasers will The Use of Bonds 111 increase. Special features such as the conversion privi- lege deserve careful consideration in popularizing the issue. Provision for Eepatment Care must also be taken to provide for ultimate refund- ing or repayment of the bond issue. In case it is the intention of the borrowing concern to retire the bonds at maturity, it is desirable fo make provision for the accumulation of a sinking fund. In general practice, however, bond issues are refunded at maturity by means of a new issue of bonds, stock, or short-term notes. Which of these three types of security may be used to best advantage wiU be determined largely by conditions prevailing in the investment market at the time of maturity. In the case of bonds on buildings, equipment, etc., the serial form of payment is usually adopted. A certain number of bonds mature annually, thus retiring the issue and maintaining the security behind the remaining bonds. In this connection, it is evident that the date of the ma- turity should be planned so that it does not come at a time when other heavy financial obligations must be met. Increased Popularity op Bonds While in the past the use of bonds in financing was con- fined chiefly to the national, state, and municipal govern- ments, to railroads and other public-service corporations, and to some of the larger industries, the tendency today is toward the use of the bond issue as a means of financing medium-sized business concerns. The reason for this is chiefly the greater familiarity of the public with bonds as iuvestments. The war, with 112 Financing a Business its issues of Liberty bonds, gave an enormons impetus to this movement of educating the public and enlarging the investment market. The probability seems to be that business will find more general use for bond issues as a means of borrowing on long terms in the future, altho during the first two years after the war it was claimed in financial circles that there had been an over-floating of bonds too great for the public to absorb easily. To reach the small investor, it is advisable to make the denomination of bonds as low as possible; the so- called "baby bond" having a value as low as $100 or $50, can be more easily distributed among a larger number of purchasers. General conditions will usually indicate the wise choice of the denomination in which to issue bonds. SELF-TEST QUESTIONS 1. BONDS. What advantage have they over stocks in financing an enterprise ? What disadvantages ? 2. PERIOD. OF BONDS. What are the important factors affect- ing this? 3. SIMPLE MORTGAGE. Why is this superseded by the flotation of bond issues in many businesses? 4. "OPEN" OR "CLOSED." How do such mortgage bonds affect the security and subsequent flotations? 5. TYPES OF BONDS. Which is the most popular, and why? 6. DEBENTURE BONDS. What are thfiir featuMs, and how are they used to best advantage? 7. THE BOND INVESTOR. What is he most interested in, and why? 8. LIBERTY B(»7DS. What signi«eBnt effect hav^ ttiey had on the bond mariKt? CHAPTER Vn MEETING ADDITIONAL CAPITAL NEEDS IN A GOING CONCERN A Wisconsin man started a candy business on a small initial capital. He planned to build it np gradually, fig- uring that his profits would take care of necessary ex- pansion. He had a bank account, but he never talked his affairs over with the banker, and had never asked for a line of credit. His business grew rapidly, and within two years he was unable to take care of the demand. Here was an unexpected situation for hitn — a flourish- ing business with insufficient capital to meet his custo- mers' demands. Orders swamped him. He tried to catdi up with the expanding sales end of the business, but could not finance it satisfactorily. He had no line of credit, and, having failed to prepare ahead for a contingency of this sort, decided to sell out. Others with larger capital and varying sources for additional funds were, of course, eager to take advantage of the opportunity and made him attraelive olEears. H^ finally aoeepted $10,000 for the business and focnd a salaried position wMi anofiier fijm. H> gars7» np iiaee years of e&yrt and a kicpateve opjportu- niif far hina^eSf, mK^ply becaasse he had not seen far enoo^ ahead to maet additional capital needs. Had he foresee his legjiremeHte, he ©onld qiaeMy harwe made the $MM300 he aequired from the sale and still have retained the bofiiness he had created. 113 114 Financing a Busi/ness This is only one of the many somewhat similar in- stances of where inadequate capital for a going concern has meant disaster, a forced sale, or financial difficulties of varying degrees and duration. It matters little whether the concern is large or small, the effect may be the same. It is therefore highly essential that a new enterprise have the proper financial attention all along the line. Consult Youb Banker Eably It is worth while repeating here that one of the first acts of an individual or corporation planning aild start- ing a new business should be to take up with a banker the probable future needs of the concern. Expansion requirements should be thoroly gone into and, if pos- sible, an understanding should be rea'ched with the banker, by which Ms counsel and assistance in the natural development of the enterprise may be counted on. And, as indicated in a later chapter, the choice of the banker should be thoughtfully determined upon. For instance, one middle-western concern had been deialing with a small bank friendly to one of the directors, f his was perfectly satisfactory so long as the business was small. Gradually, however, the sales grew, taxing the owners financially and necessitating more and more money. Finally, and at a crucial time during the World War, it exceeded the lending capacity of the small bank. The directors recognized the urgency of seeking bank- ing cpimections of greater financial strength, and began casting^ about. But the quest was not an easy one, for the business was still young and the times were not pro- pitious for this particular enterprise. Certain larger banks investigated the affairs of the xjompany, but hesi- Additional Capital Needs 115 tated to take it on as a borrower. And it needed a liberal line of credit. As a result it was many months before the directors finally persuaded a larger bank to take them on, and then for a very limited credit. Had the promoters of the enterprise prepared earlier to meet such a possible contingency; they no doubt would have been relieved of many anxious, discouraging hours. So the question of additional capital is one of great importance, especially when it means taking care of an unexpected growth at an unexpected time. As a matter of fact, no healthy business can stand still. This is very generally recognized. It must either retrograde or show advancement. Progress should be anticipated and fore- seen from the beginning, and plans laid accordingly. The question should be asked at the start, "What will be our future needs?" If the business is manufacturing, the requirement may be improved machinery; if a retail store, a better method of displaying goods. In any event, it may be urgently necessary to provide more floor space. Plant extensions, provision for depreciation, and so on, all have to be con- sidered in order to play safe. Estimating Additional Capital Eequibements In securing additional capital for a going concern, the same principles as outlined in Chapters III and IV would apply. The danger of overestimating capital needs should at the same time be carefully considered. For instance, if $100,000 were used in a project, when $50,000 would adequately answer the purpose, the interest on the other $50,000 would be an unnecessary burden of expense to the concern. In other words, the new additional capital would not be working efficiently. 116 Financing a Business SfiiiLiNG Securities — ^Acoumulating a Surplus Additions to fixed assets, sucSi as buildings, machinery, fixtures, and so on, can ordinarily be raised by selling additional securities. This is usually the procedure, as outlined in a general way in Chapter VI. A new buildilig might perhaps be financed thru a mortgage or bond issue at 50 to 80 per cent of the cost of the building. Construc- tion companies or builders often undertake the financing as well as the building questions themselves. Machinery, equipment, rolling stock, etc., may often be secured on a leased basis, on an instalment basis, or by means of some form of equipment bonds. Money required for testing a new advertising plan or for extending some new service to customers should be provided from an accumulated surplus. Obviously, there may be exceptions to every rule, based on the type of the business, its management, and its possibilities. The tenacity, wit, and courage of the guiding officers of a concern sometimes are of great assistance in bridging crises in business progress. Increasing the Capital Stock Probably the most popular method of enlarging the scope of a business is that of increasing the capital stock. The sale of these securities replenishes the treasury and furnishes the money to cover expansion requirements. But here again, should occasion demand larger quarters, the need of corresponding additional working capital should not be lost sight of. In this problem the bank should be frequently consulted. In the allotment of additional funds for fixed and work- ing assets, it is essential that the proper proportion be decided on. To illustrate : A farmer bought an excessive quantity of land, which left him a very limited amoiint of Sources of Additional Capital for a Going Concern [.v.;.7!f.;j;^tjw;?:5^^ K? Fig. 19.— Sources of Additional Capital for a Going Concern 118- Financing a Business money to put into implements, horses, live stock, and cash with which to compensate his laborers. He was unable adequately to cultivate the land on account of the lack of working funds to finance its operation. This misjudg- ment resulted in the farmer's being "land-poor." Making a Bond Issue The sale of bonds in order to obtain funds for a per- manent enlargement of a business has its advantages. This may be done when the stockholders desire to get funds at a low rate of interest, and to enjoy the additional profits of the new investment on their present holdings. For instance, if the funds from a $100,000 bond issue at 5 per cent ena,ble the concern to increase its earnings $25,000, this will leave a net profit of $20,000 after deduct- ing the $5,000 for interest on the bonds. This procedure will enable the stockholders to add to their return on the shares or to put it back into the business, thus increasing its worth. The interest charges on borrowed capital should, of course, be carefully weighed to prevent over- loading the business with this expense item. The question of bond issues was taken up more fully in the preceding chapter. BOBBOWING ON PHHrATE CoLLATEEAL In some instances, the private collateral of individuals connected with a firm can be utilized to meet the exigeneiesi of an expanding period. For example, an Illinois con- cern at the close qf the war received a sudden avalanche of orders, but had insufficient funds to put them thru. The officers estimated that they would need $50,000 for a period of six months in order to finance the increasing business. They appealed to their banker but, circum- Additional Capital Needs , 119 scribed as he was, he could offer them only a small per- centage of the figure named. A friend suggested that they pool their private investments and present this collateral to another bank equipped to handle it. This they did, with the result that they avoided certain stagna- tion and possible failure, and made good by the end of the six months. AcCUMTTIiATINa A EeSEBVB But this is in reality an emergency measure. A busi- ness ought to expand naturally on its own merits, and that is what this chapter is intended to point out. In figuring on all future developments it is necessary to keep in mind all the facts regarding the enterprise. To illustrate, depreciation may be great in certain lines, which means that funds must be available for necessary replacement. Reserves for depreciation, repairs, and so on have become much more common in recent years, and they are an encouraging sign in the general business structures of today. So important are they, in fact, that they are considered more at length in later chapters. Here the subject is touched on only in reference to the initial planning as a means of providing for expansion demands. Cost knowledge, turnover figures, and all other everyday financing facts as brought oiit in later chapters must not be overlooked; nor should the usual two-for-one rule on the ratio between quick assets and quick liabilities be ignored. Too often this feature in business financing is forgotten in going ahead with expansion plans. CONVEBSION OF WoEKING AsSETS InTO CaSH Often a concern will unnecessarily tie up money in accounts receivable and in an unnecessarily large supply 120 Financing a Business of materials. The former could perhaps be reduced by a more rigid credit and collection system. The use of trade aeeeptanees, as explained in Chapter XI, is another method of converting accounts receivable into available funds. The diseounting of notes receivable releases tied- up working capital for other uses. A big store of ma- terials may be reduced in many instancfes without inter- fering with the efficient operation of the concern. By practicing such methods, cash may be released for a more profitable use. This will help to meet the demand for additional capital. Pbotecting the Busikess Against Depeession Still another point to be proved is the probable per- manency of the increased demand for goods or services. Is it brought about by some temporary, unusual boom, by post-war conditions, or by the vagaries of the buying public? To make expensive plant additions, to buy new machinery, or to make extravagant improvements in service to the public, in order to meet a demand which possibly may be only temporary, is not good financing. A business should be carefully protected against the collapse of a boom or an abnormal selling period of any sort, and this should receive thoro attention in planning for additional capital. Conditions following the war were a tax on the coun- try's finances because of high prices. These circumstances called for additional capital in many concerns. In the majority of cases banks were able to help, thru the offices of the federal reserve banks. Eediscounting of high-class commercial paper helped considerably to relieve the strain on business. Inventories of usable materials furnish good collateral Additional Capital Needs 121 for obtaining loans, but care must be taken not to have on hand an overstock. Especially is this important in boom times. The termination «f inflation is always fol- lowed by a period of deflation. This fact must be borne in mind in making a loan. A minimum stock on hand is wise at this period. A safe margin of surplus, reserve, 6t working capital, must be allowed for the deflation period in order to avoid this disadvantage. It is sometimes true that bankers fail to see the sound future in an industrial development, and this makes it difiScult to obtain easily tie assistance required in ex- panding. For example, yA&a. the automobile industry first began to grow, baifers looked askance at it. Few of them would lend to autemobile companies at all, taking the attitude that it would collapse just as did the bicycle boom. Their judgment proved entirely wrong, for many of the banking houses wMeh at first refused to accept any automobUe paper now seek it in normal times as particu- larly attractive for their holdings. So it is that an expan^Hg new business may not always receive the support to wMch it is entitled. Yet ordinarily, if the men in control of it will "lay all of their cards on the table," both for their banker and their partners or stockholders, they will find ready support in planning expansion and in providing funds for healthy growth. SELF-TEST QUESTIONS 1. ACCUMULATED PROFITS. Is it safe to depend on them for additional capital needs? 2. CONSULl YOUR BANKER EARLY. Why? 3. RAISING FUNDS. -For what purposes are they raised? Will each case be financed in the same way? 4. CAPITAL REQUIREMENTS. What ones should be consid- ered when adding to the fixed capital ' 122 Financing a Business 6. MAKING CAPITAL AVAILABLE. In what is it usually tied up? How is it made available? 6. A MARKED INCREASE IN BUSINESS. Why should the cause be analyzed? 7. FINANCTAL SUPPORT. How can it be obUined? CHAPTEE Vni MAKING THE RIGHT CHOICE OF A BANKER A business man chooses a bank, not primarily for a depositary, but for a source of borrowing to meet his day-to-day needs. Most banks are safe, enough to trust with your deposits, but not aU of them can be depended on to lend you money when you require it. If the good business man were buying an automobile, he would not buy of the first dealer he approached, unless the dealer had a machine that served his purpose. The same com- parison can be made of the good business man and the banker. He is not choosing at random. He is going to study the organizationi the class of business which each bank is accustomed and prepared to handle, the char- acter and reputation of its directors, and the business ability of the banker. Thru this study and analysis he chooses his banker. To analyze these qualifications sufficiently a fair knowl- edge of the different types of banks and of the significance of the various kinds of services which they are capable of rendering, is necessary. There are so many bankers offering so many kinds of services in so many different places that it is no small task to make the best selection. The right choice of a banker can often be made by asking your friends where they do their banking. If thfey are successful men, their judgment will guide you right. Examine the literature sent out by the institution; if it appears conservative, find out who the members of the 123 124 Financing a Business firm or the directors are. You might not be able to tell at a glance whether their literature appears conservative, yet you can often make a good guess. If they are adver- tising ' ' gilt-edge bonds " at an xmusually high interest rate and assuring you of big profits, it may be well to consider this as a danger signal. A reputable banking house does not make glaring announcements of huge profits on the securities it is selling, but is more inclined to offer securi- ties bearing a reasonable rate of interest. The experience of many business men shows that the so-called "tight wad" should be avoided as much as the too liberal banker. In whatever class the banker may be you should find outvall you can of his business policies. If a loan officer freely lets out his money, and fails to use reasonable caution with his customers, you may know that he will do the same with you, and is therefore a dangerous man with whom to do business. As a general rule, a person who cannot handle his own business suc- cessfully, will not handle the bank's funds or your funds to the best advantage. A :^rm, careful bank officer, even tho yoTji may feel he is almost unnecessarily strict, is likely to be a better guiding counsel for the financing of your own business than a less cautious one would be. A successful shoe dealer in Illinois attributes a large share of his prosperity to having formed the acquaintance of the right banter, aaid to having e«teblishfid a satis- factory reiation-siiip with him. "Having cmoe dbosyen hfen and |oa«d him woaKtih while," he sagr^ "I bav* always mad« lit a pdn^ to be most fascik w^ him aijd to ki^ all my <3B3sds Oct && table. I harve alk^iQ^K knJoambed laai fully di 8Jly ioapflaqdijig %pji^^1 trou^ or disastee^ sod this teamworfe ka^ mvariaMy mv^ tbe day. "Had I been without hie eo-operati«n, however, I stHrely sltould not have been the success I am today." The Right Choice of a Banker 125 Skevices of a Bank Thus far, we have considered the policies a bank should follow, the reputation and ability of its officers, and its financial standing. These qualifications are of paramount importance' to the business man. Yet alone they would not be sufficient to secure the maximum benefit for the business. The average business needs a bank for one or more of the following services: 1. To lend money and to discount notes and com- mercial paper. 2. To carry a commercial checking account. 3. To put away savings. 4. To furnish financial advice. 5. To give business counsel and to advise on invest- ments. In selecting a bank for the services needed in your business, the accompanying chart will serve as a splendid guide. It shows the principal departments of a modern city bank, and the services each department is capable of rendering. The small circle of the diagram, divided into six divisions, represents the following departments : com- mercial department, savings department, safety deposit vaults, bond department, trust department, and special departments. The space between the two circles rep- resents liie services each de{>af faiiaiit renders to the busi- ness maai. It is not to be supposed that every business will need all these serviees, nor that all buaajjees ooncerns will choose as a banker one who has all these services; but by the aid of this chart you can check up your business ^k1 determine what services are needed, a^ then choose 126 Financing a Business the banker who does offer the services which your busi- ness needs. Taking up more specifically the services whibh a bank renders, we will consider the first, i. e., the lending of money and the discounting of trade paper. % m^m:^.^'^ ^^.TVr» ^^^S^ ^'%.^ ^^z 03 I M •S >• ^ -■ o pr s p K g O n m H » f ywr ." , , , , , • Costofsales -..\., ,- - . ... . , Gross profit op. sales. .1 , gellijig expenses (itemized to correspond with ledger accounts kept). ... j ; Total selling tsn^ense .,. 1 1 1 1 Other income: Deductions from income: "P'Fidfsidspaid ,.,,..,... .- , Fio. 25. — Form for Profit and Loss Account (For Form of Balance Sheet, see other side.) TFORM OF BALANCE SHEET " ASSBTS. Cash: ' la. Cash on hand — currency and coin. . . , zb. Cash in bank , Notes and accounts receivable: 3. Notes receivable of customers on hand (not past due) ' 5. Notes receivable discounted or Sold with indorsement or guaranty 7. Accoxmts receivable, customers (not past due) 9. Notes receivable, customers, past due (cash value, $) , zx. Accounts receivable, customers, past due (cash value, $....) I,ess: 13. Provisions for bad debts 15; Provisions for discoimts,' freights, allowances, etc Inventories: 17. Raw material on hand 19. Goods in process ai. Uncompleted contracts Less payments on account thereof 23. Finished goods on hand . Other quick assets (describe fully): Total quidc assets (excluding all investments). , Securities: 35. Securitiesreadilyniarketableandsalable without impairing the business; a?' Notes given by officers, stockholders, or employees* 39. Accounts due from officers, stodcholders, or employees Total current assets. , 'pSzed assets: 31. Land used for plant 33. Buildings used for plant 35- Machinery .* 37. Tools and plant equipment 39. Patterns and drawings 41. Office fumittu'e and fixtures 43. Otherfixedassets,ifany(deschbefuny). less: 45. Reserves for depreciation., Total fixQd assets Deferred diarges: 47. Prepaid ezpeafies, tfloces, etc , Other ossdts (49). , interest, insurance. Total.MseU. LIABIUTmS. Bills, notes, and accotmts payable: pnsecured bills and notes — s. Acceptances made for merdiandise or raw material purchased 4. Notes given for merchandise or raw material purchased ; . , , 6, Notes given to banks for money bor- rowed , 8. Notes sold through brokers xo. Notes givenfor machinery. additions to plant, etc ' 12. Notes due to stockholders, officers, or employees : . . » . Unsecured accounts — 14; Accounts payable for pui'chase (hot . yet due) '. z6. Accotmts payable for purchases (past due) 1 x8. Accounts payable to stockholders, officers, or employees Secured liabilities — 30a. Notes receivable discounted or sold with indorsement 'or guaranty (contra) ;...'....... jfib. Customers' accounts discounted or- assigned (contra) ■ 30C. Obligations secured by liens on in- veatbries '. 2od, Obligations secured by securities deposited as collateral 22. Accrued liabilities (interest, taxes, wages, etc) Other current Uabilities (describe fully): Total current Uabilities Fixed liabilities: 24. Mortgage on plant (due date ) . . 26. Mortgage on other real estate (due , date )., 38. Chattel mortgage on mactdnery or equip- ment (due date ) .''.. 30. Bonded debt (due date ) 32. Other fixed liabihties (descrilte/ully): Total liabilities Net worth: 34. If a cotporation— ' (o) Preferred stock (less stock in treasury) '. (6) Common stock (less stock in treasury) ,' (c) Surplus and undiyided profits. . Less— (d) Book value of good will (c) Deficit 36. If an.indxvidaal or partnership — (a) CapiUl (b) Undistributed profits or deficit.. Total Fig. 26. — Form of Balance Sheet (For Form for Profit and Loss Account, see other side.) Will Your Statement Pass Miister? 153 It will show him what facts are necessary to make his statement complete. A Lack of Fbankness A third reason for so many turn-downs is the fact that some statements are not entirely frank. They have been "doctored" more or less. By this it is not meant that applicants deliberately falsify their statements. Inves- tigaltion shows that the proportion of men who are con- sciously dishonest in this way is extremely small. The trouble apparently comes more from an unconscious de- sire to "put the best foot forward," so to speak. As the salaried man tells his friends he is getting $5,000 a year when he is receiving actually only $4,800, so the business man sometimes wants his banker to see him at the top notch of financial progress. He may intend no dishon- esty, yet that is what it amounts to in the banker's eyes. Inquiry indicates that bankers would far rather have a borrower tell the worst about his business, rather than the best. Then there is no doubt about the condition of the concern, and the banker knows exactly how far he can go in lending. It is therefore absolutely essential that a statement be confined strictly within the facts. Efforts to make a concern's finances appear rosier than they are will usually be of little avail in seeking a loan. Often business men' suddenly find themselves in need of money and immediately become fearful of the future. They nervously rush to the task of -getting up a statement and in their anxiety stretch a figure here or cover up a weakness there to make it look good. Without realizing, they often are setting down amounts that are not exactly true. This is the worst method they could pursue. Many times the business man would receive at least some help 164 Financing a Business if he were frank, whereas he goes away empty-handed because his figures are "off-color." Essential Facts Omitted A fourth reason for turn-downs is that altho a state- ment itself may be complete as to items, yet facts neces- sary to explain fully the conditions behind these items are omitted. Hidden weaknesses are not shown. Thus the banker, with his keen financial analysis, senses some- thing that is not right and has to dig farther into the status of the business. Putting the House in Obdeb To obviate this difficulty every applicant should put and keep his "house in order" financially, as pointed out in Chapter III. In the first place, the costs of the busi- ness must be kept accurately and the collections speeded up. Next, the owner or manager should check his finan- cial condition thoroly against the points outlined in the chart. Then he should diligently make up his statement, based on the exact conditions. It would help if he made one out every month, whether in need of money or not. By analyzing his statement he may be able to eliminate weaknesses in his business which would otherwise cause the bank to shut off his open line of credit. In other words, the business man can thus learn to finance himself better, and when he comes to the bank for help, he will not only find his banker willing to co-operate with him, but will have the reasonable assurance of financial assist- ance at any time. This means that he will be absolutely frank and honest. He will have his figures so correct that no flaw will be found in them, and the relations of customer and banker Will Your Statement Pass Musterf 155 will automatically become more advantageous to both. This would obviate having to turn down men whose state- ments could not possibly warrant a loan, for they would know from their own analysis that a bank operating under strict rules and laws could not grant their request. Take the instance of a small concern whose financial statement showed a net worth of $4,000, while the quick assets were entered at $6,000 and the quick liabilities at slightly over $4,000. According to net worth, this com- pany believed itself entitled to a loan of $1,500. On the other hand, the owner did not analyze his figures enough to see that his liabilities were too great. According to the usual ratio of 2 to 1 his quick assets should have totaled $8,000. As it was, the margin between them was too small. It might have been possible and indeed perhaps easy for this concern to have got its affairs in better shape had it spent a little time outlining its condition according to facts. In every instance care in placing a business on a definite financial basis should result in favorable attention from the bank and should tend measurably to reduce the great percentage of turn-downs. The chart, then, together with the foregoing outline, indicates just what a statement should contain and how that statement should mirror the true condition of the business. Inquiry shows that men frequently have missed opportunities to enlarge their activities because of their failure to put up to their banker a favorable analysis of their finances. Appeoachinq the Bankbb This brings us to the important question of making the proper contact with the banker. When approaching a 156 Financing a Business lending officer some men take the attitude that they are just about to ask a favor. This is no more true than it would be to say that getting a salesman to wait on you is asking a favor. In either instance it is a business oppor- tunity. The banker makes his profit on loans. You are a customer and should go to bjm realizing that legitimate borrowing is purely a business transaction. Tour right to borrow must not be overlooked. Keeping this in mind, then, the business man who has analyzed his own statement and presents it in the knowl- edge that it will certainly pass muster can face his banker with no compunction of conscience. Frankness cannot help but command favorable attention and the proper sort of help. Tell your banker everything and make your attitude one of co-operation. A common ground of un- derstanding is necessary and a complete statement encourages co-operation and mutual trust. It is, of course, taken for granted that you have chosen the banker who can take care of your needs satisfactorily, as pointed out in the previous chapter. One successful executive calls his banker on the telephone whenever he is about to make a new important move. Even tho he may not re- quire additional funds, he gets this helpful co-operation from day to day. He is always careful, too, to get his statements in promptly. He never waitg for the banker to ask for them. Another man sends his banker a state- ment every month, regardless of whether he wants to borrow. Thus the banker knows minutely the progress of the business and holds himself ready to extend credit at any time should it be called for. Besides the statement, this business man sends the banker a brief summary of his sales from montliJo month in comparison with iiie previous year. This makes a valuable bird's-eye view of the concern's finances. Such co-operation tends to the Will Tour Statement Pass Muster? 157 building of a strong and important relationship between bank and customer. Business men generally are grow- ing to see what this means in financing their concerns evenly and without worry. The Personality of the Bobboweb . It should not be forgotten that, aside from financial strength, bankers weigh carefully the personal equation in regard to loans. For instance, it may not matter how much money a young man may have behind him, yet if he is untried, he presents a serious personal risk. Investi- gation reveals the fact that many young men, well financed, have started out brilliantly and in the end have failed bitterly, simply because they lacked balance, finan- cial acumen, and vision. Therefore the banks usually proceed cautiously in granting a line of credit to young, untried executives. They must have proved themselves to insure having their statements passed on favorably. An instance of the danger of giving a young man too much credit is' shown in the experience of an automobile com- pany. The head of the concern was a successful adver- tiser and organizer, but he was untried as a financial executive. Eeverses came ; he could not meet them. As a result the concern practically failed, and even a re- organization could not put the company on its feet. Bankers do not want to lend money on a personal gamble, even tho the business itself invites attention. This indicates how necessary it is for a borrower to possess all three "C's" of credit — ^the familiar line-up of "Character, Capacity, and Capital." A banker shies at "mushroom" growth of industries and frequently shows partiality for the concern which has built itself up patiently and slowly. Promptness in taking care of 158 Financing a Business obligations is another point which the banker considers of greatest importance in bori'owers. He also frowns sharply on any inflation of figures describing assets. Too much in "bricks and mortar" is also a bad credit sign. Still another point of tremendous importance is the adaptability of the borrower to the business he is in. A banker sizes up a man's fitness for his job quite minutely, and he takes little interest in lending to a grocer who obviously would make a much better farmer. This and the tendency to speculate are both factors that reflect unfavorably on a man's borrowing capacity. All these points a man should consider seriously when approaching Ms banker for a loan. His business, too, should be a "going one" and not standing still. MAIlTTAIKIlirG A PbOPEB BaLANCB Once a borrower has favorably impressed his banker and obtained his line of credit, he should remember that, aside from presenting a comprehensive statement at fre- quent intervals, he should keep his deposit balance at a proper fi^re. Many banks require a deposit equal to 20 per cent of the amount borrowed. Quick assets must at all times be double the quick liabilities, and loans above a certain nominal amount must usually meet the approval of the bank's discount committee, which passes on the bulk of borrowers' applications. COLLATEEAL LoANS We have said nothing so far in this chapter about col- lateral loans. Our aim has been to point out the require- ments for a "line of credit" which is so important to all concerns. Collateral loans often are helpful in tiding over a tight period in which a full line of credit has been Will Your Statement Pass Muster? 159 used. Collateral loans, of course, depend largely on the type of security presented and do not demand the study necessary for short-term "credit" or commercial loans. Provided with good collateral, a concern can usually bor- row on it without question, the bank lending up to within a certain margin to cover any possibility of a change in market price of the collateral, or the necessity of selling it should the borrower fail to pay. Summed up, the great point to remember in borroAving for business needs is always to keep faith mth the banker. Never give him an opportunity to doubt you for an in- stant. Then with a statement which is honest and com- plete and which you know will pass muster, you can doubtless obtain the help you need to finance your busi- ness successfully. SELF-TEST QUESTIONS 1. DANGER SIGNALS. What are they in a balance sheet? 2. DEFECTS IN BALANCE SHEETS. What ones will cause the refusal of a line of credit? 3. COMPLETE FINANCIAL STATEMENTS. Why are they de- manded by the banker? 4. "PUTTING THE BEST FOOT FORWARD." Is it a good policy in making out a financial statement? 5. PUTTING THE HOUSE IN ORDER. What are the three steps, financially? 6. ASKING A FAVOR. Is it a favor for the banker to extend credit? 7. PERSONALITY OF A BORROWER. What three points does the banker investigate? 8. SUPPLEMENTING A LINE OF CREDIT. What wayB are open to the business man? CHAPTER X HOW TO BORROW PROFITABLY In Chapter II we' have seeh the distinction between owned and borrowed capital, and it was pointed out that funds borrowed on long time for the purpose of supply- ing the need for capital on the part of the business or public undertaking can usually be secured at lower in- terest rates thru the sale of bonds. ^ The emphasis in the present chapter is placed more strongly upon borrowing for current needs rather than for the purchase of capital assets, altho many of the principles outlined in this chapter apply in a general way to long as well as to short-trnae loans, fo fixed as well as to working capital requirements. Two chief considerations should be thoroly appreciated by the business man who wants to obtain a loan : first, the fact that it is good business to borrow for legitimate re- quirements; and second, the importance of getting the lowest possible rate for the use of the money. This chapter will cover these points specifically, with the object of showing how necessary it is to take into account every angle of financing a business. When It Is Good Business to Borrow Let us look at the first consideration. Borrowing serves no economic purpose except as it enables the bor- rower to make a greater profit, to reduce his costs, or to 160 How to Borrow Profltdbly 161 obtain valuable (productive) publicity. Unless he is creat- ing, he is going down hill when he borrows, even at a low figure. Thus, borrowing profitably is linked invariably with good business. It touches closely on the successful elements inside the concern and cannot be profitable un- less the everyday financing is on a sound basis. Thd mere fact that credit is obtainable at a reasonable price does not necessarily mean that it is wise to borrow. What is wise or justifiable borrowing requires close analysis to the same extent as does the internal management — costs, buying, mark-up, and so on. If however, there is a legitimate reason for borrowing, the business should have no hesitancy in seeking a loan. Too often the young business man launches forth into commercial or industrial life saturated with the repeated warning: "Don't go into debt." He has been taught to abhor debt until gradually he shrinks from borrowing, even for business purposes. It is essential to distinguish, therefore, between personal debts incurred needlessly and business obligations assumed for the purpose of im- proving the activities of the concern. Let it be empha- sized here, then, that you have a right to borrow from the bank for the purpose of handling a profitable propo- sition, and no business man should ever approach his banker with the thought that he is asking a favor for a loan. It is legitimate in every way, and one needs on^y to look at the "loans and discounts" item of a bank state- ment to see the great part that banks play in fostering the financial success of concerns of all kinds. Thk Good Will of the Banker But first of all it is essential to be on good terms with the banker when you go to him to obtain a loan. This 162 Financing a Business means that you must be financing and running your busi- ness well, as pointed out in previous chapters. In other words, you can't expect to have his enthusiastic co-opera- tion if you are using slipshod methods in your organiza- tion and if you are plainly not entitled to a loan. These are days of knowing — ^not guessing — and investigation shows that the executive who is hazy about his costs, his supervision, and his general prospects, is not in favor at the bank. On the other hand, the good business man finds it easy to borrow at a reasonable rate. "We have a strictly high-class customer," says one banker, "whom we urge to borrow from us, even when conditions are unsettled and rates are higher than usual. We want him to have the use of the funds because we know he is good, and we'd rather have him owing us than be tempted to let the money oiit elsewhere." As a result, in tight times, this customer can get credit from his bank when he most needs the temporary help. And he can get it at a low rate comparatively — simply because he knows his business and conducts it profitably. This, then, is certain : If you have y6ur business on a trustworthy basis you will have no trouble in borrowing for your regular requirements at a reasonably low rate of interest. If youf banker will not accommodate you under these circumstances it is time to look for another connection. Conditions Apfboting a Loan We are assuming here that you are confijiing your bor- rowing operations to your banker. But this may not al- ways be advisable, if you would get the best "buy" on money. Many factors come in to affect the price of bor- rowing. To cover the subject thoroly we shall find it How to Borrow Profitably 163 well to touch on the various ways to borrow and the in- fluences and tendencies that affect the rate. Broadly considered, the price you will pay depends on these conditions : 1. The time 2. The source 3. The location 4. The type of business 5. The specific need 6. The risk, security (if any), and the period of the loan 7. The effect of indirect influences. Time Factors in Securing Loans Let us look into each point carefully. As suggested by the banker who relates the interesting incident in a pre- vious paragraph, the period when you apply for the loan has a considerable bearing on the result. If the country is in a state of panic and you are not in a strong financial position, you may have to pay a high rate of interest to obtain a loan at all. In using the. term "strong" finanicial condition, it is not the intention to intimate that a busi- ness must be in the million-dollar class. A very small concern may have an A 1 credit. Thus, the time of bor- rowing is often highly important. Should the community in which you live be highly prosperous you might then have to pay a higher rate of interest, for under these circumstances money is in much greater demand. A strik- ing example of this presented itself during the years im- mediately following the World "War. If times are quiet, but not panicky, the money market is usually easy, so that you can obtain fimds at a minimum price. It re- quires far-sighted financing, usually, to enable a concern WhatWill It Cost Y<«1 loBomw? Factors Affiecting the Cost of Loatis Stes;'' High Rates ';;;^^^^fc,„ Fig. 27. — Factors Affecting Cost of Loans How to Borrow Profitably 165 to use borrowed money for special requirements at a quiet time when funds are obtainable at the cheapest price. Investigation has shown that many concerns make a practice of borrowing in quiet times for the purpose of making improvements and for other special activities, getting the work done at a reasonable cost, and then liquidating the obKgation as the upturn in business bomes. The condition of the crops and of the stock markets, and foreign trade conditions at the time of applying for a loan all tend to affect the rate. Considered from the standpoint of a long-time loan of a fairly large amount^ the interest charge under varying conditions fluctuates so widely as to make it a serious consideration. If it is found necessary to borrow at a high rate, some firms insist on a stipulation that the notes be made for a short time only, so that they can be taken up and reissued at a lower rate of interest when the market declines. The Source of the Loan The next factor to be considered is the source of the loan. This question frequently is, neglected to a serious extent by business men. Investigation indicates that many concerns in small communities are handicapped because they do not realize the possibilities of borrowing profit- ably from sources other than their own banker. Not that outside borrowing is always the part of wisdom. On the contrary, it is sometimes recognized as poor business judgment, especially if the local banker is broad-gauged and ever ready to give his undivided support to his cus- tomers. Perhaps he is especially valuable for emer- gencies and fulfils all the demands made upon him. Under such circumstances some men consider it far more 166 Financing a Business important to stick to one bank, even tho the rate on loans is higher at times because of the assurance of safety it gives in times of need. Leaving this consideration out, loans are often obtain- able from brokers or outside bankers at a lower rate than from the local banker. The note broker, having a wide field, frequently -will buy paper at a price a shade lower than the local rate and dispose of it to investors who are content to accept a smaller return. Owing to its different location and its faster turnover, an outside bank will fre- quently take paper at a lower rate if the maker has estab- lished a good connection. Many concerns have this addi- tional outlet for their business requirements. In addi- tion, a supplier whose interests are closely knit with the local concern may find it advantageous to lend money at a lower price in order to safeguard; its own in- terests and its selling outlet. Friends sometimes offer the same opportunity for obtaining money at a rate that will be profitable to the concern. Effect of Location Location — ^the third factor in borrowing profitably — frequently has a direct influence on the, interest rate. For instance, in some towns of the Southwest the bank may be charging 9 per cent to its regular customers, while the rate in Chicago is as low as 5 per cent. As a matter of fact, the small-town man, as a rule, pays more for the use, of money than the man in the large industrial or com- mercial center. This is one reason in favor of establish- ing a connection with a large city bank if your business is large enough to warrant it and to make the bank willing to handle it. Generally speaking, the rates in the East run less than How to Borrow Profitably 167 in the far West and South. The Middle West prices are usually about the same as those in the East, while in the far North and Northwest the rates are higher. For this reason the matter of location has to be considered, altho usually the interest rate will be found to conform satis- factorily with business conditions in each particular sec- tion of the country. Growing concerns, however, are prone to seek outside sources for floating at least some of their paper. Sometimes they can borrow m this way for as low as 4 per cent, in contrast to a rate of 9 per cent or more at the local bank. In fact, the financial expansion of certain concerns makes it impossible for the local bank to float all their paper, which necessitates the outside help. A concern should, of course, guard against outside bor- rowing , unless conditions are distinctly favorable, A small business might find it difficult to secure a market for its paper unless it has grown to a fair size — ^perhaps with annual sales of around $300,000. The expense of looking up and proving the absolute safety of a concern quickly gnaws into the commission of the note broker, and he is not interested in unprofitable business. It therefore behooves the man who is conducting a small business to be careful that he does not jeopardize his position with the local banker, who may be the only dependable bulwark against a possible emergency. Type of Business Next we come to the type of business as an influence on the borrowing price. Here is a point which cannot be overlooked. You must expect to see the rate for money vary according to the class of business you are in. For instance, if your product or stock is highly seasonal and likely to deteriorate in value quickly, you will probably 168 Financing a Business pay a higher rate of interest than the concern handling a staple which does not change and is always in demand. Good examples of this contrast in stocks are found in the cases of women's apparel and of soap. The former quickly loses its chance to bring a top-notch price, while the latter sells always for practically the same. Pro- visions are always necessary and salable and are consid- ered better security for a loan than less staple wares. In other words, banks and other lending agencies consider the risk involved, and while a concern may be safe enough to lend to, there is always the element of uncertainty in- volved in a loan which must be covered as fully as pos- sible. Concerns whose business is of a speculative nature may find it difficult to borrow even at a high rate. This ac- counts for various stock-selling schemes for small in- vestors. In order to obtain a loan at a reasonable rate of interest a business must have proved itself, and young concerns may be unable to borrow, as pointed out in the previous chapter. The present condition of a business, aside from its apparent financial strength, is the object of scrutiny of bankers before any loan is granted. If em- ployees are dissatisfied and labor or other difficulties threaten, the interest rate is likely to mount higher, be- cause of the possible chance of having the loan outstand- ing longer than first intended. "Cattle loans," which have developed in the past gener- ation, have been a boon to the farmers and stock raisers. Banks, and in some cases cattle loan companies, have been organized to handle cattle paper. Loans may usually be obtained for the purchase value of the cattle at the time of the loan by a reputable borrower, on making a satis- factory financial statement a,nd on giving a note and chat- tel mortgage on the cattle and on sufficient feed to feed Eow to Borrow Profitably 169 them adequately for the period of the loan ; the maximum time being usually six months on live beef loans. Nat- urally, with proper feeding and care, they will appreciate ^ in value. Before the loan is completed by the bank, a representative will investigate the (condition of the cattle, the conditions of sheltering, water, fences, and other cir- cumstances, all of which, of course, must be good. Stock cattle, such as cows, young heifers, and steers, which are kept on farms or ranches for growth and feed- ing purposes ("stock loans"), and milch cows of dairy- men ("dairy loans") are often the basis for loans for longer periods thru renewals or with the stipulation that payment of small instalments shall be made at monthly in- tervals. On account of the larger period involved, these loans are not so desirable for the commercial bank as the more liquid live beef loans. The Specific Purpose of the Loan This brings us to the fifth influence on the price of money — ^the specific need of the borrowing concern. Bankers feel they have the right to know what the money is to be used for— whether to buy a special order of goods, to pay off an obligation, or to make a necessary improve- ment. It is practically always regarded as good policy for a sound concern to borrow money, if necessary, to discount its biUs, since not only is the credit reputation of the con- cern improved by such a policy, but it also usually results in a snug item of profit because of the margin between the rate of discount offered and the rate of interest charged by the bank. Ordinarily, the applicant for a loan will find his chances for getting the money he wishes far greater if he tells 170 Financing a Business voluiitarily at the outset why he is borrowing. This, ex- perience shows, immediately establishes a friendly con- tact with the banker and gains in the long run greater favor. The Risk Factor Closely linked with the purpose of the loan is the risk involved and the length of time it is desired. Money de- sired for a long period sometimes brings a rather high interest rate, and this is increased further when the risk becomes greater. Of course, the security element ajffects the price to a certain extent, tending to reduce the rate of interest in proportion as it is sufficient to cover any possible loss. Loans backed by high-class securities, such as Liberty or other government bonds, are made often at a very low rate of interest. The element of safety makes the lending attractive from the banker's standpoint. Bills of lading, warehouse receipts, and chattel mort- tOHS DOE WAREHOUSE COMPAMY Nn uW.A. 8MB n C9MZUM . ^ '^^ ^\st : _ ' tV^ - «J x. Ijter ... _— .-. L . 1^ .Nkft ''^ ■ "^^ ^ao-— — M» akt«ft mui •* MM* K Wt aMtaf .^Sk.^ ■mt> fn»— - ■ v-, ■ ' Fia. 28. — Kon-negotiable Warehouse Receipt Form How to Borrow Profitably 171 ' *' " ^ . .-■■ — ;■■- ... ■ , - I • 1 I H" If. ~r~— — JOHN DOE WABEHOUSE COHPANY taaaua«Miilha»1jMfMiWaHtaMl«alKiA.lfti9atrllto«i#Bd«am ---- I u IndkiM Waw; ^ (Mwr duriM fn wUeh Km is cUlmad- ■ «wrt My It ■■% ar M « rAtTui. KunBiu Mtrm on th< imk op THM RBCSm IthiMd hMMn. Um IMttnng mercbandiM; Mum* vf ffoodi in ston t* ba nqMwiUi Iw bD «tMtf ^•'■^ Dm Mimia Paouo* Hi SlGMTCM •»' AOTMsntD Aim Fio. 29. — Negotiable Warehouse Receipt Form gages enable concerns engaged in handling staple prod- ucts to secure loans at very favorable rates by pledging these paper representatives of commodities as collateral security. A good example of the usefulness of this type of col- lateral is the Order Bill of Lading. Eepresenting, as it does, a claim for a specific lot of goods, it is a negotiable instrument that is very useful to the individual or 172 Financing a Business concern that needs prompt settlement, or wants to be sure of getting the money for the goods. By indorsing the Order Bill of Lading over to the order of the bank, funds can be obtained promptly at low rates, since they are secured by commodities possessing stable value. Further reference is made in Chapter XVII to the use of the Order Bill of Lading in connection with foreign trade. Miscellaneous Influences Coming to the final — ^the seventh — ^point of the tabu- lation, it is worth while to consider other miscellaneous influences which affect.the price of money. One is the use of the trade acceptance which tends to stabilize everyday business, as shown in Chapter XL Another is the Federal Reserve System which tends to make the interest rates of the country more uniform. Providing as it does a back- ground for the lending operations of the banks of the country, it is probable the rates generally will tend to be- come uniformly lower over the country. Another influence on borrowing rates is the service feature. Often a concern will pay a high rate because of the prompt service obtainable. Instances have been fpund where a business house could afford to pay 8 per cent where ordinarily it would pay only 6 per cent, simply to turn a quick deal and make a profit far above the extra interest charged. To borrow profitably, then, it is necessary to have an accurate knowledge of the condition of the business itself and of all these other factors which influence the price. No business man, ordinarily, can afford to pay 10 per cent for money which is going to bring him in net profits only 9 or 8 per cent. That covers the whole situation tersely but truly. How to Borrow Profitably 173 SELF-TEST QUESTIONS 1. OBTAINING A LOAN. What two factors are to be considered? 2. "DON'T GO INTO DEBT." Does this apply rigidly to business concerns ? 3. TIME FACTORS. What are they, in securing loans? 4. "BORROWING AT HOME." Is it always advisable? 5. PECULIARITIES OF A BUSINESS. What are some which affect the rate of interest on a loan? 6. PURPOSE OF A LOAN. What three purposes will get a loan most quickly and most cheaply? 7. RISK OF MAKING A LOAN. What two considerations affect it? 8. INTEREST RATES. Why does the Federal Reserve System make them lower? CHAPTEE XI HOW TO USE THE TRADE ACCEPTANCE Not long ago a manufacturer in Pennsylvania changed his selling terms on a certain line from "1 per cent 10 days, or 30 days net" to "net cash, remittance within 15 days from date of invoice, or 30 days from date of in- voice providing our trade acceptance is signed and re- turned to us immediately." This notice, therefore, caused the withdrawal of the 1 per cent 10 days discount privilege. The action of this manufacturer is thus set forth at the beginning because it has a significant bearing on the sub- ject of trade acceptances and also because it illustrates a condition that every business man must consider care- fully before using acceptances, as we shall see later. The trade acceptance is exerting a tremendous influence as a credit instrument. Some merchants and manufacturers indorse its use ; others hesitate about employing it freely. In order, therefore, to determine its general adaptability, the business executive should analyze the acceptance in relation to the needs of his own particular business. Teadb Acceptance Defined Let us consider first the meaning and the functions of the trade acceptance. The trade acceptance is a time draft or bill of exchange drawn by the seller of merchandise on the buyer for the 174 Eow to Use the Trade Acceptance 175 purchase price of the goods. The acceptance bears on its face the signed acceptance of the bnyer with the date and the place of payment (Fig. 30). When a bUl of goods is sold, the seller, if he is employing the trade acceptance method, sends with the invoice an acceptance form show- ing the net amount of the invoice, and the date of matur- ity (Fig. 30) . The buyer, unless he chooses to remit pay- ment in cash, deducting such cash discount as may be allowed, accepts the instrument, by writing on its face the date of acceptance, the place where payable, signing his name, and returning it to the seller (Fig. 30). .jjSisa . t i hl c pig B, _ l y i BOl e . fif i ptm i lifrr^l 0. — ytOS^— Fio, 30.— Trade Acceptance The seller may hold the acceptance until a few days be- fore it is due, when he will turn it over to his baiik to be forwarded for collection ; or if he needs funds, he may dis- count the acceptance, or a batch of acceptances received from various customers, at his bank; or, again, the accept- ance may be sold in the "open market" thru dealers in commercial paper or otherwise. It may be stated here that the open discount market is not any particular place, but comprises the banks, bank- ers, and commercial paper dealers who discount, buy and sell, or deal in prime commercial paper (Chapter XII). 176 Financing a Business Bankee's Acceptance Defined Of equal iinpoi'tance in many ways is the banker's ac- ceptance. This particular form of acceptance is a bill of exchange of which the acceptor is a bank or a person or company engaged in the business of granting banker's acceptance credits. Tersely stated, a banker's acceptance means the extension of the bank's credit to a customer in return for which the bank requires a consideration based on percentage. Th6 credit thus permitted is secured or unsecured according to the character and financial stand- ing of the borrowing customer. Pros and Cons of Acceptances What, then, are the advantages and the disadvantages of the trade acceptance and of the baiter's acceptance? Before answering this question it is worth while to turn again to the action of the Pennsylvania manufacturer who withdrew his cash discounts, because some users of the acceptance say it is their experience that the system of cash discounts is impaired by the liberal employment of acceptances in credit. This criticism, and there are other minor ones, should, therefore, be kept in mind be- fore coijsidering the major advantages of ttie trade ac- ceptance. Now, the aecsptor of the trade acoespteaioe is almost al- ways the merchant or manufacturer who is not able to dis- count his biQs. Some&nes he is willing to sign a note for merohandise pTKrcbased; agsaa lie aiay resist the recfuest for a note and try to pay som© iSkne withm 90 days after date of purdmse. So, when the business man decides to use the acceptance among his customers he will find that he must necessarily confine himself to those buyers who do not discount their bills. And he will find among this class How to Use the Trade Acceptance 177 a large number who will refuse to sign drafts or notes for merchandise purchased. How, then, are these buyers to be converted to the idea of giving acceptances? How are they to be taught the difference between the acceptance and the note or the draft? In the whole subject of trade acceptances there is prob- ably nothing more important than this point. It is an obstacle that is almost sure to be encountered by the busi- ness man who begins to use the acceptance among his customers. It is, therefore, desirable to show at the outset that an acceptance is, in reality, not a note, because a note may be given for a past due account. The trade acceptance should never be. A note may be given for money bor- rowed ; a trade acceptance never. The acceptance is not a sight draft, because a sight draft is generally used for the collection of an overdue account ; an acceptance never. A draft may be drawn on demand, payable at sight or at the end of a stated time; the acceptance, which is a type of time draft, must have a definite maturity. So much for the major differences between the accept- ance and the note or draft. ' When an acceptance is signed there is a definite bar- gain between the buyer and the seller, both as to the amount due and as to the time of settlement. Thus, it helps to provide a check on reckless buying because it compels k€seping better track of outstanding obligations. It simulates the habit of prompt payment and furnishes an excellent reason for requiring prompt payment from customers. Moreover, it' enables capital to turn over more frequently and puts the acceptor in the position of a preferred buyer, thus strengthening credit. The ac- cumulation of overdue accounts is naturally lessened. 178 Financing a Btisiness All of this helps to develop a sounder and more serious attitude toward the buyer's own obligation and it relieves the seller from the burden of financing his customers and the consequent burdening of his own capital. And since the acceptance represents a definite business transaction it furnishes a more liquid asset than a note or a draft for the reasons already stated. Introducing the Trade Acceptance How can the buyer be taught to see these advantages and to use the trade acceptance? That is a problem for every business man who decides to adopt the use of ac- ceptances as a method of financing his business. The experience of a manufacturer in Ohio may prove helpful here. He instructed his salesmen to give terms of 2 per cent, 10 days; 30 days net; or net 70 days for acceptance. If the customer wishes to take advantage of the, longer terms, the salesman makes a note of this on the order and an acceptance is sent with the invoice. This manufacturer finds that the retailers are reacting satis- factorOy to the idea of the acceptance, especially in the larger centers, such as New York City and vicinity. Out of $125,000 in acceptances received in one month, not one was dishonored by a failure to meet it on the due date. Directing the salesmen to teach customers about the acceptance is, therefore, an effective method of extending the use of this plan of payment. Another satisfactory way is to employ direct-by-mail methods. A large south- em mill, for example, has sent out the f oUoAving letter to all its customers with excellent resxdts: Gentlemen: In order to keep up with the times, we should work together and co-operate. We can help you and you can help us. If you do not discount this shipment, will you send us an acceptance? How to Use the Trade Acceptance 179 Mutual Interests. The interests of the buying house and of the selling house are mutual. ^ What affects the one affectg the other, and tiiey should work together for their mutual advantage and protec- tion. Our trade acceptance terms give you the advantage of a cash» buyer's discount, lowest commercial interest rates and conversion of merchandise into cash before maturity of obligation. Form of Acceptance. Attached 'hereto is a form of Trade Accept- ance (this form is like that shown in Fig. 1) which we should be pleased to have you use for the term of time desired. This accept- ance should be dated fifteen days from date of invoice, for an amount covering value of invoice, after deducting freight and 2 per cent discount, plus interest at 4 per cent per annum for 60 days' maturity, 4^4 per cent interest for 90 days' maturity, plus bank ex- change charges of 10 cents per $100.00 or fraction thereof, of net value. This acceptance should be signed on the red line on the margin at Koell as across the face of the acceptance. Our Terms. Cash less 2 per cent 15 days. Open account, net 60 days, or trade acceptance dated 15 days from date of shipment less 2 per cent discount plus interest at 4 per cent per annum for 60 days, or plus interest at 4^4 per cent per annum for 90 days. In- terest subject to change without notice. Two Per Cent. To encourage the immediate use of trade accept- ances in our business relations with the buyer, we intend for the time befng to allow 2 per cent discount from net value of account, giving the buyer the same advantage as accrues to iiie cash buyer, and, in addition, interest at lowest commercial rates. \ With this letter a regular trade acceptance is inclosed for the signature of the buyer. The following is another interesting illustration of how the direct-by-mail appeal may be employed to enlighten business men on acceptances. This letter was sent out by the president of an eastern bank to all commercial cus- tomers. The letter follows : Have you followed the development of the Trade Acceptance system? Do you realize that hundreds of millions of dollars now tied up in open book accounts can be made available for greater service to our government thru the general substitution of the Trade Accept- ano«? Open book accounts, as such, are not liquid. Trade Acceptances 180 Financing a Business are negotiable and in a form that can be used as a basis for cur- rency and the support of our financial system. The customer's Trade Acceptances in your portfolio provide you with the best paper to present at your bank for discount. The Trade Acceptance is considered a better document than your single-name note, and by its use you can save interest. If you are a buyer you will show your patriotism if you give Trade Acceptances in settlement of your accounts payable. The advantages to be gained by use of Trade Acceptances are too numerous to set forth in a letter, and I would therefore appreciate the privilege of going into the subject with you by personal con- ference. Yours very truly. President Thus the letter can exert a strong independent force or it can be made an effective supplemental aid to the sales- ^ man by any business man who wishes to show his cus- tomers what the trade acceptance really is. Eelation of Acceptances to Notes and Dbafts Reference has already been made to the difficulty that sometimes arises over the question of notes and drafts and their relation to acceptances. Ri^ht here it is worth pointing out that under the present system the business man borrows from his bank for current business opera- tion^ largely on his note, which is called single-name paper. These notes, as now executed, are closely al- lied to commerpial activities, tho some portion of such borrowings undoubtedly goes into fixed investment. Some business men, however, feel that these notes are not so self -liquidating as trade acceptances, and as they are drawn in fixed amounts and for from 4 to 6 month periods,- couM not fluctuate so readUy with the rise and fall of business volume as can the trade acceptance which is drawn for shorter periods and which may be more readily rediscounted at federal reserve banks and serve as the How the Trade Acceptance Originated "to/,. &1V •^ %-.. -APpocesscf ^, Cutting off the Undesirable in Receivables COJ Af> ^^ ^^%S^ "O ^^<.*^4^v. / T/ot :C9^ ^ .Z.^^- ,,'/,^^ #///;**" ^ ^ /? • A 4j ^ 7r I o (2, <3:' / If all your receivables, (accounts receivable- notes receivable)' ar«. converted into Trade Acceptances, they be- come more negotielble because undesirable qufd* itiea are omitted. Fio. 81.— How Trade Acceptance Originated 182 Financing a Business basis for the issue of federal reserve notes. Acceptances might be substituted to a certain degree for accounts re- ceivable, which in turn could be used by borrowers instead of their single-name notes. It is upon this point prin- cipally that a difference of opinion has arisen concerning the true value of trade acceptances and it will be consid- ered more fully later. The value of the item of accounts receivable in the financial statement of any merchant or manufacturer de- pends, of course, upon the credit standing of the debtors. At present the banks do not know a great deal about this phase of their customer's affairs, but it would be disclosed thru the presentation of acceptances, and the bank would thereby know the class of persons to which their borrower was selling and the credit risks which he was taking. The success of any business depends upon the character of the credit it extends, and the opportunity to know this phase of its customer's business abUity and methods, would be helpful in determining the value of his indorse- ment (Chapter IX). The borrower's ■ own responsi- bility would be strengthened, inasmuch as his credit ex- tensions would be stronger thru the tendency of ac- ceptances to lessen the dangers of over-buying and the creation of an obligation which buyers would take care of more conscientiously than they do open accounts. True, there will always be some borrowers who cannot dispense with borrowing on their single-name notes because of the small amount of bills receivable that they hold, but the presentation of both kinds of paper from the satne house need not be dangerous. As previously stated, the users of trade acceptances be- lieve they are more liquid than promissory notes because they represent specific transactions which are to be closed How to Use the Trade Acceptance 183 when completed; i. e., when the buyer of goods converts into cash those goods for which he has given a trade acceptance. Bank borrowings on promissory notes are presumably loans made to the signer until he receives cash for goods which he has bought and paid for; but each note repre- sents many such transactions and is one step farther re- moved than the discounting of the acceptance would be. A bank whose funds have been advanced on discounted trade acceptances possesses assets that are more liquid than if these advances were made on promissory notes. It is a fundamental principle of banking that any institu- tion whose deposit liabilities are payable on demand, as is the case with commercial banks, should possess assets that are as liquid as possible. It is probably true that there will be more documents to Be handled by the banks if the use of the trade accept- ance becomes greater. On the other hand, many of the checks now handled by banks are received by their de- positors in payment of open accounts. Trade acceptances, being made payable at the bank, could frequently take the place of these checks, thus changing a like volume of transit items into collection items without increasing the total. ' Credit Standing an Impobtant Factob The fact that the paper is in trade-acceptance form should not lead anyone to believe that proper investiga- tion of the credit standing of the parties to the bill is not just as necessary as if the goods were sold on open ac- count. If the trade acceptance is to mean d,nything more than single-name paper, there should be responsibility j^ttaehed to the acceptor of the bill as well as to the drawer. While, of course, the bank which discount* a 184 Financing a Business trade acceptance for its customer may not require a state- ment of tlie acceptor, except in the case of those who accept for unusual amounts, yet the business man should see to it that his bank is provided with sufficient infor- mation to enable it to determine whether the acceptor is financially able to meet at maturity the amounts for which he has given his acceptances. Practices That Violate the Peinciple OF THE Teadb Acceptance Trade acceptances should be neither taken nor dis- counted nor marketed for overdue accounts. The trade acceptance, as an instrument in trade, has a specific func- tion to perform, and is used for one purpose only. It is a negotiable acknowledgment of an actual sale of goods by a seller to a buyer/ and constitutes a promise to pay, representing a live transaction and covering the time in- volved in the terms of the contract of sale. In order to cover a number of small sales in one acceptance, no ob- jection can be made to making the acceptance for the average time, but it is a distortion of the trade accept- , ance method to convert an overdue account into a trade acceptance. Acceptances should never be renewed, for the reason just mentioned, since a renewed trade acceptance does not represent an absolutely current transaction. There have been cases where it was expected that a trade accept- ance would be renewed from time to time, since shipments between the same parties to the acceptance were occur- ring each month in an amount equivalent to the amount of the trade acceptance, or exceeding it. This is not good practice, and the acceptance should, wherever possible, be drawn for the actual amount due on the sal6 or the accu- How to Use the Trade Acceptance 185 mulation of sales. The exception arises when it is neces- sary to issue acceptances for smaller amounts in order to facilitate their discount. The giving and taking of trade acceptances should not be used as an excuse for an unreasonable time in the terms of sale. The time for which a trade acceptance should be made ought to cover only a sufficient period to enable the buyer to dispose of the goods and receive settlement therefor. If the buyer is receiving trade acceptances from his customers, these will be available for obtaining funds to meet his own acceptances. Therefore, in the use of the trade-acceptance plan, unreasonable extensions of time should be avoided. Such unreasonable extensions of time defeat the primary purpose of the trade accept- ance — the release of tied-up capital. Goods shipped on consignment should never be the basis for a trade acceptance, as the goods are not actually sold. A trade acceptance should be issued only ror goods actually sold. Some firms have inaugurated the trade-acceptance sys- tem in their business by beginning on their slow-pay cus- tomers. The only serious objection to this method arises when the concern attempts to market or discount these acceptances and makes claim to a prefe;:ential rate be- cause of the two-name self-liquidating character of the paper. One argument in favor of the trade-acceptance method is that it serves to show the character of the people to whom the borrower is selling and whether or not they pay him promptly. The business man should, therefore, keep in mind that the bank receiving for discount an of- fering of acceptances accepted by concerns of inferior credit standing and slow-pay reputation will not become enthusiastic about making a, preferential rate, and may even feel like revising upward the loaning terms. 186 Financing a Business Opposition to the ITsb of Teade Acceptances Having considered the main advantages of the trade acceptance and the method of using it, let us now turn to some of the objections that have been made by business men to this plan of financing business. In establishing credit ratings, the buyer who does not take advantage of this cash discount is usually classed as of uncertain credit. Even if his statement appears to show him as a good credit risk, his credit rating is lowered when he does not take advantage of the cash discount. A buyer who gives trade acceptances practically admits that he has not taken advantage of this cash discount. The best that can be said of a business man, and which, when once said, eliminates any further consideration of his credit, is "He discounts his bills," says an Eastern business executive in comment- ing on acceptances. Any business house that takes trade acceptances from its cus- tomers and sells them oil the street, or to its banlc, by so doing demonstrates that it has not sufficient credit for its business re- quirements. Any house whose requirements embody credit quality can provide for its needs by its own single-name paper. Any buyer who settles his bills by trade acceptances tacitly ad- mits that he is not in sufficient credit to provide for his require- ments, for if he were he would borrow his money as needed, and take advantage of the cash discounts. Trade acceptances, it seems to me, constitute a method for com- pelling the seller to finance the buyer. The selling of the paiper constitutes the financing of the buyer thru the seller's banks, which may not be familiar with the buyer's standing or condition. The logical financing of the transaction is fir the buyer's bank to finance the purchase in the community where the goods are for sale or for consumption. If the buyer cannot finance himself thru his own community, he shows a weakness in his own credit in that community by the issu- ance of trade acceptances. If the community banks have not funds, they can accept or indorse for the buyer and sell the paper for the benefit of the buyer and the community. If a name is not good enough to carry the best rate as singlc- aame paper, duplication of names of insufficient strength cannot How to Use the Trade Acceptance 187 compensate for lack of flttbig: credit in any one of them, and two or three additional names, all evidently of Inferior grade, should not expect a rate so low as one name of recognized good credit. This statement is illimiiriating because it reveals an unmistakable tendency in many business establishments which have considered the acceptance problem. They are opposed to thQ broad general use of the acceptance for the reasons already given. A large wholesale grocery house, for example, decided to make a nation-wide investigation into the subject of acceptances. It found that in the larger part of the United States the limit of grocery terms had been reduced to a 30-day basis, and where 60-day terms still prevailed, such terms were on special lines of goods and represented but a small percentage of the turnover. The wholesalers were found to be discounting to the extent of probably 90 per cent, the retailers to the extent of approximately 50 per cent, and the wholesalers' average outstandings were about 30 days' business. This particular grocery house feels it' is hardly worth while to draw acceptances for bills amounting to less than $100.00, and as the average wholesale grocery bill is only about $40.00, it will not draw acceptances for single bills. To draw acceptances against occasional bills of large amount and charge smaller bUls to the same customer on open account might be confusing and unsatisfactory. To draw an acceptance for a 30-day statement would mean in practice giving official recognition to 60-day terms, whereas such terms in the wholesale grocery line are sel- dom to be found nowadays. So this grocery house believes that the acceptance plan would have a tendency to increase current grocery terms and, therefore, of necessity to increase credit risks, be- oeuse, after all, an account is not paid simply because a 188 Financing a Business buyer has signed an agreement to pay, whether it is a note or an acceptance. It is sometimes xirged, it is true^ that economies effected by adopting trade acceptances would enable the granting of longer terms. This might involve increased credit risks. In this connection it is interesting to note the fol- lowing statement attached to an acceptance sent out by a large Michigan firm : Thirty Days Extra Time can be secured on this invoice by signing' attached Trade Acceptance 1. Do Not Use it Unless You Want To. If you prefer you may destroy the Trade Acceptance, and settle this bill just aS you have al^rays done on our usual terms, 1 per cent 10 days, net 80 days with 30 days' dating. 2. Thirty Days Extra Time. K you do sign the Acceptance, you are granted 30 days extra time, for the Acceptance is payable at the end of 90 days under the old terms. 3. To Anticipate or Discount. Do so on the basis of our usual terms, 1 per cent 10 days, net 30 days, 30 days extra. Another similar case is found in the terms quoted by a large paper house. This concern allows 2 per cent for cash in 10 days on open a:CCOunt, but allows the equivalent of 3 per cent and 60 days time if the buyer gives an un- dated trade acceptance with the Order, the date to be filled in by the seller at the time of shipment. Now it is prob- ahly true that no buyet would olqect to trade acoeptances drawn by Responsible sellers under such conditions. But the advaiitage of such trade-acStJeptance terms is aJl with the buy^, pit^vidirig the seller is STdScie'ntly reliable. The sellers in this case claim that these terms, "Accepted Trade Acceptecace with order," effect a saving to them in immediate turnover of capital, eliminatio'n of collec- tion expenses, and simplification of accounting, of some How to Use the Trade Acceptance 189 3 per cent, and for this reason they can, in connection with this plan, grant a concession which is equivalent to 2 per cent to those whose co-operation makes such savings possible. Some Typical. Uses In its practical application the acceptance is simple, as the following typical cases will indicate. Let us suppose, for exaanple, that the Dressed Beef Products Co. sells to Jones, Jones & Co. a bill of goods amounting to $5,450 on terms of 60 days net with a discount of 2 per cent for cash in 10 days. "When sending the invoice to Jones, Jones & Co., the Dressed Beef Products Co. also sends a trade acceptance (Fig. 30) properly filled out and signed by themselves. Now Jones, Jones & Co. may pay the bill within the cash discount period if they wish and if they do so there will be no need of accepting. If, on the other hand, they wish to take the full credit term, they may accept the acceptance by writing on the face, accepted, and the place of payment. Then they sign the acceptance and re- turn it to the Dressed Beef Products Co. On the date set for pajrment, which is December 15, 1919, the buyer will be expected to have sufficient cash on hand to take up the acceptance. If the sellers need funds in the meantime they can discount the acceptance at thear batok or sell it in the open market. So inueh for the domestic acceptance. Use in E^NANeiNG Imposts , Let us turn now to a method of financing imports with acceptances. Dorlin & Co. of Lowell, Mass., for example, have pur- chased from the Yokohama Raw Silk Co., of Yokohama, Route of the Trade Acceptance in a Domestic Transaction Described on Page 189. *1.^„ 1^ •Iff'-' > W\,£ ''S Fig. 82. — ^Routc of T^ade Acceptance in a Domestic Transaction - if ..in — »,. — < i_mj, Rnancind Imports with Aci^ptances Rriutes of Travel of fhe Items Involved Illustrating sUk-importing transaction described on pages 189 and 192 Fio. 33.— Financing Imports with Acceptances 192 Financing a Busimess Japan, 100 bales of raw silk, amounting to $25,570.15. As soon as the details of the transaction are completed, Dor- lin & Co. apply to their bank and obtain a letter of credit sufficient to cover the deal. The silk was bought on four months' time, so Dorlin & Co.'s bankers issue the letter of credit authorizing the Yokohama Eaw Silk Co. to draw upon it sight drafts at four months covering the cost of the shipment. The bank stipulates that a complete set of shipping documents must be attached to the draft, in- cluding the original invoice, the consular invoice, bills of lading, and insurance certificates. The fetter of credit is now handed to Dorlin & Co. to be forwarded by them to the Yokohama Eaw Silk Co. In most cases deals like this call for immediate shipment of the goods, and it therefore becomes necessary that the bank cable to its Yokohama banking correspondent giving advice of the issuance of the credit and Stating the terms and conditions. The correspondent, in turn, notifies the silk company of the opening of the credit. The Yokohama Eaw Silk Company then proceeds to make shipments of the 100 bales of raw silk to the United States. When the sUk is placed on board steamer, the silk company obtains from the steamship company the rela- tive bills of lading. It then draws its draft on the bank in the United States at four months' sight for the amount of the invoice. To the draft it attaches the bills of lading and other documents required, and takes the whole to its bank, which negotiates the draft and pays the proceeds in Japanese funds. The negotiating bank, having purchased the draft, for- wards it to its correspondent in the United States with instructions that it be presented for acceptance to the American bank. If, upon inspection, the bank finds that the documents are all in order, it accepts the draft and How to Use the Trade Acceptance 193 returns it to the presenting bank, after detaching the bills of lading and other documents which it will hold as secur- ity against the acceptance. The draft is now a bank acceptance (Fig. 34) and is eligible for purchase by a federal reserve bank when hav- ing not more than three months to run, or if for sale in the open discount market. It can be discounted and the proceeds placed to the credit of the bank in Yokohama, thus reimbursing them for the money paid to thf silk company. All of the documents pertaining to this importation of raw silk being now in the possession of the bank in the y^Wh...., lamiitry in. j/IZ/ i. FatSTi Fio. 34. — Bank Acceptance United States, it notifies its customer, Dorlin & Co., of the fact. Upon arrival of the steamer carrying the silk, Dor- lin & Co. request that the documents be turned over to them so that they may arrange for the unloading of the silk and for its entry at the United States Custom House. Before surrendering the documents the bank will re- quire that Dorlin & Co. sign a "trust receipt" in which they pledge themselves to store the silk in a public ware- house and to give to the bank the relative warehouse re- ceipt, pending sale or delivery of the merchandise. In case of sale or delivery of the merchandise, Dorlin & Co. sign, a "trust receipt," pledging themselves to turn Use of Bankers Acceptance ffT'^ inRnancing Exports To illustrate sale of bill of dry goods by Bay State Cotton Company to an Argentine firm. Described ' on page 195. Pio. 8&.— Use of Banker's Acceptance in Financing Exports Row to Use the Trade Acceptance 195 over to the bank the proceeds of the sale when they re- ceive payment. In many instances, where the bank allows the merchandise to be sold, it requests that the invoice covering such sale be "accepted" by the buyer, and that it be assigned and made payable to the bank. Use in Financing Expobts Turn, now, to a case of financing exports by the buyer. A firm in Argentina has ordered from the Bay State Cot- ton Co. dry goods amounting to $100,000 in value and has requested its banker there to finance it on 90 days' credit. The Argentina bank issues a letter of credit on the bank in the United States, asking it to accept 90 days' sight drafts drawn by the Bay State Cotton Co., provided such drafts are accompanied by a full set of shipping docu- ments covering the dry goods in question. On receipt of these instructions the bank in the United States notifies the cotton company of the opening of the Fio. 36. — Bank Acceptance credit, and advises it to present draft and shipping docu- ments within the time specified. Upon making shipment of the goods the cotton company secures the bills of lad- ing and attaches them, with invoices, consular invoices, and insurance certificates, to a draft drawn, at 90 days' Step !*• Financing Shipment fh>m Houston to New\brk . Described on Page 00. nwwwttwiHi nnw ifTwfwwwwtw* EDcpoirleii^s ili rn i(i i |h^*MM— m m il l U lii imr i " ] , til Fio. 37. — Step 1 in Financing Export Shipment of Cotton Step 2-Bnandn^ Shipment ^ from Newl&rk io Liverpool and $ale There Ifverjpooi J W <0 TJ O O O Cg") Cas^ . (6) Goods I MM IIWtt [ l ] l - l l! l l.l ! ll!l] !! mmUm * ' ffioods British ; Market i The charts on this and the oppo- site page illustrate financing a ship- ment of cotton from Houston to Liverpool, as described on page 198. Fig. 38.!— Step 2 in Financing Export Shipment of Cotton 198 Financing a Business sight, on the bank in the United States. The bank ac- cepts (Fig, 36) the draft on presentation and then dis- counts it and pays the proceeds, less 90 days' interest, to the cotton company. The documents are then forwarded by the bank in the United States to the bank in Argentina, which will be ad- vised that a draft for the amount of the invoice has been accepted for its account against the documents. Upon arrival at the Argentina bank the documents will be han- dled in accordance with that bank's usual custom, or in accordance with any arrangement it may have made with its customer. On maturity of the draft, the Argentina bank will have to deposit with the bank in the United States funds to enable the latter bank to meet its accept- ance (Fig. 36), together with the usual acceptance com- mission. Use in Financing the Shippeb Now let us take a case of financing by the shipper by means of an acceptance. The Southern Cotton Co., of Houston, Tex., has pur- chased 500 bales of cotton for export. The company wishes to ship to Liverpool on consignment, with the un- derstanding that the shipment is to be sold there after arrival. The cotton has cost $130,000, which amount is immediately "hedged" on the New York Cotton Exchange by selling futures against it. The firm then requests the bank to finance the shipment of the cotton by railroad from Houston to New York, from where it is to, be shipped to Liverpool as soon as freight room can be ob- tained. The bank, having agreed to finance the cotton thru the medium of bankers' acceptances, authorizes the South- How to Use the Trade Acceptance 199 ern Cotton Oo. to draw upon it, at 90 days' sight, for 80 per cent of the value of the cotton, i. e., $104,000, pro- vided that the railroad bills of lading covering the ship- ment are attached to the draft. The bank then accepts this draft (Fig. 39), sells it in the open market, and places the proceeds to the credit of the Southern Cotton Co. The bills of lading are retained by the bank as collateral security. In addition to that security the cotton company signs an acceptance agreement pledging the 500 bales of cotton as collateral for the credit, and promising to place MHitnn, Tnniiii , nirnli IQ, /SLA_ ~t— '♦ ff '"7T ■TO"—" -°i^''""'g''*— •'/"y-^"^" t>n/a, //' Pio. 39. — Bank Acceptance the bank in possession of funds to meet its acceptance at maturity. Later, when freight room can be obtained, the bank will arrange to have the cotton placed on board a steamer sailing for Liverpool, and will receive the ocean bills of lading covering shipment. The Southern Cotton Co. provides for marine and war risk insurance to cover the cotton while in transit to Eng- land, and will turn the policies over to the bank. These policies, together with the biUs of lading, will be for- warded by the bank to its Liverpool correspondent with 200 Financing a Business instructions to receive the cotton on the arrival of the steamer, and to place it in a warehouse pending further instructions. The Liverpool agents of the shippers are notified of the arrival of the cotton, and they inunediately proceed to sell it. Upon conclusion of the sale the bank instructs its Liverpool correspondent to deliver the cotton to the buyer against payment of the amount of the invoice in English currency, or against an undertaking to pay the invoice within ten days. On payment of the invoice, ^the amount collected is placed to the credit of the bank in the United States, and the bank is advised of the fact. The bank then converts the amount into dollars, at current rates for telegraphic transfers on London, and applies the proceeds to the payment of its acceptance (Fig. 39). It may happen that the bank would receive these funds before its ac- ceptance matures, in which case it would rebate the in- terest allowed until maturity. This completes the trans- action growing out of the consignment of the 500 bales of cotton. If the drafts have been paid, a new transaction can be consummated along the same lines. Here, then, is an export transaction. A domestic trans- action of the same character may be described as follows : J. M. Blank & Co., of Boston, purchase from J. W. Bryce & Co., of Galveston, 300 bales of cotton amounting in value to about $50,000. Bryce & Co. ask for immediate payment, as they wish to use the money for the purchase of other cotton. As Blank & Co. will require about 90 days to turn the cotton into Cash by reselling it, they apply to the bank for an acceptance credit (Fig. 40) of $48,700 to enable them to finance the transaction. The bank agrees to accept the drafts of Bryce & Co., drawn at 90 days' sight, provided certain specified documents, bills Eow to Use the Trade Acceptance 201 of lading, invoices, insurance policies, etc., are attached to the drafts when presented. !»1w..>n.. T.-m., g.rt, in. J^.l£». Fig. 40. — Bank Acceptance The bank then notifies Bryce & Co. that it has opened a credit in favor of Blank & Co, against which they may draw at 90 days' sight. Bryce & Co. now deliver the cotton at the wharf or railroad for shipment, and having secured the bills of lading, can obtain iramediate pay- ment for their cotton by drawing a draft on the bank, at- taching to it the required documents and discounting it at the bank in Galveston. The Galveston bank forwards the draft, with the docu- ments, to its correspondent bank in Boston, instructing them to present it to the bank for acceptance. The bank accepts the draft on presentation by placing its stamp and signature upon the face of it. The draft, which has now become a bank acceptance, is returned to the pre- senting bank; the invoices, bills of lading, and other docu- ments remaining in the possession of the bank in Boston. Acting under instructions from the Galveston bank, its Boston correspondent bank may sell the acceptance in the open market and credit it with the proceeds, thus reim- bursing it for the money advanced to Bryce & Co. when discounting the draft. Fmancim^ the Sh^er ma Domestic Shipment Described on page 200. ^» n I li W uttm i J Fia. 41. — Financing the^ Shipper in a Domestic Shipment How to Use the Trade Ac^eptanee 268 Title to the cotton is now vested in the bank in Boston thru its possession of the bills of lading pledged to it in the acceptance agreement. The bank will continue to retain possession until Blank & Co, provide funds for the payment of the bank's acceptance at maturity. When the cotton arrives in Boston the bank may allow it to be Credit No Guaranty Trust Company of New York Foreign Departmeni New York- tfaw* 90lh, _|j Chino-Ruesian Export Corporation Shanghat. Gentlemen^ We hereby authorize jrou to value on Guaranty Trust ComptLoy of New York, New York, for account of Ameriean Import Company. Netc York. up to an aggregate amount «| Tmtkousand DoUars ; available by your diafls at ^p^^ nioniks sight ^ igainat shipment of_ Tmnirnnw- ^ Warrisk effected in New York raw silk t_ (Vcw York Bills of lading for such ahiinnenta must be made out to the order of the Guaranty Trust Company of New York, unless otherwise specified in this crediL CONSUL&It INVOICE AND ONE BILL OF LADING HUBT BE SENT BT THE BANK OD BaNEEB NXGOTlATmO DBAFTS DIBECT TO GUARANTY 7RCBT COMPANY OF NEW YORK, NCW VORH. The remaining documents must a^ogifaDy the drafts drawn on Gimranty Tru&t Company of New York. New York. "* The amount of each draft, negotiated, together with date of negotiation, must be endorsed oa bock hereof. We h««by agree with bona fide holders that all drafts drawn by virtue of this Credit and in accordance with the above stipulated terms shall meet widi due honor upon presentation at the Office of Guaruity Trust Company of New York, New York, if drawn and negotiated prior to , — . Guaranty Trust Company of New York, N. B. Drafts drawn under this Credit must state that they arc "drawn under Letter of Credit No: Dated. — _ " Fio. 42. — Commercial Letter of Credit Payable in Dollars 204 Financing a Business placed in a public warehouse. In that case the bank ar- ranges for the transfer of the cotton, its title to it being protected by the negotiable warehouse receipt which is issued to the bank. It may have been the purpose of Blank & Co., when purchasing the cotton involved in the above transaction, to resell it to a mill and thus secure the funds for pay- ment of the acceptance of the Boston bank when it falls due. In that case Blank & Co. may arrange with the bank to have the cotton reshipped to their customer. Blank & Co. would then draw a draft on the piill for the amount of the invoice and give it to the bank. The bills of lading covering this shipment would be made out "to order," indorsed in blank, and would be attached to the draft. When the draft was collected, the bank would retain a sum sufficient to pay its acceptance for $48,700 at ma- turity. The balance would be placed by the bank to credit the account of Blank & Co, Accounting fob Trade Aocbptanobs Keeping a record of trade acceptances on the books is a comparatively simple matter, as they are handled in practically the same manner as notes receivable. A form for a Trade Acceptance Register is shown in Fig. 44. When a bill of goods is sent out with a trade accept- ance accompanying the invoice, the customer's account is charged and the Sales aceouut credited. If the cus- tomer accepts the trade acceptance and returns it, his accoimt is credited and the Trade Acceptance account is charged. If the seller is in need of ready cash he will discount the acceptance with the bank or sell it on the market. O O o o o o O rt o ^ o o m >n o o w o o < < Q I o to V " -is a s o o w -3 t! 0o 8 S" t •3 •g sta O o o < 5 o o o o o o o O <-t CO T3 O (o 3 ii ■s "a •" 'O ^ ••H O "O JH •s ^ -^ Id 3 o 5 u « ^^ o o o K S s rt S3 W <'>$•£• o * _ "a § 3 rt *3 -s-o 8 Z 09 pq IS •a * 2 B ft aw a SJ'O ■ CO CO 206 Fmaneing a Business la either case the seller will charge the Oaeh account with the amount received, and charge Discount Paid with the difference between the amount of cash received and the face value of the acceptance. The face value of the acceptance will be credited to Trade Acceptances Dis- counted, to show that the seller is secondarily liable as the indorser. When the acceptance is paid at the bank by the acceptor, the purchaser of the goods, the seller is in- formed and he closes his books, as far as that transaction is concerned, by debiting Trade Acceptances Discounted and crediting Trade Acceptances. O o Trade Accqitance Regiitgr G C«r Dtm«^ cr A*eftm VwJ. Fio. 44. — Trade Acceptance Register The fact that acceptances always grow out of an ex- change of goods is the characteristic difference between them and notes and drafts. Notes and drafts may be for How to Use the Trade Acceptance 207 a purely financial transaction not affecting accounts re- ceivable at all. SELF-TEST QUESTIONS 1. GETTING CASH FOR ACCEPTANCES. What three ways are open to the holder? 2. ACCEPTANCE v. NOTE OR DRAFT. What are the four major differences ? 3. ADVANTAGES OF ACCEPTANCE. What are they to the buyer? To the seller? 4. INTRODUCING THE TRADE ACCEPTANCE. How would you do it in your business? 5. CREDIT INFORMATION. How can the banker use trade ac- ceptances for this purpose? 6. CREDIT STANDING OF ACCEPTORS. Should the bank in- vestigate ? 7. VIOLATING PRINCIPLES. What practices violate principles of the trade acceptance? CHAPTER Xn ADDITIONAL SOURCES OF FUNDS The banker, as shown in Chapter X, is far from being the sole source of funds for business requirements. For- tunately, because of the effect it has on keeping the inter- est rate more nearly normal, this competition in the money market is often of great value to many types ol concerns. The availability of funds, aside from those offered by banks, has much to do with the mobility of money for business needs. In fact, experience shows that frequently it is the salvation of numerous smaller con- cerns. How this works out will be shown in this chapter. The chief sources of funds, in addition to bank credit, may be listed as follows : 1. The Note Broker • 2. The Supplier 3. Miscellaneous The Note Bbokbb We can begin by going thoroly into the subject of the note broker in his relation to everyday financing. Aside from banking, probably no factor exerts so great an in- fluence on the country's financial activity as the note broker. He fills the gap in the financial needs of con- cerns where the bank leaves off. It is especially interest- ing, therefore, to see just what his functions are. Briefly, a note broker negotiates short-time loans to 208 Additional Sources of Funds 209 business houses on commission, wMch amounts usually to 14 of 1 per cent. Handling a large amount of business, he often makes a steady and enviable profit. His funds are available from banks, investors, and others who want to make a reasonable and sure increment on their money over a definite short-time period, usually not THE NOTE BROKER Next to the banker, the note broker is the greatest single factor in financing commercial operations. -O •^^ ^«^ leave, °^/}/.?s AyX<2 Offf^S 4°-^> 4< ^if'-'-> 5R 'P w ml C/)| O ) c ; f 1 -^r .py suiBtqo® Fio. 46. — Characteristics of Note Broker 210 Financing a Business over six months. Many banks like to lend thru note brokers because of the independence it gives them. With customers, it is sometimes difficult for them not to grant renewals without giving offense, where with the note broker as a go-between, the transaction is clear-cut and the paper purchased has to be taken up on time. The note broker also affords the business man a quick source for borrowing. If the borrower stands high enough he can state his wants and get his money within an hour if necessary. Often, as indicated in Chapter X, the maker of the note can get it at a lower rate than his own bank can afford to make. Here is an important point to keep in inind. The note broker, having access to funds in various localities where interest rates are low, can place idle funds with borrowers in sections where the banking rate is ordinarily fairly high. Thus a borrower who would pay his local bank, say, 8 per cent imder nor- mal conditions, is able to get money from his broker for as low as 4 per cent or even 2% per cent for short-time needs of not longer than two months. As in the case of choosing a banker, however, it is essential to select a liote broker whose integrity and ability to take care of your needs are unquestioned. You must not only know that a note broker will co-operate with you in normal times, but that he will do so in abnormal or panicky periods as well. Your note broker should be a source to fall back upon when your banker has curtailed your line and when you must have more money in an emergency. You must, therefore, choose your note broker with great care. Experience has shown that your very business existence may depend on how far he ' can back you up in times of stress. The size of a business and its needs should be con- sidered in establishing relations with a broker. The Additional Sources, of Funds 211 small individual commission which this service brings to the broker precludes lending to very small concerns. It is probable that a concern with less than $200,000 annual business would find it difficult to borrow from this source^ because the business would not be profitable to the note broker. The loans would be too small to cover the ex- pense of handling the business. The note broker, of course, exhaustively studies the condition of the appli- cant for a loan and requires most detailed figures, including statements over a five-year period or even longer. Thus a concern must have a fine financial record to offer, and be large enough to borrow fairly sizable sums. If it is in this class and chooses the right sort of broker, it has taken a big step toward strengthening its financial position. Many business houses are so sound financially that brokers solicit them to borrow. Such paper is gilt-edge and is easily marketable, both to in- dividuals and banks. "Brokers constantly are asking to supply us with money," says the head of a prosperous Missouri firm. "We can have all the money we need, and more too, at any time, simply because we are doing a profitable busi- ness on sound financial principles." This indicates how essential it is to finance a business right. It means one additional prop against financial collapse. Some note brokers accept negotiable paper on consign- ment. They do not furnish the money at once, but try to market the paper first and then turn the funds ob- tained over to the applicant. If the borrower can wait, this sometimes works out satisfactorily. Note brokers, however, differ entirely from so-called "note shavers." It is not considered good financing to deal with shavers any more thanit is for an individual to patronize a loan shark. A note shaver, in other words. Where to Rnd Funds of Credit Fi0. 46.— Where to Find Funds or Credit Additional Sources of Funds 213 seeks out men who, altho intrinsically sound finan- cially, require funds so badly and so urgently that they are willing to sell their paper at an exorbitantly high discount — perhaps at 10 per cent or 15 per cent, instead of at 4 per cent or 6 per cent — simply in order to obtain ready cash. It is unfortunate that this type of brokerage exists. Every business man should endeavor to keep his concern so well balanced financially that he will be able to borrow profitably from the best note brokers in his locality. In the same manner as does a banker, a note broker aims to be a permanent source of service to his clients and to afford a continuous and adequate increased line of credit for short-time needs. Loans of this sort run from $25,000 on up. An instance of the value of note broker's service is shown in the experience of a pros- perous concern in the Northwest which required a loan of $50,000. The capital of the local bank was too small to fiirnish this amount legally. The president of the company, therefore, quickly got in touch with a reputable broker in a large city a few miles away. An investigation' of the business was made at once, with the result that the note broker furnished the entire $50,000 at- an attrac- tive rate of interest. The concern had the money, too, within a week after filing its application. Some concerns have found an arrangement of this sort more elastic than opening an account in a big city bank in order to gain a larger line of credit. The advantages of the note broker, then, are many, and deserve careful consideration. It may be well to repeat that the subject of borrowing requires careful analysis in order that the business may have the proper financing, while still main- taining the friendship and co-operation of the local banker, who so often is fairly indispensable for advice 214 Financing a Busi/ness and help. But these points, investigation shows, are easily handled if given wise attention and if a satisfactory working balance is maintained between the business con- cern, the banker, and the note broker. In other words, the broker, as suggested by the title of the chapter, is valuable as a supplement to bank service, but he does not supersede it. Before passing on to the next division, it is worth while to mention briefly just how the broker disposes of the paper which he accepts. He sells it to banks or individ- uals on a 10-day option, furnishing at the same time a complete financial statement of the concern offering the paper. If the bank or other buyer is satisfied to buy the paper within the allotted time, the transaction is closed with the note broker, and the buyer accepts all responsi- bility in connection with the repayment of the money furnished. The note broker is then free of any responsi- bility, as he does not guarantee the borrower will pay. However, the broker has a reputation at stake and it is known that many of them have voluntarily made good in the case of a loss, in order to protect their clients. SUPPLIBBS By "suppliers" is meant such manufacturers, contrac- tors, jobbers, and wholesalers as supply the equipment, materials, and goods that a business man needs in his business. Let us see now how these suppliers sometimes offer a source of funds.- As a matter of fact, suppliers are fre- quently the chief financial help of the new or young busi- ness man. Banks generally, owing to their peculiar character and the laws under which they operate, do not lend to the new concern which is limited in finances and Additional Sources of Funds 215 in business experience. The supplier, then, is the banker, so to speak. This is the source of success of many a business. It is, therefore, obvious that the financial in- fluence of the supplier cannot be passed over lightly. And the starting help is not all. Many suppliers, investigation shows, continue to be of great assistance to concerns and frequently help them over financial emergencies. It is not always money, either, that the supplier has to ad- vance. Perhaps his advice or counsel may at times be the thing that is most required. At any rate, the sup- plier is an important factor in business financing. Says one executive : "We should have gone on the rocks at one time but for the extensions our suppliers gave us. We could not borrow any more at the banks and were up against it. We had a reputation for honesty, however, and our creditors granted us the time we needed because of our rapid expansion. We paid a little on these bills each month until, before the end of a year, we were better fixed for cash. It pays to be scrupulously honest with suppliers. They can be of unusual assistance at times — especially in 'hard' times." Suppliers, then, are especially helpful when (1) the business man is lacking in actual experience; (2) the banks cannot make a loan; (3) the business is facing a financial emergency. A merchant in the Northwest who wanted to embark from a clerkship into business for himself, says that suppliers financed him until he had established himself and was able to obtain a line of credit at the bank. The co-operation and advice he gained was invaluable to him and resulted in his building up a lucrative business. When it proves impossible to borrow money in a slack season, suppliers sometimes grant extensions so that a man may meet his other obligations. This amounts to 216 Financing a Business < the same as borrowing. It is conceded, of course, that the supplier wants the distributor to succeed, because it means that much more outlet for his goods. The help, therefore, has a mutual reaction for the benefit of each. Some supplying concerns obviate the necessity of a new business borrowing by selling goods on time. Other sup- pliers actually lend money to merchants who exhibit good judgment and show their abihty in expanding their operati6ns safely. Of late, however, suppliers have tended toward limiting their lending operations and other banking functions as ill advised, except under rare cir- cumstances. . A big middle-western supplier still feels it is good busi- ness to finance his customers, even to lending money, and insists that under proper restrictions it enables new con- cerns to grow to the point where they can obtain a line of credit at a bank and finance themselves. In handling credits he tries to inculcate the best business practices in his customers and shows them the importance of taking discounts. This helps them to learn the value of good financing. In collecting the data for this book, numerous instances were found of the help given by suppliers to worthy busi- ness houses. It was shown also that trade acceptances, which are discussed in the preceding chapter, constitute an important instrument in strengthening the best finan- cial relations between supplier and customer. In placing dependence on suppliers, it is essential to keep in mind certain possible disadvantages. Financing necessitates looking carefully and thoroly into every fea- ture of this problem. For instance, is it better to have one supplier or several? There are favorable points to be found in both directions. To illustrate : By sticking to one supplier you are likely to have his fullest financial What to Raise It On How to Raise It Where to Raise It Accounts Receivable Sale Credit Companies, Bank Accounts Receivable Unsecured Personal Note Banfc, Money Broker, Individual Bin of Lading Sight Draft, Trade Acceptance.or Bank . Acceptance Bank, Money Broker Booked Orders Note Ban^, Money Broker Booked Orders Sale Competitor, Agent Business Reputation Unsecured Personal Note Bank, Money Broker, Individual Contracts Sale Competitors Contracts Unsecured Personal Note Bank, Money Broker, Individual Copyrights and Patents Sale Agent, Business Concern, Individual Copyrights and^ Patents Lease Agent, Business Concern, Individual Copyrights and Patents Collateral Note Bank, Money Broker, Individual Equipment Sale Concerns in Similar Line, Agents, Suppliers Equipment Lease Concerns in Similar Line, Agents, Suppliers Franchise Collateral Note Bank, Money Broker, Individual Franchise Sale Agent, Syndicate, Individual, Competitors Franchise Le^se Agent, Syndicate, Individual, Competitors Freight Connections Freight Connections Sale Business Concerns, Agents, Railroads Lease Business Concerns, Agents, Railroads Going Business Unsecured Note Bank, Note Broker, Individual Going Business Stock Issue (original or extra issue) Investment Banks, Stock Brokers, Employees, General Public Going Business Bond Issue Investment Banker, Bond House, General Public Going Business Sale Competitor, Friends, Capitalists Goods in Process Sale Customers, Competitors, Individuals Investment — Stocks and Bonds Sale Stock Broker, Bank, Individual Fio 47. — Ways to Raise Ready Money (Continued on next page) 218 Financing a Business What to Raise It On How to Raise It Where to Raise It Investment — Stocks and Bonds Collateral Note Bank, Money Broker, Trustee, Individual Lease Collateral Note Bank, Money Broker, Trustee, Individual Lease Assignment Agent, Business Concern, Individual Life Insurance Collateral Note Life- Insurance Company, Bank, , Individual Location Contract Advance Payment Business Concern, Real Estate Agent Mailing Lists Sale Concerns In Similar Lines, Advertising Agencies Notes Receivable Discount Bank, Money Broker, Individual Notes Receivable Collateral Note Bank, Money Broker, Individual Option Sale Agents, Individuals, Business Concerns Option Note Bank, Broker, Individual Personal Property Note Secured byi Mortgage Bank, Money Broker,^ Individual Personal Property Sale Agent, Business Concern, Individual Personal Property Lease Agent, Bus/nesS Concern, Individual Production Contract Advance Payment Customers Proposed Business Stocks Investment Syndicate, Bank, Stock Brokers, Investing Public Raw Materials Sale Competitors, Agents, Customers, Suppliers Real Estate Note Secured by Mortgage Bank, Money Broker, Individual Real Estate Lease Real Estate Agent, Business Concern, Building Contractor, Individual Real Estate Sale Real Estate Agent, Business Concern, Building Contractor, Individual Reputation of Friend Indorsed Personal Note Bank, Money Broker, Individual Royalties (future) Sale Manufacturers, Individuals Royalties (future) Personal Note Bank, Individual Salary Note Morris Plan Bank, Individual Standing Crops Sale Commission Men, Individuals Trade Marks and Trade Names Unsecured Personal Note Bank, Individual Trade Marks and Trade Names Sale Concerns in Similar Line, Capitalists Warehouse Facilities Sale Business Concerns, Agents Warehouse Facilities Lease Business Concerns, Agents Warehouse Receipts Sale Commission Agent, Business Concern, Individual Warehouse Receipts CoUateral Note Bank, Money Broker, Individual Water Rights Sale Business Concerns, Agents, Individuals Water Rights Lease Business Concerns, Agents, Individuals Fig. 47. — ^Ways to Raise Ready Money (concluded) support. He is interested in you to an unusual degree because he can count on your loyalty. On the other hand, the help you may obtain is possibly restricted, especially if the supplier is not financially big. There is always the Additional Sources of Funds 219 possibility that he may fail you at the most ci^tical time. With more than one supplier you have at least an alter- nate to fall back on, even tho no one of them can give you all the help you need. Thus it is necessary to analyze your needs, study your suppliers and their strength, and decide accordingly. In determining whether to have one or more suppliers you must also take into consideration the question of prices, quality of goods, and service generally. For these reasons it is sometimes better to buy of several than of just one. A tendency, too, in depending on suppliers for financial backing, is to skip discounts. This is a distinct financial disadvantage. It means considerable loss over a year's period and might mean playing into the hands of the supplier to his very great advantage. It is evident, then, that the question of having the financial help of your supplier requires close attention before you can decide on the best policy to pursue. MlSCELIANEOTTS SoUBCBS And now we come to the third division of supplemen- tary sources of funds jimder the head of "miscellaneous." Here may be listed: , 1. Insurance 2. Personal investments 3. Credit companies (purchasers of accounts receiv- able) 4. Loans on fixed assets 5. Sale of property 6. Sale of city lots 7. Warehouse receipts and chattel mortgages 8. City associations 220 Financing a Business 9. Customers 10. Friends and character loans. It is not intended that this list should be considered as representing all the sources of miscellaneous borrowing, but simply a suggestive line-up of possibilities. It serves to indicate that no busines^ man need feel that he is at the end of his rope because his banker cannot help him. Per- haps right at his elbow, so to speak, is to be found the source for which he is looking. In fine, there are almost innumerable ways to finance a business legitimately, even tho such methods may not appear to the banker as exactly orthodox. Insurance To take up the first on the list — ^insurance. This is an important subject; so much so that men are buying in- surance on their ability as executives in order that, should they pass away, their business may be carried on with the insurance money until a safe executive is raised up to take their place. Borrowing on ordinary insurance policies, investigation shows, often affords men help for their business "in a pinch." Insurance companies often lend on property for a long- time period running as high as 99 years. They insist, however, on the security being high class and make sure that all interest payments will be made on the dot. One feature favoring this type of loan is that the funds do not necessarily have to be used for temporary working capital, but can be utilijsed for permanent improvements. Personal Investments If a man has made investments from time to time from his personal savings, he finds this a possible source of Additional Sources of Fwnds 221 emergency help when his business requires financial as- sistance. Providing the investments have been made wisely, it is usually not difficult to borrow something on them, whether they consist of real estate, Liberty bonds, or other holdings. "I have found my Liberty bonds a great help in financ- ing my business over temporarily difficult periods," re- lates one business man. "They give me increased independence and security and prove to me their value aside from the help they have been to the Government." Investigation shows that the man who has carefully put away his' savings in good investments, year after year, has created an emergency "reserve" of great value in business later on. Credit Companies More recently credit companies, which purchase ac- counts receivable, have gained in popularity among con- cerns seeking additional working capital for their busi- ness. By borrowing on their accounts receivable they are enabled to turn their money more rapidly into profit. Under some circumstances this method is looked upon with favor, altho many bankers see no reason why a sound concern should have to resort to this method of obtaining funds. Notwithstanding, the business of ob- taining money on these accounts has grown very exten- sively. Some credit companies charge for the service 1 per cent a month on the money outstanding. Of course, it is important in disposing of any accounts receivable to be sure that your line of credit at your bank is not jeopardized. The money borrowed should be used only to make a desirable purchase of merchan(^ise or to 222 Financing a Biisiness discount bills coming due. Several concerns testify to the benefits gained from this source. In this connection, too, it is well to consider such credit companies as handle instalment paper for dealers, particularly paper originating in the sale of automobiles. Few banks can handle loans on "instalments" of this Mnd. As described in an earlier chapter, special banking corporations have been organized to finance instalment dealers. Few men have the ready cash to carry custo- mers over long periods in the purchase of a high-priced commodity like an automobile. A great number of dealers have thus, with this assistance at hand, increased their sales and total business with resultant larger profits. Loans on Fixed Assets Still another source for funds is that from loans on fixed assets. When a firm owns its property, it has the chance of obtaining money on that security. State banks and trust companies frequently handle loans of this type when the security is high class. Sale of Property Some concerns are able to sell some of their property without impairing productioii. For instance, a middle- western concern, finding itself hard pressed thru poor management methods, sold at a substantial increase a portion of its lots, purchased years previously, and got on its feet permanently. By Sale of City Lots Another plan which is very good in certain cases can best be shown by illustration. A foundry was located in the center of a small city and Additional Sources of Funds 223 needed room to expand. It made arrangements with the Retail Merchants' Association by which about eighty- acres on the edge of town were bought. The new foundry was built on a portion of the land and the rest was divided into city lots and bought by the merchant& and other citizens at considerably more than the original cost of the land. This difference was given to the foundry, while the buyers of the lots came out even or with a slight gain as this new addition to* the city was soon built up with working men's homes. In such a case care must be taken to see that there is proper transportation to the city, so that the lots will be built upon. Another attempt of like nature in the same city was not successful from the point of view of the merchants, as the land was too far out and was not built upon. Warehouse Receipts — Chattel Mortgages Then there is the method of borrowing on warehouse receipts, bills of lading, and chattel mortgages. Borrow- ing on the warehouse receipt is common with produce houses which obtain the money from the bank to get the goods from the warehouse and to repay the loan as the goods are sold. Borrowing on bills of lading against shipments is frequently possible, at banks. Some dealers buy fixtures on chattel mortgage, paying for the purchase on instalments at 6 to 8 per cent interest. If the margin of profit in the business is large enough, the borrower on this basis may get by safely, but frequently it results in financial disaster. On the other hand, printing and other types of machinery are regularly sold on this basis suc- cessfully and satisfactorily. It is also poor policy to borrow on chattel mortgage 224 Financing a Business except as a last resort. Sticli borrowing is usually done only in cases of extreme necessity, and for this reason, once a chattel mortgage is given, it is almost impossible to secure money from any other source. This does not apply to chattel mortgages or conditional sales contracts, where only the article purchased is covered by the mort- gage. Such a mortgage does not show an unsound finan- cial condition. One word of warning. In order to secure money it may be necessary to give a judgment note. This should be done only in a case of last resort. If so, be very careful to read the printed matter in the body of the note. It JUDGMENT NOTE Chicag;o, 111 Ninety days after date I promise to pay to the order of. John Doe five hundred dollars ($500), with interest at the rate of 6 per cent per annum, at the Continental and Com- mercial National Bank, for value received, and I hereby authorize and empower any attomey-at-law to appear in any court of record in the United States, at any regular term of such court, after the above obligation becomes due, and waive the issuing and service of process, and cqnfess a judg- ment against me in favor of the holder hereof, for the amount then appearing due, together with costs of suit; and /here- upon to .release all errors, and waive all right df appeal. Fio. 48. — Form of Judgment Note Authorizing Creditor to Take Judgment in Case of Default in Payment of the Principal at Maturity may be drawn so that judgment can be taken only in case of default in payment of interest when due, or in case of default at maturity, or it may provide that the creditor can take judgment at any time he feels himself insecure. Additional Sources of Fwnds 225 This last form is especially bad, as the creditor can at once take judgment and cause a levy of execution on the property of the debtor, thus virtually putting him out of business, even tho it may be long before the note matures and there has been no default. Aid from City Associations Investigation shows that some city associations, such as chambers of commerce, will help a worthy concern which furnishes employment to a number of citizens and promises ultimately to be prosperous. Here, tho, much depends on the type of association and its financiaL activity. Customers In certain cases it may be possible to borrow from your customers. This is especialy true of a business which has but few customers, or is of such a nature that the cus- tomers are dependent on it for certain supplies which it is hard to get elsewhere. Character Loans The final method of obtaining funds to be mentioned here is that of character loans from friends or other sources. Investigation proves that many a business has been saved by friendship. Altho such loans to friends frequently seem to cause trouble, yet they do prove a potent factor in financing struggling concerns out of dif- ficulty. It is important to have friends and to inspire their confidence. A number of men testify to the splendid manner in which their friends have helped "set them up in business." The Morris plan banks also have a character loan 226 Fincmcing a Business department, in which they handle many loans to smaller business men who pay back the money on instalments. All of these sources have proved helpful to various concerns — some finding one plan best adapted to their needs and others a different one. It is not expected that all of them will appeal to all readers of this book, but they i are enumerated briefly in order to point out the latitude possible in obtaining funds legitimately for business pur- poses. No doubt you will find at least a suggestion here to assist you in meeting your financial requirements. SELF-TEST QUESTIONS 1. CHIEF SOURCES OF FUNDS. What three are there besides banks? 2. ;N0TE BROKERS. Why do banks like to loan thru them? What facts would you consider before establishing relations with one? How do they operate? 3. SUPPLIERS. When are they of unusual helpfulness? 4. CONCENTRATION OF PURCHASES. Is it a good policy? Why? When? 5. MISCELLANEOUS SOURCES for obtainmg financial aid. What are they? CHAPTER XIII EVERYDAY FINANCING THAT PAYS It is not thru spasmodic efforts at so-called "financing" that a business is put on a sound basis. It is rather the day-to-day careful watchfulness and planning that con- vert a situation involved in uncertainty and chaos into one of soUd, substantial prosperity. A thoro investiga- tion of business of all sorts indicates that the beneficial results of spectacular "financing" are rare. Permanent, satisfactory business really comes from close supervision of the ordinary details of everyday conservative manage- ment. It is the purpose of this chapter, therefore, to show how positively the wise conduct of business is after all true financing. In fact, we should hear far less of finan- cial problems, so called, if every business man under- stood fully the necessity of using everyday common sense in the management of his concern. This is speaking plainly, but we have only to see the financial successes which have resulted from plain, simple business — buying and selling — ^to see how true it is. One can readily see that finance did not originate busi- ness. Supply and demand — ^primitive barter and ex- change — created the idea of business, and financing is an outgrowth of business progress from the primitive to the modern. A survey of the question suggests that we have been inclined to let the tail — finance — ^wag the dog 227 228 Financing a Business — ^business. In other words, the statement is often made that if you conduct your business economically and wisely, the finances take care of themselves. Let us see", then, how this works out in actual practice. One of the most successful stores in the Middle "West does not borrow a penny on the outside. It is financed strictly on the "inside." How? Simply by attention to every business detail — costs, selling, mark-up, service and so on. For years the business has been closely, faithfully managed, and it enjoys an enviable trade in the com- munity. Banks have offered this firm liberal borrowing facilities, but without success. Similarly a manufacturing concern in "Wisconsin has never borrowed. The business has been built up slowly but surely over a period of sixty years. It, too, enjoys a splendid reputation and numbers its customers all over the country. These instances are not given to suggest to business men that they should not borrow when it is profitable to do so, but they are cited in order to prove that so-called good financing is, after all, simply good business. Proper attention t6 inside financing usually means that the financial problems of the concern automatically take care of themselves. Success Factobs in Everyday Financing It is essential in financing any business that the man- agement be awake to its responsibilities. A well-managed concern should find its everyday financing simple. But what are the chief points to watch? The experience of others is illuminating in this connection. A study of successful concerns shows that the following factors have a direct influence on everyday financing : Everyday Financing That Pays 229 1. Definiteness of purpose 2. Direct supervision 3. Proper location 4. Careful progress and planning ahead 5. Taking discounts 6. Increased turnover 7. Keeping funds at work 8. Borrowing profitably 9. Attention to important details 10. Careful analysis of costs 11. Getting full use of space 12. Personality 13. Encouraging harmony in the conduct of the busi- ness. Let us take up each of these points specifically because they are often too lightly passed over as only incidental to financing. But, from the viewpoint of today, according to the most successful business authorities, they are financing, itself, in the highest sense. Definite Purpose No business can expect to succeed permanently which has no purpose or plan behind it. How quickly the so- called "fly-by-night" concern falls to pieces 1 An organ- ization slapped together just to make money is doomed at the start. Every reader of this book understands the necessity of having a business well planned to fill an economic purpose. Therefore, if you want to start on the right basis to develop a permanent financial strength, there must be a clearly defined plan of what the concern is going to do. It is also necessary to know how you are going to do it. , A successful manufacturer emphasizes this point by showing how he constantly failed to make Hci+HNOa AQUA REGIA The Acid Test Of Successful Everyday Financing 1. Have you a definite purpose in busi- ness? 2. Do you have direct supervision? 3. Is your location right? 4. Do you plan ahead to make careful progress? 5. Do you discount your bills? 6. Is your turnover frequent enough? 7. Do you keep spare funds at work? 8. Do you borrow profitably? 9. Do you pay attention to important de- tails? 10. Dd you make a careful analysis of costs? 11. Do you make full use of your space? 12. Do you use proper personality in busi- ness? 13. Are the relations in yoiu: business har- monious? Pio. 49.— Acid Test of Successful Everyday Financing Everyday Financing That Pays 231 good when he went from one job to another, without a definite idea in his own mind of just the type of business and work he wanted to be in. Finally, he saw his mistake and set before himself a definite business goal. The busi- ness of his company now runs into millions annually. Direct Supervision Once this point has been determined, then the necessity of close and direct supervision is apparent. This does not mean that a managing executive must always be on hand at 7 o'clock in the morning and stay until late at night. It means that he must know how to direct the work and know what is going oh. A new business, par- ticularly, no matter how rosy its prospects, requires this close personal attention. A long list of failures due to neglect of opportunities confronts one in every town. As one banker has succinctly expressed it : "We find it use- less to help the business man who thinks more about baseball than about his business. Recreation is necessary, but it has to be taken in its proper place." Neglect is a deadly error in financing. It is sure, as experience shows, to lead to disaster. It pays, then, to be on the job, even tho you may have a trustworthy assistant, or several of them. Financing means being instantly ready to make every move necessary to play the game. But some men may cite various big concerns, the own- ers of which are seldom individually on the job. This appears to be true on the surface, but it is not actually so. These concerns have worked out record systems, double report ideas, and checking methods by which they are able to know in detail more about the business than many employees who are on hand day in and day out. It is a mistake for a young business man to think that 232 Financing a Business he can imitate successfully the wealthy leader of affairs who has made his millions. Too mudh time spent at the golf club is likely to be disastrous to the executive who has not yet fully "arrived." This is the modern tempta- tion which wrecks many a business. It amounts to reck- less financing. Proper Location The third danger in financing a business lies in the question of location. One after another, concerns have gone down because they chose a pooi^ location, or they agreed to a lease charging an exorbitant rent. This fac- tor of location is receiving far more attention than formerly, but it still fails in many instances to receive the proper consideration. It does not matter whether you are in a retail store, a factory, or any other line: Location is frequently vital — ^much more so than is com- monly realized. A textile, mill found its production greatly restricted because it was located in a small city containing numerous other concerns which employed a large number of girls. To overcome the difficulty it was necessary to build an- other plant in another city where labor tends to heavier lines. The new factory, of course, required much addi- tional financing, a great proportion of which could have been eliminated had it seemed practical to put on an addition to the main plant. Labor market, transportation, distribution, and other factors, when considered in the light of month-to-month expense, must all be taken into consideration. In the larger cities there is always the question of whether the plant shall be in a downtown location, in a suburb, or in a particular district. Some concerns have had difficulty in getting help where transportation to and from the Everyday Financing That Pays 233 plant has been poor. Thus one new concern just choosing its location intends to spend nearly a million dollars in furnishing roadways and street cars to the plant. From the retail standpoint, location means the very activity of the business. The best of so-called financing is frequently helpless to save a badly located business. It is important to analyze the type of neighborhood, whether it is changing rapidly or is of a fixed character. Altho advertising may help greatly to overcome a poor location, yet it is dangerous to attempt a new business — ^yes, and even one already established — ^unless you are sure that" you can draw the trade. Still another important financial point to have in mind is the lease. Many a business has become successfully established in a certain location, with no clause in the lease to cover a renewal of the premises if desired, at a certain reasonable rate. If, after the expiration of the current lease, a high rent is imposed, it may be necessary to move to an inferior location or, as an alternative, to try to meet the increased rent demanded. In either event, the business is likely to suffer severely. Business men should be careful to protect themselves on leases. This is as much a part of financing as having a line of credit at the bank. Planning Ahead Next comes the necessity of planning ahead and of provision for making careful progress. Right planning includes arranging your finances to meet the seasonal demands, analyzing your sales and turnover so as to have on hand always sufficient working capital, having a defi- nite plan of selling for cash or credit, and taking care of obligations which fall due from time to time. Your 234 Financing a Business buying and selling and your terms of credit, if any, must be balanced properly to insure working capital at all times and the backing of your bank as well. Especially is this essential foe concerns selling on instalments. It has been the tendency for business houses to jump into the instal- ment game and to meet competition, without sufficiently realizing the amount of capital involved in the under- taking. Instalment sales mean tying up a large amount of capital in accounts receivable. Have you the financial organization and backing to 'swing this feature of the business? A survey of your field, the amount of sales you expect to make^from month to month, and the size of payments required from customers will show you what you will need at "peak" times in the way of working capi- tal. A tangible plan, with figures of sales and payments for each month, should be made up to present to your banker for approval before going khead., Then you will be better able to play safe. Notwithstanding the fortunes made by instalment houses, many of them have drifted into bankruptcy because they were not properly financed. Consistent, conservative progi'ess is always considered wise financially, rather than too rapid expansion. Many bankers say they lack faith in a man who is too impatient — ^who cannot wait for his business to have a natural growth. There is always the danger line between safety and growth. To overstep it may mean disaster. Investi- gation indicates that the conservatively growing concerns frequently have the best financial records, altho a few exceptions are to be found in some localities. Usually these exceptions are enterprises started by men who already have made an eminent success in some other activity. Here, too, the general organization of the concern must be considered. It is usually dangerous to conduct a "one- Everyday Financing That Pays 235 man" business, so-called. Too much is left to the re- sponsibility of one individual. Under these circumstances the concern is actually jeopardized in the event of the incapacity or removal of the chief executive. Every business should be so organized that the elimination of an owner or officer "wUl not disturb the general routine. In other words, every person should have someone ready to step in and take his place. Authority should be bal- anced properly, so that there is no uncertainty about the conduct of the business. It isn't always necessary to make unnatural plans to provide for emergencies. This is illustrated by the ex- perience of one small concern whose owner suddenly died. No one at the plant had the slightest inkling ofi the future of the business. The man 's wife stepped in, however, and went ahead with the regular conduct of the plant. Every- thing continued just as it had before. The careful prog- ress of the past was maintained. How was this so easily possible? The owner had seen the natural business ability which his wife possessed. He therefore made it a point from day to day to acquaint her with every policy, detail, and problem of the plant. He discussed his plans with her and asked her advice. In this way he trained her to handle the business without her having to come into the daily grind to learn. When the duties of management devolved on her, she had every detail at her jBngers' ends. This, in brief, Suggests how precautions can be taken to insure the permanent success of a business. Talcing of Discounts The fifth factor in everyday financing is the taking of discounts. Eeference is made elsewhere to the import- ance of this practice, but it deserves frequent mention. 236 Financing a Business for no itdm of financing is, more often overlooked, es- pecially by small concerns. This may be due in part to the fact that executives fail to realize the big gain in profits possible by taking discounts. For instance, figuring on the basis that the average discount is 2 per cent 10 days, net 30 days, you get this discount for giving up the use of your money for 20 days, the difference between 30 and 10 days. This means that you make 1 per cent every 10 days, or practically 3 per cent a month. This in a year, amounts to 36 per cent on ' all the discount-term goods which you buy. Now, sup- pose you do have to borrow at the bank to settle for a purchase. The rate probably is not more than 6 per cent or % of 1 per cent a month. It is obvious that you will make a substantial profit on the transaction. In per- centage figures it amounts to the difference between 3 per cent and V^ of 1 per cent, or 21/2 per cent a. month; in other words, the yearly saving of $30,000 on every $100,000. So impressed with the importance of this fact is the owner of one successful concern that he sells on a low margin and makes practically all his profit from his dis- counts. Thus he readily meets all competition and main- tains a permanent trade. Increased Turnover Increased turnover is the sixth vital point to watch in making everyday financing pay. This question is also touched on elsewhere, but it warrants particular emphasis. How necessary it is to get the best possible turnover is illustrated "by contrasting two general stores doing busi- ness on the same street in a small western city. One store carries a stock amounting to $12,000, and the other, Everyday Financing That Pays 237 one of $28,000. One has a turnover of eight times an- nually, and the other only three. What is the result? The one store is prosperous and has a big trade. The owner drives an automobile. The other scarcely makes a living. He does not turn over his stock fast enough and therefore has to carry a larger one. The fallacy of this is pointed out in a succeeding chapter. The mistake men sometimes make is to figure they are making sufficient turnover when they are not. Turnover, as every one knows, means the times you sell your stock completely each year. For instance, if you carry an average stock of $3,000 and sell $12,000 in goods in a year, you have turned over your stock four times — if you have handled the problem correctly; that is, if you have figured your average stock at selling price. If $3,000 is the cost price, and $12,000 is the selling price, then your turnover is not four, but considerably less. At cost, your sales may amount to only $8,000, in which event you have turned over your stock not quite three times instead of four. Keeping Funds at Work The seventh point to consider is that of keeping your Working capital profitably at work. It is poor business to have money lying idle — except what is necesary for a bank deposit which will satisfy your banker. As pointed out in the chapter on investing your surplus, it is good business to have your money earning dividends — ^if not in merchandise, then in short-term notes or bonds that can quickly be liquidated in an emergency or borrowed on. Interest quickly mounts both ways, so that it is im- portant to be getting the increment on otherwise idle funds. This is the practice of many successful concerns. In this connection it is worth whUe mentioning the 238 Financing a Business necessity of keeping one's credit absolutely clean. This does not mean always paying a bill before it is due. Some- times it may be poor judgment to be ahead of ordinary promptness. One business man discovered that he laid the scene for an embarrassing episode because he was too prompt. He always sent his checks ahead of time in order, as he thought, to cinch his credit standing. A busi- ness slump came and he was unable to abide by his cus- tom. Immediately the suspicions of his creditors were aroused. He had been so scrupulously ahead of time that now he had given the people he owed a distinct shock. He had hard work recovering from the predicament. So credit is a peculiar thing, and it has to be watched and studied closely to make the most of everyday financing. Borrowing Profitably The eighth factor in successful financing is to borrow profitably ; but this point is so well covered in Chapter X that it need only be referred to here. Attention to Important Details Coming to the ninth factor — attention to important de- tails — we encounter several points which should be con- sidered carefully. One of these details is to avoid borrow- ing on short-term notes unless you know you will be ready to take them up or will be able to renew them. Some con- cerns have had a difficult problem to meet in taking care of such loans. It is something to consider in everyday financing. Another important point is to watch the advertising appropriation and to know how much you can spend. Advertising is valuable to the success of all business, but the tendency of some concerns is to spend more than their Everyday Financing That Pays 239 field, their size, or their financial condition will warrant. This is a financing factor which must be carefully and wisely balanced. Again, every tendency of the owner or owners to specu- late should be halted promptly in order to avoid disaster. Numerous instances could be cited of the failure of other- wise prosperous concerns, simply because those in finan- cial charge could not resist the temptation to speculate. The necessity of employing the right sort of workers is ^also apparent. Faithful, efficient and loy^l workers ob- viously make the financing problem that much easier. Where possible it has been found profitable to have a financial adviser, a man who can visualize the concern's requirements and plan the use of funds accordingly. One other important detail is that of insurance-^fire insurance and other insurance depending on the nature of the business — ^in order to cover a possible loss. This should be fully attended to. Most banks will now ferret this question out before granting a line of credit. Insur- ance should be wisely figured and placed so as to accom- plish the necessary protection and still be reasonable. Investigation shows that many concerns are spending far more for their insurance than they need to, and in some cases, on the contrary, not enough. Cost Analysis We now come to cost analysis — the tenth point in our list of financing factors. Nothing is more vital to a con- cern's welfare than an exact line-up of the costs of doing business. Yet it is astounding how few businesses know their costs — all of them— accurately. Yet after all, it is a simple task to accomplish. Any cost accounting plan will suggest how to work out a full record of your costs. 240 Financing a Business It is not within t^-e province of this book to go into all those details, but to point out how necessary cost systems are today. Without accurate cost knowledge it is impos- sible today to manage' a busiuess, to compete successfully, and to find expensive leaks. By knowing your costs you can find many ways in which to cut expenses, as numerous concerns have done. It makes profit- figuring a definite task and eliminates guesswork in man- aging, A business cannot be financed properly unless costs are analyzed and then reduced to the minimum. "That's management I" perhaps you will say. Yes, it is, but it bears a pretty close relation to financing, too, and is worth bringing out in this book if it is to accomplish permanent good for any reader. Many concerns visited by the author, which formerly suffered many near dis- asters financially, pointed out that after they had analyzed and got their costs on a definite minimum basis they had no more trouble financing themselves. HOW A COST SYSTEM HELPS FINAKCING llach month the head of a large retail establishment in Michigan distributes an appropriation over 21 divisions in his store in order %o carry on the business. This ap- propriation is based on a computation that is made each year and represents the approximate expenditure that wiU be needed to finance the business. In addition to the annual and monthly distribution, the seasonal require- ments are estimated, for example, those of the spring and fall, and are carried along with the monthly and annual figures. Here, then, is a definite approach to the so-called budget method, yet it differs in some respects from the budget idea because a certain degree of flexibilily is pro- Everyday Financing That Pays 241 vided to meet any contingencies that are likely to arise. Much has been said and a great deal more has been written about the budget plan as an aid in financing the business. Undoubtedly the budget method represents certain advantages in every line of business, because it enables the business executive to determine his financial needs and to avoid the deadly sin of guesswork. But the budget plan, meritorious as it is, is often likely to lead to confusion and possible loss if it is arbitrarily applied. This is especially true in a business where price levels are subject to sharp and violent changes and where the prob- lem of raw supplies and merchandise stocks is an uncer- tain one. Still the budget system can be worked out with certain modifications, as in the case of the Michigan re- tailer already referred to; and almost always it will be found to produce satisfactory results in cutting out waste, in revealing those departments which are a source of profit or a cause of loss, and in stabilizing the sales efforts. In order to simplify the distribution of the appropria- tion, this retailer first divided his store into 33 depart- ments. After this was done he estimated the expenses of each department under the following 21 divisions : 1. Sundries 2. Branch office 3. 4. 5. 6. 7. Express Freight and cartage Advertising Cleaning and repairing Eent 8. Salesmen's salaries 9. 10. Buyers' salaries Floormen's salaries 11. Elevators and watchmen 24& Finanemg a Business 12. Light and heat 13. Marking room 14. Deliveries and carfare 15. Bundle desk 16. Stationery and supplies 17. Insurance 18. Taxes 19. Charity 20. Trading stamps 21. Officers' salaries. This distribution takes care of all the items of expense that enter into the business, with the exception of the merchandise purchases which are estimated seasonally as already indicated. AU of these items of cost are carried on a long sheet. The estimate for December, for example, would show in a separate column the amount needed for December, 1921, and then in an adjoining column the amount actually spent in 1920, thus furnishing a helpful basis of compari- son. At the end of the month the actual expenditures for December, 1921, are placed in a third column, so that the appropriation and the actual expenditures can be com- pared. The 33 departments are designated as A, B, C, and so on, and to each department the approximate cost of opei;- ation for the current nlonth is distributed. In the lower right-hand comer of the large sheet space is provided for a compilation of the sales. Here is shown the total sales for each department for the month, the actual expense, the percentage of cost to the sales, the percentage of the salesmen's salaries to the sales, and the percentage of the buyers' salaries to the sales. On the actual tabulation the following information i« shown : Everyday financing That Pays 243 1. Sales at retail 2. Sales at cost 3. Margin 4. Expense 5. Profit 6. Percentage on 7. Percentage off 8. Percentage profit 9. Percentage loss. These records reveal at a glance all the information the prudent business executive should have at his fingers' tips. And they are sufficiently comprehensive and simple to be adaptable in almost any line of business. What are the advantages of employing a method of this kind? Does the operation of the plan create unnec- essary accounting burdens! A COST SYSTEM MAY AVBKT DISASTBB These questions can best be answered by the experience of this retailer which demonstrates that a careful scru- tiny of costs and an analysis of sales will prove to be an investment that pays big returns. It is surprising [says this retailer], how a department can shift so quickly from profit to loss and vice versa, and unless you have the spotlight continually on every tendency you can be led very easily into deception that creates financial embarrassment. Looking back over a period of six months, for example, I noticed that the cost of doing business in one department averaged 24.7 per cent. Then suddenly this cost went up to 28.2 in one month, to 29.6 the following month, and to 32.8 the third month. I saw something was wrong and I immediately began an investigation of the de- partment. I found that the sales efforts in this department had become slack and the buyer was not giving proper attention to it. Now a condition of this kind can happen in any business, and unless you have a report that will flash the danger signal monthly or at some other regular interval, you are simply inviting insol- vency. 244 Financing a Business Again, the fact that you are keeping a simple check on both the department buyer and the salesman has a salutary moral effect, because it sustains logical and consistent effort. It often happens that the buyer or the salesman will come to me and ask for more pay and then proceed to point out why the advance should be given, usually explaining that they are doing an increased volume of business. Now, it is not necessary to say that no matter how big the volume of business may be, it amounts to little imless there is a commensurate profit. And you cannot get the most money out of your sales imless your costs are closely regulated. I have, therefore, tied up the costs and the sales, and as a result I am always prepared to talk to my employees with definite knowl- edge in hand. Not long ago, for example, I had one of my buyers come to me with a request for a big raise in salary. He went on to explain how the business of the department had grown. He was making the common mistake of considering only the volume, with scarcely a thought to profits. I pulled out my big sheets and showed him that the cost of doing business in his department for six month! had averaged 7.6 per cent — a department where selling expense was low — and that this figure had jumped to 10.2 per cent for a corre- sponding period later on. I showed him that my estimates of the cost had to be revised on account of this increase. I convinced him there was something wrong in his department. He was glad to see my figures and he decided to begin an investigation on his own hook. He changed some of his buying policies, gave more atten- tion to the sales people, and within a year brought the cost down where it belonged. I was pleased then to raise his salary. Here is an instance where the manager was in posses- sion of exact knowledge as a basis for determining a given line of action. 'The facts presented by his metho^d of keep- ing his accounts were what gave him this exact knowl- edge. There was no guesswork about it. This method, as previously stated, is a step in the direc- tion of budgeting your business in an enlightened manner and it is simple enough and practical enough to be worked out in almost any line of business. Ypu cannot get the most out of your business unless you know your costs. It is just as necessary to know what has gone into your goods as to know what has gone out to your customers. Everyday Financing That Pays 245 This applies with equal force to the manufacturing estab- lishment, the retail concern and the bank. A FtiEXIBLB SYSTEM KEEDED It is only from an accurate knowledge, of costs that future business policies can be determined intelligently. In order to get the best results out of any cost system, the figures should be worked out on a statistical basis that will indicate the comparative tendencies, as in the case of this Michigan retailer. One month or one year can be set off against corresponding periods and thus show what is actually happening. This comparison of corresponding periods is an ex- tremely valuable guide to the management of a business. Many accountants advocate that records be kept on the basis of thirteen four-week periods rather than on the basis of the regular calendar month, in order that com- parison may be made of uniform corresponding periods. It is probably true that the cost system which is satis- factory in one store or factory may not be successful in another store or factory. The cost system, to be effec- tive, must be fitted to the individual needs of the business. It should not be too elaborate, because experience has shown that many cost systems which were inaugurated with enthusiasm were gradually allowed to decay because the intricate accounting that was required did not justify the cost. A COST SYSTEM IN BELATION TO GBNEBAL ACCOUNTIKG Many firms, altho watching their costs thru different kinds of statistical comparisons, do not tie up their cost calculation with their general books of account in such a way as to prove the accuracy of the estimates, appropria- tions, and mark-ups. 246 Financing a Business The first rule in making a correct mark-up is to find from the accounting records, what percentage of the vol- ume of sales has been spent in the past for the cost of doing business, and how much profit on the sales is ex- pected. In calculating the cost of doing business great care should be taken to include all the items of cost. Eent, heat, light, supplies, insurance, taxes, depreciation, shrinkage, and general expen_ses are the items usually in- cluded in the overhead charges. But there should also be added the interest on the capital invested. If the latter consists' of borrowed capital the interest on it would be a charge against, sales, so the owning of the capital cannot change the correctness of such a charge. Salaries, which should include the salary of the owner at the amount he could earn in a like position working for someone else, advertising, delivery, and bad debts are the usual expense charges borne by selling and administration. The combined percentage of the cost of doing business and profit expected subtracted from 100 per cent give the percentage of the selling price, consumed by the cost of the product. For instance, in a certain shoe store, the cost of doing business is 22 per cent and the desired profit is 12 per cent of the sales price, making a total of 34 per cent. Subtracting 34 per cent from 100 per cent, which represents the sales price, we find that the cost of each pair of shoes is 66 per cent of the sales price. The next thing to do is to find the sales price. This is done by treating the cost price, which we find from adding the amount of the purchase price to the cost of freight and cartage necessary to get the article into the store, as 66 per cent and finding 100 per cent. Say that this cost is $7.59 ; this divided by 66 per cent gives $11.50 as the selling price I per pair. RULES FOR MARKING UP YOUR GOODS I. Learn the factors that enter into the tellins price. They are — (1) Cost of Goods, (2) Cost of Doing Business, and (3) Profit EXAMPLE: If the cost of shoes in a shoe depart- ment amounted to $18,975 for one year, if the cost of doing business for that year ^as $6,325, and if the net profit was $3,450, then the sale's were equal to the sum of these three figures, or $28,750. II. Learn what percentage of the selling price is the cost of the goods, AND KEEP THIS PERCENTAGE ON RECORD TO AID YOU IN MARKING UP FUTURE GOODS IN THE SAME DEPARTMENT. EXAMPLE: If the sales for the shoe department were $28,750, and if the cost of the goods was $18,975, then the cost of the goods was 66 PER CENT of the selling' price (found by dividing the cost by the sell- ing price). F». SO. — RuIm for Mark-up. (Continued en next pagra) 248 Financing a Business III. To detennine the proper selling price of any future individual pair of shoes placed on sale, DIVIDE THE COST PRICE OF THE INDIVIDUAL PAIR BY THE PERCENTAGE OBTAINED UNDER RULE IL EXAMPLE: In marking up a new pair of shoes costing $7.59, divide $7.59 by .66 (the percentage ob- tained in the example under Rule II), and you will obtain a quotient of $lliiO, which should be the sell- ing price. Fig. 60. — Rules for Mark-up (concluded) Sometimes it is advantageous to know how much of the sales price of a pair of shoes can be spent for administra- tive and selling expenses and how much for overhead ex- penses.^ In such a case $11.50 (the selling price) is multi- plied by the percentage which past experience shows has been used for these purposes, i. e., 12 per cent for admin- istrative expenses and selling, and 10 per cent for over- head. But these figures are of little value unless it is known how close they come to being the same as the actual ex- penditures for the period. After the books are closed at the end of the month, the auditor finds, say, that the sales amounted to $5,000. According to past experience, the overhead expenses should amount to $500. He opens up two accounts necessary to show if past experience had been repeated. One is headed, "Portion of Sales Allotted to Overhead Expenses." The other is the "Overhead" account. To the first account is charged and to the second is credited the $500 representing the 10 per cent of sales. During the accounting period there have been various expenditures made which were chargeable to overhead. Everyday Financing That Pays 249 They have been collected in different accounts snch as rent, heat, light, janitor service, interest on investment, etc. These accounts are now credited with the amount of the charges against them and the overhead account is charged with the sum total of all the overhead charges. This will close all the detail accounts, concentrating them in the one overhead account. If 10 per cent of sales was the amount spent for overhead, the sum of all the ac- counts is $500, which will balance the account. The ac- count "Portion Allotted to Overhead Expense" will be closed into the "Profit and Loss" account, representing the 10 per cent of the sales which was used for over- head. If, however, as is usually the case, the overhead account does not balance, it will indicate whether the actual overhead expenses are above or below what they were in the past. It will show what correction must be made in the selling price in order to gain a profit of 12 per cent on sales. This simple method can be made use of with the other classes of accounts. Statistical tables such as the Michigan merchant uses, backed up by a cost system like the one described above will give any executive a sense of security because of the fact that he knows the exact status of his business. With- out this knowledge he is in much the same position as a ship captain who would try to make port and avoid ship- wreck by navigating without taking observations, trust- ing only to dead reckoning — he might make it safely, but he is taking unnecessary chances. In a veneering establishm,ent, every operation in the production of veneer is carried on a single sheet (Fig. 51). Here the manufacturer has provided for a clean-cut anal- ysis of every step in the production of his merchandise. These sheets are filled out weekly and comparisons are frequently made between different periods. In addition 250 Financing a Business to this, another more detailed record of the cost of opera- tions is kept on a single sheet as follows : COMPARATIVE COST OP OPERATIONS (Panel MiU) November 18 to November 19 Deparrtment Operations 1918 1919 Premium for November Band saw $ $.17 14 per cent Choppers, oak and ma- hogany 1.69 1.17 9 " " Choppers' stock , (Faces and backs) 1.06 12 " " Choppers' X-Bands .46 4 " " Jointing: .10 38 " Taping ......... .57 4 <> " Veneering edges 3.68 5 " " Thin centers Sizing 1.62 5 " " Taping 1.15 3 " " Dry kiln labor Labor in and out of kiln 2.91 No percentaga Lumber centers.... Swing saw 1.20 .95 9 per cent Band rip saw 1.34 1.75 16 " " Planers 0.95 1.29 9 " " Linderman 2.48 3.02 9 ** ** f Squaring saw Fio. 51. — Comparative Cost of Operations in Panel Mill These costs are computed from the checkers' reports. So, in a business as exceptional as veneering, a cost system can be made to perform a decidedly valuable function by furnishing the manufacturer with important comparative data. And these data in turn constitute a sound basis for compensating the employees, as in the case of the premiums paid to the workmen noted on the sheet. Many other examples of how a cost system simplifies the problem of financing a business could be given, but sufficient is shown here to reveal how all-important the Evryday Financing That Pays 2il cost factor is if you are to get the most out of your in- vestment. KEEPINQ TRACE OF STOCK The first step necessary in finding out your costs is to learn what you have on hand and then to keep track of it. In the manufacturing establishment this can be done by using inventory records and requisition forms. The importance of thus checking supplies is illustrated in an interesting way by the experience of a partnership engaged in the metal business. Two young men joined hands, one offering his practical experience as a metal refiner and the o^her investing $30,000 to get the business started. The first year's business finished with a loss of $26,000. During the following six months the loss con- tinued to accumulate at an alarming rate, and finally the partners called in an expert accountant. Investigation revealed that pigs of bronze, which were purchased for use in manufacturing a metal specialty, had been dis- appearing. "When the bronze was delivered to the factory it was thrown into a corner within easy reach of any of the factory workers who wanted to take it. The inven- tory account showed that much of this metal had been stolen. In order, therefore, to Stop the thefts, a separate room under lock and key was provided for all the raw bronze, aluminum, tin, and so on. Next, the accountant found that the partners had taken a contract to supply a large quantity of small brass parts for automobiles. The costs had not been worked out carefully, and the firm was losing eight cents on each part. When the partners tried to borrow money at the bank, the bankers were unwilling to advance the money because they felt the fii'm was doing business at a loss and also because it was without a defi- nite system of cost finding to check the leaks. 252 I Financing 'a Business So, in order to strengthen their financial position, the partners decided to hire a cost accountant. A plan of determining the costs was then worked out. Within a year, the business began to show a profit. The thefts had ceased. The partners were able to prepare a financial statement of condition that entitled them to a line of credit at the bank. What is true in this particular case is true also in many- other cases, especially with the new business enterprise. And profits are constantly menaced until merchandise and supplies are adequately safeguarded and cost sheets are consistently used. THE FUNDAMENTALS OF COSTS What are the fundamentals of cost? The average busi- ness is divided into three divisions : materials, labor, and expense. These items vary with different lines of busi- ness. In distributing the items of materials and labor to specific articles, no great difficulty is encountered. But materials and supplies must be carefully checked in sepa- rate records. Let us turn again to the case of the metal manufac- turer. When a job is accepted in this plant, a cost ticket is made out with a complete description of the article to be nxade. This cost ticket then goes to the factory and picks up each element of the entire costs as the job goes along. Cost sheets and cost tickets vary, as already indi- cated, with the type of the business, and it is worth reit- erating that the scope of the system must be fitted to the business. Howefver, the general undetlying principles of a good cost System are here set forth. Control of Material. — Malarial should be controlled Everyday Fincmcing That Pays 253 very carefully. The best way to do this is thru the stock ledger which will give the manufacturer a perpetual in- ventory of the materials in his stock room. There is an account in the general ledger which controls the stock ledger. This account is called the "Merchandise and Materials" account. The merchandise purchased is charged to this account in a lump sum at the end of each month. The individual invoices which make up the lump smn are charged to the separate accounts in the stock ledger. No material is allowed to be taken from the stock room unless a requisition, signed by a person having authority, is presented to the stock-keeper. The total amount of these reijuisitions is credited to the merchan- dise materials account. Classificatioh of Labor. — ^Labor may be classified as di- rect and indirect. The direct labor is charged directly to the job ticket, but the indirect labor will be applied to the costs thru the application of burden, or overhead expense. There are many mechanical devices on the market that are devised to aid in keeping an accurate record of direct labor. The general practice is to provide a job time ticket, bearing the workman's name, clock number, and the job number on which he is to work, and this is stamped with the time and given to the workman when he starts work on a job. When he finishes his task on that job he re- turns the ticket to the time clerk who stamps the time Of finishing and issues another job ticket. In this way all the wo^Jdng time of the workman is charged to some job. The job time tickets are made out in duplicate, one copy going in the job envelope, the other to the payroll de- partment. The payroll department checks the job time tickets against the time recorded by the clock at the gate of the factory yards, which registers the workman's time 354 Fmtmemg a Busmtss by the day and week. The hours shown on these weekly I time cards must be the same as that charged to the jobs. Overhead. — The burden or overhead is the difBcult item to apply correctly. It consists of all the expense not in- cluded in direct labor and material. There is a wide- spread custom of coll6ctiijg all the burden for a year into one lump sum and distributing it over different products at the same rate, regardless of evident variations in the actual overhead expenses of the different departments in which these products are made. The burden is usually distributed oh the basis of a certain percentage of the cost of, direct labor. The fallacy in this practice lies, not so much in the distribution on the amount of direct labor necessary, but in putting all of the overhead in one lump sum, instead of charging each department with the amount of the expense of the department. It is prob- able that some items of cost, such as the expense of the planning and cost departments, may be applied in the lump as accurately as any other, but in the case of most expenses this is not true. The making of one product may require expensive machines which take up a great deal of floor space, but only a small amount of labor of a fairly cheap grade. Another product requires a great, amount of hand work applied by skilled and consequently high-priced labor. You will see at once that there should be a greater burden applied to the first product than to the second, on account of the depreciation charge on the expensive machine and greater floor space occupied. Thus the depreciation, taxes, and insurance on the machine and the rent of the floor space occupied by the department should go into the burden of product No. 1, These items of expense should not be borne by any other product, as would be the case if all the burden items were put in one The Dollar You Receive in a Sale and What Becomes of It Remember that your sales dollar is likely to be your only source of profit. With such a small margin of profit possible from 6ach sale, you must do three things if you would make money: First, you must see to it that the ex- penses do not swallow up the profit in each sale. An appreciable profit must be as- sured. Second, you must turn over the dollar as frequently as possible. The more turnovers, the more profits. Third, you should consider increasing the volume of your business, and at the same time getting into your concern more dol- lars, each of which is to yield its profit. All business success is dependent on these three fundamental rules. Pro, 62. — Distribution of the Sales Dollar 256 Finomcing a Business lump sum, and allocated according to direct labor charges. If this method were followed, product No. 2 would bear a greater portion of the expense incurred by the et[uipment necessary to make product No. 1 than product No. 1 would bear. Once the correct burden rates for the different depart- ments are determined, the rest is comparatively easy. The charges for material and labor, in the case of the manufacturing establishment, are shown on the ticket and to this are added the overhead figures which are all the expenses of doing business other than those included in productive labor and material. When the retailer, the wholesaler, and the manufac- turer definitely establish control of their costs in a man- ner similar to those described they are adopting the surest means of forestalling the financial difficulties that arise from ignorance. Getting Full Use of Space Many a concern has been able to increase its output without any great additional capital by using rooms, machinery, and so forth, for the greatest amount of time possible. Tor instance, a factory may be doing a seasonal business. At certain times of the year it requires 100 machines of a certain kind to do the necessary work, while during six months in the year only 30 machines are needed. If the management can, by manufacturing for stock at slack times, keep 50 machines going all the time and reduce the greatest number needed at any one time to 70, a large saving is effected and the money can be put in other lines. Some retail stores keep open evenings. They have at least two shifts, the first coming on in the morning and Everyday Financing That Pays 257 leaving in the late afternoon, the second coming on in the early afternoon and leaving m the evening. In this way they have a double force during the rush hours while, since the store is open longer, more sales per square foot are made with a consequent saving in rent. In the same way, rooms in the store or factory may be put to several uses. A, room may be a rest room during working hours, a lunch room at noon, apd a room for dances and social gatherings in the evening. Personality Perhaps the greatest thiag in financing a business is the thing we think the least about, namely, our person- ality. A person must have self-confidence and force, but he must also have a friendly and winning manner and be honest. Often a man has been able to secure a loan, or an order from a purchaser upon which a loan could be effected, because he was able to convince others of his and his concern's ability. Friendliness and honesty also go a long way toward securing that co-operation and spirit of good will among the employees which bring some or- ganizations to success where others fail. Harmony in the Organisation The last point to be considered is that of promoting harmony in the organization. Financing is often made extremely difficult where constant friction among owners, officers, or officials is found. One middle-western concern narrowly missed bankruptcy simply because the manager, who also was a stockholder, antagonized the owners and employees. Production slumped badly and the concern got in bad repute with the bank and with customers. 258 Financing a Biisiness Finally, it was necessary to force the manager out to save the business. Thus it is evident that the harmonious con- duct of the business bears directly on its financing prob- lems. Not alone must there ' be harmony among the men higher up, but there must be harmony between the work- ers as well. Labor turnover, strikes, and failure of em- ployees to put in 100 per cent effort because of lack of loyalty are great sources of loss. Many times a concern has been able greatly to increase its output without the aeed of more capital simply by securing greater co-opera- tion on the part of its employees by the use of bonus sys- tems, welfare work, and above all, by giving them a square deal. After all, everyday common-sense management is the only kind that pays in any concern, and it usually means the successful financing of the business. SELF-TEST QUESTIONS 1. OUTSIDE AID IN FINANCING. What policy will make Tt unnecessaiy? 2. DIRECT SUPERVISION. ' How is it made simple and ample? 3. PLANNING FINANCES AHEAD. What are some of the steps? 4. SOURCES OF PROFIT. What one is often overlooked? 6. FINANCIAL STANDING. It will be obtained by attending to what five important details? 6. COSTS. What is the first step in obtaining them ? 7. OVERHEAD EXPENSE. What are some of the methods of applying? Which is the best way? CHAPTER XIV HOW TO CURTAIL BORROWING A middle-western merchant financed himself success- fully during four years without borrowing, and then "broke the spell" for the sole purpose of making a quick cash purchase of some goods at a tremendous bargain. He turned over his stock rapidly and was able to pay hisi expenses and buy new goods without appealing to his banker. This probably is an exceptional case. It is inter- esting to note, because it shows what can be done to keep the borrowing activity at a minimum figure. Perhaps this merchant could have made greater progress if he had borrowed wisely from his bank. But this is a happy medium to aim at in obtaining funds from the bank. Too many loans in proportion to the business cannot help weakening the independence and strength of a concern until the banker finally calls a halt. As pointed out in a previour chapter, financing does not mean running to the bank for money just because it ia possible to get it. It means borrowing profitably for the requirements in hand, just as shown in Chapter X. How, then, can you hold your borrowing at the bank ,down to the lowest figure? There are several avenues open, according to the kind of business, the financial policy, and the general plan of progress. In a big way they are covered by these "don'ts": 1. Don't overbuy 2. Don't carry too big a stock 259 260 Financing a Business 3. Don't let expenses mount too high 4. Doi^'t neglect collections. These "don'ts" hinge primarily on good management, which means that the executive in charge must, exercise self -discipline in guiding the everyday affairs of his busi- ness. For instance, he has to know when his borrowing is mounting to the danger point and correct this trend before it goes too far. No matter how much he wants to spend, he must know when he has reached a safe limit and say "No." One of the most successful executives in the, country declares his enviable financial position has in a large measure resulted just from the ability to say "No," when he has reached his full capacity on expense, stock, or credit. Investigation shows that too large a credit-^ the ability to borrow above the proper limit— has actu^illy resulted in failure for some businesses. One executive, whose progress has been particularly noteworthy, says that he makes it a point to settle all his loans once a year, even tho the bank does not demand it. In this way he catches up on himself and checks, any tendency to borrow too much and to let the amounts run. So much for general points on keeping borrowing down. Don't Oveebuy Let us consider now the influence of buying on borrow- ing. Obviously, if a concern overbuys, its money is need- lessly tied up in a surplus of goods. A concern in the Northwest failed for this reason alone. An inexperience^ manager was put in charge and he proceeded to load the place up with a great array of goods far in excess of the ability of his market to absorb them. Idle goods meant lost profits, capital tied up which was needed for adver- tising, for salaries, for new stock,- and for other expenses. How to Curtail Borrowing 261 A local bank, some of whose directors were interested in the concern, loaned funds to the limit in an effort to over- come this handicap, but eventually the store had to close its doors. Then a reorganization under new management took place, and by clearing out the old stock at a bargain, the business was put on a new basis. Here is an extreme, but a very common, instance of the result of overbuying. It means borrowing, peAaps, to full capacity — ^which means high interest charges and lost interest thru the idle goods. One of the first things which a business man ought to guard against is overbuying. He then frees himself of the burden of unnecessary and expensive borrowing be- yond a profitable amount. Watching this element, too, trains the executive to turn over his stock faster and to keep it fresh. It also enables him to balance his buying so that he does not overstock on unprofitable or mediocre lines to the detriment of better ones. Thus if we are in the same line of business and you carry a stock worth $10,000 and I carry a stock worth $25,000, but I turn over my stock only four times as against ten turnovers f(^r you, the amount received will be the same. HoWever, at 6 per cent, $25,000 will bring an income of $1,500 per year as against $600 for $10,000. In other words, my extra stock is costing me $900 a year just for the capital tied up. There is also the cost of in- creased space, insurances, taxes, and so forth. A lot of mistakes, too, are sometimes made in figuring turnover. It should be remembered that the word used alone means total annual sales. The rate of stock turn- over is the number of times you dispose of your mer- chandise each year, as was shown in Chapter Xlll. Turnover can often be increased by a thoro knowledge of the business and of substitutions that may be made. 262 Financing a Business Thus when a well-known automobile manufacturer took over a factory he found it without either ready money or credit. There were many automobiles nearly finished, but which could not be completed because of the lack of a certain casting. By using an equally good, tho much higher priced metal in making these castings, he was able to finish the machines, sell them, and get his money. This more than compensated for the increased cost of casting and improved the financial condition of the business greatly. Another important thing in buying is to avoid inju- dicious bargains. Many times you will have a chance to buy odd sizes at reduced prices. Avoid them unless you can see exactly how they can be used or the sizes changed with little or no expense. If you do not take these things into consideration you will have a lot of stock on hand that you cannot get rid of or use without a great deal of ex- pense. In the same way, watch quantity discounts. Re- member that the tie-up of money invested, even for two months, may equal the quantity discount. \ Don't Cabby Too Big a Stock The second "don't" is equally important, and very much like the first one. This, of course, is often the result of overbuying or sometimes of poor judgment in buying. Rarely, suddenly changing conditions may cause a slump in business which results in an overstock. Or an execu- tive may say that he has no overstock when in reality he is carrying a bigger stock than his trade warrants. This mistake is not likely to occur if he has a well-kept stock ledger and a good accounting system. In any case it is necessary to reduce it, as pointed out earlier in the chap- ter under the section on "Overbuying." GETTING THE SAME WORK OUT OF LESS STOCK Of the two gears shown above,, the larger has twice the circumference and twice the number of teeth of the smaller. The larger gear contains approximately four times as much metal as the smaller. And yet by revolving twice as fast as the larger gear, the smaller gear can do the same amount of work as the larger. If you can manage to turn your stock twice as fast as formerly, you can get along with just half the stock, thus cutting down costs of storage, insurance, depreciation, and tied-up capitaL Fio. 53. — Getting the Same Work out of Less Stock 264 Findncing a Business Occasionally too large a stock can be trimmed down by- eliminating an unprofitable line. An eastern manufac- turer reduced his needs for outside funds by cutting his raw material supply in half. He was able to do this by contracting for deliveries at a specified market rate and paying for it at intervals thruout the year. Thus he used his own working capital to advantage without borrowing sp much from the bank. ^ Don't Let Expenses Mount Too High Turning to the third safeguard against too much bor- rowing — ^keeping expenses down— we come to one of the most important factors of business financing. There is probably no greater "bugbear" to all business men than rising costs and increasing overhead. Concerns too often find it necessary to ^borrow because they do not keep ac- curate costs and do not trim expenses in proportion to income. Even a banker is not always able to detect easily the wasteful expenditures of money here and tAere in an organization. Thus borrowing is resorted to, when in reality the question of costs should be approached with great thoroness and care. Investigations show that lack of accurate accounting and unwise distribution of over- head often make necessary an appeal to the local bank for money. There may be sufficient assets to enable the banker to grant the loan, but the concern is jeopardizing its financial position and wasting money in interest. By knowing and watching costs the borrowing habit can be kept in bounds. Aside from these main features, some concerns have kep/t their borrowing down by a willingness to build busi- ness slowly. One middle-westerner never borrowed until recently, altho he has been in business nearly half a cen- How to Curtail Borrowing 265 tury. He has a good-sized manufacturing concern whicli has grown step by step by using the funds within the or- ganization. Here, of course, conies the question as to whether it is greater wisdom to borrow more freely and grow faster or to stick to ultra-conservative financing. This naturally is an individual question. Providing the borrower follows carefully the ideas expressed in the chapter on "How to Borrow Profitably" he can no doubt make faster headway by borrowing from his banker from time to time. On the other hand, the conservative idea of financing has its advantages. Like the mountain burro, it is at least sure-footed. Borrowing should always be done with the purpose of building an organization up, not down. * Sometimes the temptation to expand leads an executive to borrow unwisely. One concern is careful not to at- tempt any expansion unless it has ample surplus funds of its own to accomplish the new task. To sum up, it should be remembered that borrowing is not the first step to financing. An eastern manufac- turer who thought he needed to borrow discovered that by studying more thoroly his whole problem he was able to dispense with asking for loans which he thought ab- solutely necessary to his success. He found that only a small percentage of his capital was working. In other words, the factory lacked the proper arrangement to give continuity to the work. There was a lot of waste effort on the part of the employees. Production therefore wa,s so slow that the working capital was really only about 50 per cent efficient. After carefully analyzing his needs, this manufacturer itearranged his departments so that there was no rehandling of the product. It went straight thru until it came out as a finished article. Other econ- omies were effected which resulted in a far greater output 266 Fmomcing a Business at practically the same cost. Workers no longer wasted time running from one location to another for materials, and so on. In this way, borrowing was reduced to infre- quent temporary occasions and the financial status of the organization was tremendously improved. It must also be remembered that, except in extreme cases, it is never wise to borrow up to the limit. You jphould always leave a margin for emergencies. A fire, a strike, or. a financial panic may very easily place a con- cern in a position where it mufet have more money, and this/ at a time when it is hardest/ to get the money. If, then, a sufficient margin has been provided so that it is possible to borrow these additional funds, you will be able to pull thru while your neighbor, who had borrowed up to the limit, must go to the wall. Don't Neglect Collections Taking up the fourth point, it is important to watch coUectidns. One of the complaints bankers so often re- ceive sounds something like this: "I'll have to borrow this month because my collections are slow ; they're good, but I just can't get them in." There are sometimes, of course, unusual general busi- ness developments that mean slack collections. But this is rare. Ordinarily there is no excuse for collections being poor. And when they are behind, what does bor- rowing mean? It means that you are paying interest on funds unnecessarily and losing a legitimate share of your profits. You are losing interest money to accom- modate customers who should be paying you promptly. In other words, if you average $30,000 the year round in accounts receivable when money out at interest is bring- ing 6 per cent, you are losing $1,800 each year simply "omtbeiSsproGtal Practices il^st m TT tiinio[vci- , J ;:|ll^Wui-e(|[ Come basts for mark- Wand the Wage '' \ \)Mainedj ia estimate /\pro|tt5, i V rf^uring cicpensci rSlmm tu tncdrrectj estimaling memi inco^fedlt-l ]/' Taking the wf on^ b^ sis for markup. Gips^B^g at an averageJ j^rcelitag^ to sales Haphazard estiJBiatlag of expense)^.' ( Vjl^Hiing fi^igWin \ Delay fngefjing^ds \ the mp\e^ Vayl on floor and incijas- \ hf/ ing bookkeepind ' 'I 1 !. expy February | esti- matBd 1921 Eipend I920 Es«- maled 1921 «?* Cxpent- •d (920 Sundries Branch Office ^ ■Express ' FreiOhi and tiriaHe -AdvePtislVm Cleaning arid IZepalrinf IZent Sales Salai-ies Buyers Salaries f loormerA Salaries / ElewtorsandWaWinien Um and Heat Markintf Room Deliveries anil CaHas Bund:ie DeslL Stationery and Supplies Insurance Taxes etiarity ^B T>5d'n(l,5tamps j Officers* SaParies J ^^^v Total . \ 1 mW \ L w^^ lierchandise/ Purcliase^ Total v \ Total 5ales IJ'^^ Per Cent Cost to Sales V Per Cent. Sdlesmenis salaries to sales Percent; Buyers' Salaries to Sales mmsm Pia. 67.— Budget Chart Keep Pace With Business Growth 289 helps to maintain a balance between available money or working capital and the requirements of the business. For instance, one company in the Middle West has a surplus of money for three months every fall. It there- fore buys ninety-day comcmereial paper, receiving a fair rate of interest, and cashes in on it in time for late fall needs. Thru the use of a budget these opportunities become more quickly apparent. In some instances, where fluctuations are great, the budget might not be practi- cable. On the other hand, it acts as a sort of chart, even tho incomplete in some ways. A budget really amounts to charting the business financially. The use of charts showing statistics by months, quar- ters, or years, is a splendid guide for some businesses, especially those enjojdng a steady growth. By taking the volume of sales for a term of periods or years, it is easy to determine the rate of increase shown, and for the purposes of the budget it is fair to assume that an aver- age rate so found will be maintained in the future, barring unforeseen commercial and industrial complications. By charting the expenses in the same way and by putting them on a percentage basis of the sales for the respective periods, it is then easierto apportion the proper amounts to the various expenses in the making of the budget. The free use of graphs showing the comparative records of the various phases of the business, such as sales, receipts and disbursements, department quotas and records, cash balances, sales details by districts or trade classes, reserves and depreciation, and so on, is an excel- lent practice. Such methods show in a quick and com- prehensive way the demands of business growth and the trend of business conditions, whether up or down, which is a valuable aid in budget making. The graphs save the manager's time by presenting a picture of the facts. 290 Financing a Business Many firms from habit and experience have well in mind the month-to-month financial needs, yet they have no concrete budget plan. It ;s surprising how few actually , have diefinite budget figures. One man says: "Our business is prosperous and we have generous lines of credit at our banks. Our sales fluctuate unexpectedly according to weather conditions and other causes. A bndget, therefore, would hardly help us. When we need additional money temporarily, our baijks supply it." Another concern follows a budget made up from month to month, based on crop conditions, trade prospects, and so on. The heads of the concern simply figure out on scratch paper what money they will need to borrow, and how far to carry production^ and issue instructions ac- cordingly. A budget of this sort, no matter how abbre- viated, should, of course, thoroly cover both probable income and probable expenditure. This often can be based on records of preceding years, with additions to cover a natural or expected growth. Under income you would include all receipts from sales, rentals, or other similar sources ; income from savings, investments, or any other sort of revenue. Your probable out-go would be cost of materials or stock, man- ufacturing costs, if any, general selling and overhead expense, interest, and any miscellaneous or expected ex- pense, such as improvements, repair g, and so on. Such a budget, carefully worked out according to terms of credit and other factors, is of invaluable assistance in keeping the proper financial balance in the business. Finally, no business is intended to be for today. It is established to fill a permanent niche in commerce or in- dustry. It is, therefore, necessary to plan for the future and so to map out its progress that its finances will keep I Keep Pace With Business Growth 291 pace with its growth. To accomplish this, the ideas pre- sented in this chapter should serve to point the way. SELF-TEST QUESTIONS 1. CAPITAL NEEDS. Is it sufficient to have jnst enough in start- ing a business, and why? 2. INCREASING THE BUSINESS. How does th^ rapidity with which a' business increases aflfect the amount of capital required? 3. STARTING A NEW BUSINESS. Would you put some of the profits back into the business, and why? 4. LOCATING A NEW FACTORY. What are the most important factors to consider in such a procedure ? 5. FUTURE MONEY REQUIREMENTS. How may they best be determined? CHAPTER XVn FINANCING EXPORTS AND IMPORTS Within two years a manufacturer of stationery in the central western part of the United States built up an export business from an original order of less than $5,000 to an annual volume exceeding $150,000. All of this export business was confined to the Scandinavian Penin- sula. When the manufacturer found that this particular field offered promises of attractive profits, he concen- trated on it. He did not scatter his energy in other over- seas markets. "I expect to reach out for more business in foreign countries," he says, "but I will not undertake further development until I have made a thoro analysis of the pjpspective territory by sending out personal represen- tatives, interviewing the banks and making extensive mail inquiry. All of this will provide information that should act as a dependable guide in developing future foreign sales territory." FoBEIGN TbADB SiMILAE TO DOMESTIC Now, the plan of this manufacturer is simplicity itself and is not fundamentally different from a course that he would pursue in opening up a new market right here at home. Indeed, the business practices that prevail in domestic trade are much the same as those in foreign trade. The business man who begins to think in terms 292 Exports and Imports 293 of overseas commerce must recognize this point at the outset. He may be tempted to conjure up a lot Of compli- cations in handling business with foreigners, when, as a matter of fact, he can usually develop a satisfactory volulne of export business by following out plans similar to those that have been successful in his own community. True,^there are certain differences in handling foreign and domestic trade, but they are not of a character to puzzle the enterprising American business man. In a preceding chapter, for example, we show how the accept- ance form of credit could be advantageously used in exporting and importing, and we found that it was just as simple as the domestic trade acceptance. Let us consider now some of the incidental problems that confront the American business man who is planning to sell his goods abroad or who is buying merchandise in foreign lands. Pbopeb Information and Qtjotations After you have made a thoro study of the Spanish market, for example, and you decide to enter that terri- tory, the logical starting point is to determine "How much does the prospective customer know?" Has he purchased goods like yours from a competitor and is he familiar with the way business is handled by the Americans ? And, finally, how should quotations be made? If the foreign, buyer indicates that he is not wholly familiar with your goods and your methods, make sure that you give him in a direct and simple form, complete information as to what you propose to furnish, at what price, where de- livered, and all other details. It is only in this way that your foreign market can be developed and a new outlet created for your goods. Sometimes the American is 294 Financing a Business disposed to make quotations that are most convenient for himself rather than for the buyer, and when he does this his chances for securing business are lessened by just that much. At the same time the seller must protect him- self against greater expense than is necessary ti> secure the business. This problem of making the quotation correctly is all- important to the seller because what he receives for his merchandise above the cost determines the profit. On the other hand the buyer is equally anxious to know the cost to him, in order that he may determine if he can sell at a profit. F. 0. B., C. I. F., AND F. A. S. Quotations For these reasons, the seller is interested in an F. 0. B. quotation, and the buyer in a C. I. F. quotation— C. I. F. meaning cost, insurance, and freight. The Seller, however, is just as much interested as the buyer in keeping down the price, in order, first, to help the prospective customer conclude that he can sell the goods at a profit, and second, to prevent the order from being 'placed with a competitor. And in order to make a C. I. F. quotation the seller must know just what his total outlay will be as compared with furnishing the goods for domestic consumption (for instance, F. 0. B. cars his city), to which he must add the difference in the cost of packing for export as well as the freight and insurance to destination. Thus, while it is seldom possible for a seller to have an F. 0. B. quotation accepted at his selling point, it is never- theless always the basis on which a C. I. F. quotation is figured. These quotations (F. 0. B. and C. I. F.) are stated How to Figure Quotations on Goods for Export When quoting a price to a foreign buyer, tell him just how far you will ca^ the goods for that price. See pages 294-298 for explanation. F. O. B.=Free On Board, side Steamer. C. I. F.= Freight. F. A. S.=Free Along- =Cost, Insurance and C-LR Warehouse Inidnd Point of Destination CLIfCy. Yards Inland Point of Destination C.I.F. ^ftof ¥m. 68. — How tp Figure Quotations on Goods for Export 296 Financing a Business here in their basic form and are the principal quotations governing export selling. F. 0. B. quotations are frequently fixed for a point other than the selling point, such as F. 0. B. New Orleans, when that is not the original point of selling but is per- haps the port of shipment. Such a quotation, therefore, includes the ej^pense of getting the goods from the point of origin to the outbound vessel at New Orleans. And when the quotation is F. A. S. (free alongside) there is the further addition to the seller's expenses of transporting the goods from the railroad terminal to the steamer. Except in the case of large quantities or heavy pieces or in large bulk, this is no,t a good quotation from the seller's standpoint, as the cost of transfer on a small shipment is likely to be disproportionately high. Vaeious Quotations Compabbd To make these quotations more clear, let us consider that you are a manufacturer at Bristol, Pa., and that I am a buyer at Mercedes, a city just west of Buenos Aires, in the Argentine. I ask you for your prices. You may quote me F. 0. B. cars Bristol. In this case, you simply pack the goods and deliver them to the railroad company, and I pay all the other charges and assume all the risks. Or you may quote me F. 0. B. cars Philadelphia. In this case you pay the freight to Philadelphia and assume the risk of getting the goods there. I must pay for the cost of getting the goods from the railroad to the boat and on board her. If you quote F. 0. B. cars on dock, or F. 0. B. cars on barge alongside, you pay the expense of getting the cars switched to the dock or of having the goods delivered on barges alongside. I still have to pay the expense of get- Exports and Imports 297 ting the goods on board if it is necessary to have any special equipment for this purpose. A very similar quotation is F. A. S. Philadelphia. This requires you to bring the goods alongside either by plac- ing them on the dock or on a barge or lighter alongside. The initials stand simply for "Free Alongside." So far you have not assumed any risk on the ocean. , But you may quote C. I. F. Buenos Aires. This means that the quoted price includes costs (that is the net price to you of the goods), insurance, and freight to Buenos Aires, but that you do not assume the risk of shipment or agree to deliver the goods there. For instance, in an F. 0. B. quotation you agree to deliver the goods at a certain point and if they are accidentally destroyed be- fore they reach that point you must replace them. If, however, the quotation is merely C I. F. that point, you have not agreed to deliver them there but merely to send them to that point and to pay the insurance and freight. In case of loss, you do not have to replace and my rights are against the insurance company only, unless the car- rier is also liable. There is still the quotation F. 0. B. dock at Buenos Aires. If you make this quotation you assume all risk of getting the goods laid down on the dock at their desti- nation. In addition to these quotations others are sopaetimes used, as C. A. F. or C. & F. (cash and freight), which is the same as C. I. F. except that the buyer pays for the insurance. If the term C. I. F. & E. (cash, insurance, freight, and exchange) is used, the seller pays the ex- change as well. In dealing with the Far East the term C. I. F. C. I. (cash, insurance," freight, collection charges, interest) is often used. Here the seller pays interest and collection charges as well. 298 Financing a Business Impobtancb op Definite Qitotations The importance of being specific in making quotations is therefore apparent. F. 0. B, quotations are often made without the seller specifying where he will place the goods F. 0. B. and many disputes have arisen from this loose way of quoting. It is seldom sufficient merely 'to quote F. 0. B. at the port of export, as F. 0. B. New York. The purchaser usually takes this to mean F. 0. , B. out-bound vessel, while often the shipper means simply delivery at the rail- (Toad terminal at that port. i^ , Then when the buyer is charged for additional trans- portation, a brisk correspondence develops, one party or the other has his profits reduced by expenses on which he had not figured, and mutual dissatisfaction results. And the difficulty of settling differences of opinion increases with distance. When you are dealing with a buyer in a far-off country you are limited to your ability to argue thru correspondence, and, what is more, you must re- member that' it may take three months for your letter to reach your customer. Do not quote F. 0. B. St. Paul, but either F. O. B. works, or F. 0. B. cars in St. Paul; do not quote F. 0. B. Boston, but say whether you mean F. 0. B. cars at rail- road freight stations, F. 0. B. cars on docks, or F. 0. B. steamer. You cannot make it too definite. The same applies to C. I. F. quotations. In the case of seaports, do not quote simply C I. F. the port of export, but C. I. F. Liverpool, or C. I. F. Bordeaux, etc., that is, C. I. F. the port of destination. And with inland cities, quote 0. 1. F. railroad station or warehouse, according to where you are actually offering to deliver the goods at the price quoted. Exports and Imports 299 Financing Foreign Shipments Next in importance to a clear analysis of the foreign sales territory and rigid exactitude in making quotations, we have the question of financing foreign shipments. As already stated, the financial end of a foreign transaction does not differ greatly from that of a domestic deal, ex- cept that usually the bank or a shipping merchant located at a seaport acts as an intermediary in finaucing the shipment between the time it leaves the factory or ware- house and its arrival at the foreign destination agreed upon in the terms of sale. This is done by means of discounting the seller's draft against shipping documents, taken for a period agreed upon in the terms of sale. The draft may be payable at sight, which, of course, means that it is to be paid immediately upon presentation to the buyer. Or it may be payable 30, 60, 90 days, etc., after presentation, or more rarely, after the date on which it is drawn. In that case the drawee signs an ac- ceptance of the draft (Chapter XI) when it is presented to him thru the bank, and makes payment upon the due date by depositing funds equal to the amount of the draft, which funds are then available to the seller. The fee charged by the bank or shippiiag merchant' varies according to the price of the mohey of the foreign country,' i. e., "exchange," at the time the draft is drawn, the terms of drafts, and the time for which the money must be advanced. , The American who is selling"^ abroad frequently re- quires payment before the merehandise is shipped, and it may happen also that the bu^er is unwilling to part with his money until the goods are ^e^iver^id. There are, of course, numerous ways of pvercoMng this difficulty. 300 Financing a Business The methods that have been adopted generally to meet these conditions will now be taken up in their order. Cash with Order First, we have the system of cash with the order. The foreign importer may remit with his order a draft on New York. This method places the burden entirely on the customer and is employed chiefly in small transac- tions or where a special condition justifies its use. Cash on Delivery Next is the plan of cash on delivery. The purchaser may send funds directly to an American bank with in- structions to pay the manufacturer Upon delivery of cer- tain documents, such as the export license, declaration, bills of lading, invoice, merchandise, and so on. The Confirmed Order There is also the confirmed order. A current practice is for the importer to make financial arrangements with an American house, or with a local establishment rep- resented in the Uni'ted States, whereby this correspondent confirms hji^ orders ahd accepts drafts covering his pur- chases; iTnder^his arrangement the American manufac- turer hee4 concern himself only with the credit of the house so designated. " Letters of Credit Another way in which the seller may get his money at once while the buyet <^bes not pay till he gets the goods is by use of the commercial letter of ci^edit. Let us suppose that Gaston et Cie of Paris wishes to Exports and Imports 301 buy of Johnson & Co. of New York. Gaston et Cie will make arrangements with its Paris hank by which that bank will have its New York correspondent issue a letter of credit to Gaston et Cie stating that it will pay drafts drawn on that buyer by Johnson & Co. The New York FIFTH NATIONAL BANK Boston, June 6, 1920. Expiring Dec. 31, 1920. Export Credit No. 1262. Hamilton Tractor Co., Providence, R. I. Gentlemen: We are informed that you will draw upon us for account of Uruguay Tractor Company at sight to the extent of FIVE THOUSAND AND 00/100 DOL- LARS ($5,000.00) covering ten (10) tractors to be shipped to Uruguay. Documents (complete sets unless otherwise stated) com- prising: Steamer Bills of Lading issued to order of consignee Invoices Insurance Policies covering marine and war risk, to be de- livered to us against payment Insurance as above. This letter is for your guidance in preparing documents, and conveys no engagement on the part of this Bank, as we have no instructions to confirm the Credit. Bills of Lading issued by Forwarding Agents will not be accepted unless specifically authorized over the author- ized signatures of this Bank. Drawings must clearly specify the number of this Credit. Yours very truly, PRO FORMA, Vice President Fio. 69. — An Unconflrmed Export Credit From a Boston bank to an export house, notifying it that drafts up to the amount named will be honored under pertain conditions. 302 Financing a Business New York, January 8, 1919. Expiring June 20, 1919. Irrevocable Export Credit No. 630. Hamilton Tractor Company, Providence, R. I. Gentlemen: You are hereby authorized to, draw upon us at sight for account of Uruguay Tractor Company to the extent of FOUR THOUSAND AND 00/100 DOL- LARS ($4,000.00) covering nine (9) tractors to be shipped to Uruguay. Documents (complete sets unless otherwise stated) com- prising: Steamer , Bills of Lading issued to order of consignee Invoices Insurance policies covering marine and war risk to be deliv- ered to us against payment Insurance as above. Bills of Lading issued by Forwarding Agents will not be accepted unless specifically authorized therein, and any modifications of the terms of the credit must be in writing over the authorized signatures of this Bank. Drawings must clearly specify the number of this Credit. Yours very truly, PRO FORMA, Vice President. Fig. 60.^-Confirmed Export Credit £/Stabllshecl at a New York bank for a South American Importer by hli bank, to cover the purchase of ai specifled number of tractors. bank will send this in duplicate to Gaston et Cie, which Avill send the two to Johnson & Co. by different mails. Johnson & Co. will then draw on Gaston et Cie, and pre- sent the draft to the bank issuing the letter. The bank will pay the draft which will be sent to the Paris bank Exports and Imports 303 for payment. This bank will then reimburse itself by securing payment from Gaston et Cie. Letters of credit may either be specific, for payment of a certain draft or drafts, or they may be blanket, cov- ering any number of drafts, provided the total amount outstanding does not exceed a certain sum. These letters of credit usually go into detail both as to the conditions of the draft, as to just how it shall be drawn, and also as to what papers shall accompany it. These conditions must of course be complied with. Sales on Open Account Again, there are sales on open account. The exporter may permit the buyer to carry a running account under an agreement that payments will be made at specified periods. Here the shipper assumes the risk. When a sale is made, it is important to determine to whose order the documents should be drawn. This ap- plies especially to bills of lading, warehouse and other receipts, and to the insurance certificates. Shipping pa- pers are usually drawn "to order," because of the flexi- bility of negotiation thus obtained. The indorsement of the shipper should be made in blank and not to the bank accepting the papers. By agreement between the parties, however, bills of lading are sometimes issued directly to the consignee. By this method the buyer makes certain that the goods cannot be diverted without his consent. The laws of the importer's country must also be consulted, as several countries require the bills of lading to be drawn in certain ways. The bulk of foreign trade is handled with nego- tiable documents, because the use of such instruments insures adequate protection for the banks financing the EXPORT TRUST RECEIPT Boston, January Z, 1919. ReccSved in Trust from the Fifth National Bank, Boston, acting as agei^t for Bank of South Africa _ the merchandise specified in the Bill of Lading. Issued by S. L. & M. Dated Dec. 14, 1918. Car number P. N. 29746. Routed St L. & M. and Erie. Covering twenty (20) cases of ivory and in consideration thereof the undersigned hereby agrees to hold the said mer- chandise as the property of said Bank, subject at all times to its order, for the purpose of being sold or otherwise dis- posed of, as the said Bank may direct; and further agrees that when and so soon as any or all of the said merchandise is sold to pay over the proceeds thereof to the said Bank. The said Bank may, at any time, at its option, cancel this trust and take possession of said merchandise, or of the proceeds of such of the same as may then have been sold, wherever the said merchandise or proceeds may then be found; the undersigned further agreeing to return the docu- ments or merchandise forthwith to said Bank lipon. request. The undersigned expressly accepts this trust subject to the following conditions, in addition to those hereinbefore or hereinafter specified, and agrees to fulfill them im- plicitly. It is further understood and agreed that any failure on the part of the imdersigned to fully carry out any of the provisions or conditions of this trust, even if known to said Bank, shall not be deemed a waiver of perfbrmance of any such provision or condition or otherwise by said Bank or a waiver of any of its rights or remedies hereunder, and any waiver in order to operate as such must be in writing and also indorsed hereon and properly signed by said Bank. (Signed) PRO FORMA. Amount of Draft $10,620.15. Date January 2, 1919. Letter of advice No. 750/200. Fio. 61.— Export Trust Recdpt Exports and Imports 305 transactions and simplifies the conduct of the business. Certain formalities connected with drawing and indorsing documents may appear to be nonessential to the American manufacturer, but when he ships to a foreign market his papers pass thru many hands and a slight omission might cause the shipment to be held up to await correction of the error. When the seller's bank at the American seaboard is instructed to accept or pay a draft against a railroad bill of lading or a warehouse receipt, it must relinquish possession of it for sufficient time to allow the document to be exchanged for an ocean bill of lading. The bank engages the services of a forwarding agent for this pur- pose, or, in certain cases, may accept from the exporter a trust receipt which grants the powers necessary to the protection of its interests during the interval. An export credit may be opened in a foreign currency instead of in dollars. In actual practice this is usually in pounds sterling. The American bank makes payment at its prevailing rate for time or sight bills according to the terms set forth and forwards thp relative documents to its foreign correspondent. The importer pays at the foreign bank's se.lling rate on London, the variations in this rate depending on how the cover is to be provided in that city, for example, by cable, or by mail transfer. Drafts Where, however, the purchaser does not want to pay out any money before he receives the goods, a foreign trade acceptance may be used, as in dolnestic commerce, by the seller drawing on the purchaser or by the buyer sending the draft to him (provided he has no agent in the United States to accept for him), and having him accept and return it. 306 Financing a Business If either the buyer or seller is well known, the shipper may draw on the buyer and sell the draft, either to a bank dealing in foreign exchange, or to a broker. If, however, the drawer and drawee are not so well known, the drawer may give the draft to a bank to send on for collection. In this case, the shipper does not receive any money until the draft is paid and the money is forwarded to his bank. Clean and Documentary Drafts A "clean" draft is one that is unaccompanied by any other instrument. In the ordinary course of business it may be one made in accordance with previous agreement, to be paid on a certain number of days after the shipment Las been forwarded. In other instances it may be used by the shipper as a means to hurry the payment of an account which has run beyond maturity. A "documentary" -draft is one to which' are attached the documents of title, the insurance certificate, and such others of the papers connected with an export credit as are required for clearance from the port of departure and entry abroad. Instructions with Drafts When a draft is marked with the letters D/A, it signi- fies that the documents are to be delivered to the drawee upon acceptance ; in the case of a D/P draft, the papers are to be withheld until payment is made. As already stated in the case of foreign houses of high standing, documents are usually deliverable against acceptance. It should be indicated plainly on each draft which methbd is intended, so that the foreign bank may be in possession of definite instructions when presenting the instrument. Fig. 62. — Time Draft. Orieinal and Dupllate. '^ • Sent on different dates so that loss of one will not delay transaction. 308 Financing a Business When an exporter prepares his draft and other docu- ments he usually sends them for collection directly to si bank at the point where his customei^ is located or delivers them to his own bank or to oile in a central city for for- warding abroad for the same purpose. In none of these ways does he realize cash for his goods until the return from the foreign bank of the advice of payment. Since only a few of th6 largest exporters can do a profitable business on this basis, such collections are few as com- pared with negotiated drafts covering export shipments. "When a draft is forwarded for collection, the seller should be careful to give explicit instructions so that per- sons handling the documents may know what action to take in any contingency that may occur. It is necessary, therefore : (1) to indicate whether the draft is drawn D/A or D/P (2) to state whether, if the former, the item should be held for collection at maturity or returned (3) to name the rate of discount to be allowed for payment before maturity (4) to designate a person to be notified in case of non-acceptance, non-payment, or other contingencies (5) to specify what action should be taken upon non-acceptance or non-payment, for example, whether protest is desired and whether or not, in that event, the documents should be turned over to an agent of the manufacturer (6) to arrange for notification by cable when delay would cause serious loss. These directions are highly important, especially in case of perishable goods. Sometimes such instructions are incorporated on stubs or slips, which are easily detached from the drafts. This practice is subject, however, to inconveniences, because no record of the directions is left with the banks con- nected with the earlier stages in handling the documents. This may be ob^dated by embodying the instructions in a letter of advice accompanying the draft. Protest should Exports and Imports 309 be requested in every case, as it makes non-payment or non-acceptance much easier to prove. Very often the drawee of a time draft will want to pay it before it is due. For this reason not only should the rate of interest be known but also the rate of discount the drawee is to receive by paying before maturity. HOW BANKS HANDLE THE DKATTS Usually the exporter takes his draft with a complete set of documents to a bank and negotiates them for cash. Here, again, the shipper indorses the draft and other {iapers in blank, and the bank forwards them to its cor- respondent in the place where the foreign importer is situated, or, if it has no such correspondent, to a bank that has one. As a rule American banks do not like to discount bills running over three months' sight. In case of goods sold on longer terms, the drafts may be sent forward for acceptance and return. The shipper then may hold them for negotiation three or four months be- fore they finally mature. Eight here it is worth calling attention to the difference . between negotiating a draft and handling it in some of the other ways already described^ When a foreign im- porter places cash or credit at the disposal of an Ameri- can bank and the latter, complying with the instructions it receives, pays against documents delivered by the ex- porter, the transaction is not a purchase on the part of the bank referred to. Prior to the transfer the funds belonged to the importer. Similarly, in handling a draft for collection, the American bank makes no payment to the exporter until ad\dsed that the sum involved has been realized in the buyer's market. When a bank in the United States negotiates a foreign draft, it loans its own Exports and Imports 311 money to the shipper on' the security of the latter 's in- dorsement and of the value of the goods, title to which it holds in the shipping documents. The bank relies upon its own judgment in determining the sufficiency of the papers, and forwards them with the necessary instruc- tions to its correspondent abroad for collection. The question of who is to pay the interest charges is one that always should be settled between the buyer and seller before the order is executed. One must consider the number of days necessary for mail to reacb the buyer, and to return, and, in case of a time draft, the^period the item has to run. It is customary to instruct a foreign bank to collect interest at a designated rate. When this is done, the request usually appears on the face of the draft in a simple form. LOCAL CUSTOMS A careful study must be made of the different methods of making payments and of the customary methods in use in the different countries. Thus many houses lose considerable Australian trade by demanding cash, where- as the Australian buyer prefers a draft in which is in- serted a clause stating that he will pay interest, exchange, and English and coloniaf revenue stamps. As a draft drawn in such a way can be discounted for the amount of* its face, it is really the equivalent of a cash payment. It is also important to know the local customs regard- ing long-time as against short-time payments. Many American firms do not pay sufficient attention to this fac- tor. Thus dealers in Central America usually require long-time credit. This is because in many cases they have to pay hig^ rates of interest if they borrow at home to make cash payments and also because the eountiy 312 Financing a Business depends largely on the returns from two or three crops in making its payments. Here, then, we have a concise description of the methods usually employed by the American business man who is selling his goods abroad. And, in general, the means used- to finance import shipments are similar. \ FoKEslGK Exchange We have still to see how the value of the money and credits of one country and its citizens is determined, in terms of the money of another country. This is based primarily upon three points: (1) the relative value of the metal in the coins, (2) the law of supply and demand, and (3) the faith of the people of other nations that a certain nation will redeem its credits, including those represented by paper money. Relative Value of Coins as Bullion Eegarding the first point, almost all countries except some in America ^nd a few in Asia are on a gold basis ; that is to say, the coin which represents the standard monetary unit contains a certain amount of gold of a definite fineness. Thus the gold doUar contains so many grains of gold mixed with a certain slight amount of sil- ver and copper. The silver and copper are put in simply to make the coins more durable. The value of the dollar, in terms of, say francs, de- pends on the amount of gold it contains compared with that in a franc Thus, if the doEar contained five times as much gold as a franc, the dollar would be worth five francs. These figures are assumed and not accurate, as there is more than five times as much gold in a dollar as there is in a franc, and both the gold dollar and the Exports and Imports 313 gold franc are ideal coins, that is they are not minted, but are standards by which the metal content of the gold coin^ is set. This ratio of the gold in one coin to the gold in another is called the "par point." Thus if one dollar contains five times as much gold as one franc, the par point of the franc, in terms of dollars, is twenty cents> while the par point of the dollar in terms of francs is five francs. It is this "par point" which, in the absence of temporarily stronger grounds, ordinarily limits the rate of exchange. Besides the countries having a gold standard, there are countries having a silver standard. Here the standard monetary unit, instead of being gold of a certain weight and fineness, is silver of a certain weight and fineness. For this reason there is no definite ratio of value between the coins of a gold-standard and of a silver-standard country, but the coins fluctuate in value in the same man- ner as silver fluctuates in price where gold is taken as a standard. We have said that the par point limits the rate of ex- change in ordinary times. Let us see how this is brought about. hem of Supply arid Demand Exchange rates are usually quoted on cable transac- tions, sight drafts, and time drafts. Their price varies from par according to the law of the supply and demand which, in turn, is caused by the balance of trade. If, in the case of dollars and francs, there is a great demand for francs and they are selling above par, say four and nine-tenths francs for one dollar, francs are said to be at a premium. If francs sell below par, they are said to be at a discount. 314 Financing a Business Let us suppose that we are in the latter part of the fall, and that a large amount of grain is being shipped to France while there is no increase in our imports from France. Here, then, the balance' of trade .is in favor of the United States. This grain must be paid for, and consequently many drafts will be drawn on French houses while drafts for a less amount will be drawn by French houses on business houses in the United States. Some of these will be time drafts and others will be sight drafts, and in some eases the drawing on the different houses will be done by cable. , But the.Freneh houses will have to pay these drafts as they fall due. They may do this by shipping gold to pay for them, by drawing checks against deposits or credits on houses in the United States, or by buying up drafts on American business houses and using these to offset the claims against them. The drafts on the American houses must be due at or before the time those on the French houses are due, so that the French houses can collect them and pay the money to the holders of the drafts on them. This niethod of offsetting draft against draft is the cheapest and most commonly used of the three ways. It means that there mil be a big demand for drafts on houses in the United States and consequently that their price vfill go up. In other words, dollars will be at a premiima and francs at a discount. Btlt the demand will not be the same for all classes of exchange. On the day we are discussing, there may be an urgent demand for immediate payments. This will increase the premium on U. S. cables above that on sight drafts. At the same time, it may be that in the winter imports from France will increase, and exports to that country ^villefall off. A seasonal fluctuation like this can be foreseen. Exports and Imports 315 For this reason, in the winter there will be a greater demand for francs and lees demand for dollars, and this will be at the time when our time drafts on French houses mature. They may then be selling at par, altho the sight drafts are at a discount, for when the time drafts mature there will be plenty of drafts'on North American concerns to offset them. Now let us consider the case of sight drafts on France which are at a discount. If the discounts get too low, it ■will be cheaper for the French to ship over gold francs with which to pay, as these can be melted down, taken to the mint, and turned into United States coins. In other words, when the exchange on a foreign country rises above the par point, plus cost of transportation, pjius insurance and other incidental costs, it is cheaper to pay in gold than to buy commercial paper on that country. So the par point does set maximum and minimum limits for the rate of exchange. Financial Status of a Country We now come to the third point — faith in a country's financial stability. After the war, it was impossible for many nations to supply their citizens with gold so that they might pay off their debts. This meant that the value of the paper drawn by an American on a French house depended on our belief, first, that the French Re- public would be able some day to give its citizens gold whenever they asked for it; and, second, that sooner or later, French exports would increase so that the French houses could repay us either in goods or in claims against the citizens of other nations. Needless to say, the law of supply and demand enters the case here, too, and if 316 ' Financing a Business there were a sudden demand for francs, they would at once rise in value. In fact all three elements are always existent and interacting. i If instead of France, we took Salvador, which is on a silver basis, the same things would hold true except for the additional element injected thru the fluctuations be- tween the values of gold and silver. The basis of quotimg exchange rates varies according to the country quoted. For instance, pounds sterling are usually quoted in their value in dollars and cents ; francs ahd other coins of comparatively low par value are quoted in the number that can be bought for a dollar. On the other hand, with Canadian money, the amount of discount on a thousand dollars is often quoted. It is often cheaper to secure exchange thru a third country, rather than directly with the one involved. Let us suppose that at this instant Canada and the United States are exporting to France, France to the Nether- lands, and the Netherlands to Canada and the United States. There will therefore be a denjand in France for drafts on Canada and the United States, in the Nether- lands for drafts on Prance, and in Canada and the United States for drafts on the Netherlands. Thus in North America florins (the standard coin of the Netherlands) will be high while francs are cheap, and in France floriijs will be cheap. The North American, then, by buying cheap francs and using these to buy cheap florins thru France, can offset the price of the expensive florins. This method of indirect exchange is called arbitrage or in- direct exchange. It is a little more expensive than direct exehaiiige because of additional brokers' ides and, in some cases, of revenue stamps. This method may not be con- fined to three countries only, but may be operated thru several. Exports and Imports 317 Before the recent World War, most foreign drafts were drawn in pounds sterling on London. While this tendency is still marked, the number drawn in dollars on New York has greatly increased. What the final outcome wiU be will depend a great deal upon the development of United States branch banks in foreign countries and upon economic conditions existing in the world at large. SELF-TEST QUESTIONS 1. CHANGE IN PRESENT SALES METHODS. Would this be necessary for an old established concern just entering foreign mar- kets? 2. C. I. F. SINGAPORE. Is this a greater risk than F. 0. B. Singapore, for an American shipper? 3. DEFINITE QUOTATION. F. 0. B. MobUe. Is that sufficient for goods to be shipped to Chile? 4. METTHODS OF PAYMENT. Which are most convenient for the seller, and which for the buyer? 5. DRAFT ON FOREIGN MERCHANT. How would the bank handle this? 6. KINDS OF PAYMENT. Is it ever better to pay in gold than in bills of exchange? CHAPTER XVIII protective and emergency measures Peoteotive Measxjbbs Many a business concern has suffered serious loss 6r even failure because the management neglected to take to heart the truth in the old saw about an ounce of preven- tion being worth a pound of cure. Common sense dic- tates that every possible precaution which foresight and experience can suggest should be taken to protect a busi- ness from finaiicial embarrassment and loss. Emer'-' gencies should be guarded against, and so avoided, so far as possible, but, when they do come, as they are sure to do, the -concern which has taken proper precautionary measures weathers the financial storm with a minimum of disturbance. These protective measures run the whole gamut of financing, and are largely measures of good poUoy in management. Some of them are indicated specifically in Chapters XVI and XIX. It is well, when considering important points of this sort, to turn back to, and to read over again, the other chapters of the book referred to as cross-references. It serves to give a composite picture of the particular phase of safe financing practice under discussion.. The purpose of the present chapter is to deal with a few of the protective and emergency measures that have been resorted to by business firms. The list iq not complete, 318 Protective and Emergency Measures 319 but will serve to suggest some of the practices of sound financial management. Preparedness not only makes it easier to meet emer- gencies when they do come, but frequently goes a long way in preventing emergencies from arising at all, and it is this double purpose which should be kept in mind in considering measures of protection. Importance of Maintaining a Reputation for Integrity The president of a widely known manufacturing cor- poration attributes the remarkable ease with which his concern weathered the panic of 1914 chiefly to the abso- lute confidence that bankers had in the integrity of the corporation and its officials. This confidence was not built up over night, but was the result of a well-defined policy of fair and square dealings with the banks observed thruout many years, in good times and in bad, and of scrupulously meeting every finan- cial obligation as it became due, whatever the cost. Integrity is a foundation stone in sound financing. To buUd up a reputation for integrity is therefore a strong protective measure against possible future disaster. Training Others for Management Eef erence was made in Chapter XIII to the experience of a small concern where the wife of the manager was able to step into her husband's place upon his death, and to manage the business successfully, because her husband had made her familiar with the details during his lifetime. The owner's foresight in this way protected the institu- tion that he had so carefully built up. This case serves to illustrate a vital point in financing 320 Financing a Business — ^the protection of a business enterprise against the un- expected. Especially important is it to make proper pro- vision for the ^o-called "one-man" business. Investiga- tion shows that many concerns of this type havp col- lapsed because they were not sufficiently protected against the unforeseen or the unexpected. It' is not enough that assistants know how to conduct the day-to- day routine of the business. They must be ready to handle any financial emergency. After a failure has occurred one often inquires the cause of the trouble, only to find that it simply arose out of the fact that no one has been trained to take the place of the managing executive or to meet financial emergencies. Experience shows that the man who considers it good policy to keep every management problem in his own hands is practicing self-deception. He is progressikg steadily toward dan- gerous ground. Desirability of Expert Advice There should be no guesswork or experimenting from a financial standpoint. No one should be put in charge of the financial end of a concern TP?ho does not have a basic knowledge of that particular line of work. But, more than that, he should, if possible, be a man of vision, capa- ble of using his theoretical knowledge as a basis for his planning against the unknown contingencies which the future is sure to bring in some form or other. In fact, every business should have a financial adviser — a man who knows the game and can discern ahead of time any dangerous tendencies. He may be the treas- urer, the auditor, or the general' manager, or he may be the local banker. Just what he is doesn't matter so much. The main point is to have a man skilled in financing and Protective and Emergency Measures 321 applying that skill in watching the condition of the enter- prise. ^ There are many cases where a man may be a wizard at selling and may be able to instil enthusiasm into a sales organization. Yet he may — indeed often does — need a cool-headed financial executive to balance his enthusiasm, and to act as a sort pf pilot in steering the vessel thru possibly treacherous waters. Building a Surplus After a business has reached the "going" stage, atten- tion should then be directed toward putting aside a sur- plus for a "rainy day." This is a protective measure which ought under no circumstances to be overlooked. In times of depression or other business upheaval these extra funds, as is pointed out more fully in Chapter XIX, can be used to advantage in tiding an enterprise over the rough places. In other words, it is considered unwise to put every cent back into the business. A quickly available surplus may be found essential to protect a business against failure. The head of one prosperous business makes it a rule to keep $25,000 in gold in a safe de|)osit vault for emergency. His interests are large and he has other investments, but he feels safer thru having these available funds ready, no matter what else happens. Of course he loses consider- able profit from the money tied up in this way. Yet he figures that a man pays premiums and fees for insurance and other protective measures, and that to do so is good business. His theory is, therefore, that the amount of in- terest lost each year on such a sum is that much gained thru the knowledge that, regardless of what emergency 322 Financing a Business may arise, he has cash ready to meet th* situation until he can realize on other securities. ' \ Sufficient Capital To be sure of a suflSciency of capital is also vital to the adequate protection of a business. A progressive manu- facturer who has given special attention to financing has found that a growing concern absorbs capital much more quickly than is usually realized. To be prepared for this growth is essential to maintaining a business in balance. This manufacturer says he has recapitalized his business several times and has i3iscovered that he never really has suflScient money to meet the demands of the business. He advises that a man must be careful not to underestimate the necessity for capital. Insuring the Executives Many concerns are protecting their business by taking out insurance on their leading executives, this insurance to be used to obviate any losses during the changing and realigning of executive management, in case an important officer should die. Such an arrangement as this was found to have become popular in a number of concerns visited. OTHEB TYPES OF INSURANCE POLJCIES There are many other types of insurance policies which the business concern may purchase as a protection in the event of emergency or loss. Practically everyone is aware of 4;he importance of in- suring against loss by fire, and few if any business con- cerns would think of neglecting this precautionary meas- ure. Insurance against other casualties is not, however, so generally well known or resorted to as it miglft be. Protective and Emergency Measures 323 During the World War very many concerns in this coun- try, particularly along the Atlantic seaboard, took out in- surance policies against riot, bombing outrages, attack by enemy forces, etc. Such insurance in troublous times is a sound protective measure. Another form of insurance which is closely analogous to fire insurance is the insuring of leaseholds. Where a business is conducted in rented quarters upon which it holds a lease on long and favorable terms, a heavy loss may be sustained in the event of fire which a mere fire in- surance policy would not cover. It is becoming a common practice to insure such leaseholds. Credit insurance is another protective measure com- monly adopted by business concerns. There are several companies which specialize in insuring business organ- izations against losses from bad debts. The prudent financial manager takes eyery reasonable ■ precaution that experience of precept may suggest to in- sure his business against every possible shock or disaster. Obtaining Widely Diversified Markets "One concern which sells a commodity in general use, pays special attention to covering widely diversified mar- kets. It is not content to push its sales in the easiest or in the most thickly populated territories. It has built up a line of customers, everywhere as a protective measure. Then if a business depression should come to manufactur- ing centers, its sales may still continue to be good in the western agricultural sections, thus serving to offset in some measure the slump in other districts. The head of the concern finds this policy to operate as a mighty financial help in stabilizing the factory output, which in turn makes financing easier and protects the business. 324 Financing a Business Making Customers Stockholders A commission dealer has applied this idea of insuring his market in a somewhat different fashion, by selling shares in his corporation among his clients. By this means he has insured a permanent list of customers who are likewise investprs in the business. The United Drug Company, with its chain of Eexall stores, has adopted a similar plan of insuring an outlet for its goods. Each Eexall dealer is a stockholder in the United Drug Company, and consequently is iijiterested in buying and pushing the products of that company. Under such an arrangement care must, of course, be taken that control does not slip out of the hands of the existing management. Defirdte Business Standards Definite standards of financing, manufacturing, and selling also help to stabilize a business and keeji it finan- cially sound against emergencies. This policy makes the estimating of profit and loss more accurate and enables the management to determine future financial needs. Haphazard conduct of a business is dangerous to financial stability. Well-defined standards minimize the dangers of chan^ng policies to meet, the whims of meddlesome stockholders, and secure orderly production and manage- ment. Carefully drawn corporate by-laws help to define and safeguard standard policies of financial management against the attacks of short-sighted or unscrupulous stockholders. On the other hand, the fact should never be lost sight of that what is a desirable standard today may become obsolete and undesirable six months or a year from now. Protective and Emergency Measures 325 Changes in' inventory standards and values during the years that preceded and followed the World War offer a good illusti;ation of the need for constant revision of standards. What constituted an ample stock of goods in many lines before the war became totally inadequate under wartime conditions, because of the length of time required to re- plenish stocks, as well as because of the steady upward march of prices. On the other hand, during the years imm^iately succeeding the war boom, merchants found themselves confronted with the ever-present possibility of rapid deflation in inventory values and consequent losses, and the tendency was to steer a middle course, somewhere between the standards of the war period and those which prevailed in 1915. Constant vigilance is the price, not only of progress, but even of survival itself. There can be nO standing still in business ; it is a case of constant struggle to keep going forward. Thus protective measures may cover a great array of plans, some of which are suited to each individual con- cern's requirements. A few of the methods that have been found practicable have been outlined here. There are others, of course, but these are suggested as an indi- cation of what may be done to help a concern keep its finances "right side up." Emeegengy Measubes Emphasis has already been laid on the fact that every effort should be made to foresee and forestall emer- gencies, but as this is not humanly possible in every case, it is important to consider how to act when 'trouble does come. Let us, therefore, see briefly what others have done when emergencies have arisen. 326 Financing a Business The Help of Friends To call upon friends for assistance, except under ex- traordinary conditions, is a confession of financial incom- petence which few men relish. When confronted with a real emergency, however, probably the greatest asset is the possession of real friends. Any man who conducts his business carefully usually' makes friends who believe in him, and if he does en- counter difficulties he may be able to call on these friends for temporary help. Investigation shows that a great many executives have been helped over crises in this way. Friends, then, are perhaps the leading source of assist- ance in the event of trouble. One concern, which was expanding rapidly, got to the point where it was temjporarily unable to meet its payroll. The president called on a wealthy friend who advanced sufficient money to cover the emergency. Another man was having trouble with his partner, but had not the funds' to buy him out. He appealed to two of his friends who furnished nearly $25,000 to meet^the emergency. Numer- ous similar instances could be cited of men whose char- acter and ability won them the financial assistance of their friends, A committee of friends, or of friends and bankers com- bined, also affords a possible means of saving a business in an emergency. This was forcibly proved in the case of a large manufacturing concern which had suffered a severe fire loss. Alone, the management was unable to bring the business out of trouble, but the suggestion of a committee of friends, familiar with the condition and needs of the concern, to take over the temporary handling of affairs was followed out and a successful plan was evolved for continuing operations. Protective and Emergency Measures 327 Open Dealing with Creditors A small manufacturing concern was severly hit by the panic of 1914. Orders were canceled right and left, and things looked gloomy. However, the worst of the storm was weathered and the manager began to see daylight ahead, when suddenly the largest creditor became afraid for his account and threatened suit. Suit under existing conditions meant bankruptcy, but the manufacturer kept his nerve. He sat down and dictated a four-page letter to the creditor, setting forth the exact situation of the business, its prospects, the plans of the management, and a definite program for taking care of the account by fre- quent and regular payments. The creditor was reassured, refrained from suit, and carried the account for an addi- tional ninety days, when it was cleaned up with interest. In the matter of past-due accounts, the creditor in gen- eral occupies a relation to the debtor which may prove to be a source of considerable weakness and danger to the latter, and this should always be borne in mind by the debtor. An open and businesslike attitude is always ap- preciated by a creditor, and winning the confidence and good will of creditors frequently makes impossible to tide the business over an emergency. Reducing the Overhead Sometimes the only solution in an emergency situation is a ruthless swinging of the axe. Another instance taken from the manufacturing field will illustrate this point. A jobbing machine shop, which handled a great many small- size orders at fancy prices— orders that required careful and individual handling of niunerous details — had built up a large clerical and sales force to handle the many 328 Fmancing a Business ) details of its business. During the war some government contracts were taken on and the clerical force was still further increased. i With the signing of the armistice came a slump. Orders were canceled, and the management found itself facing a crisis with heavy loans outstanding and a large stock of high-priced material on hand. A radical change in policy was decided upon, and the company went aftor -and secured large-size orders of low-pricie products that could be handled with a minimuni of clerical labor. The clerical force and the sales force were cut down to the minimum, even some of the ■executives being "let out" ; one shop was closed, and everything else possible was done to lower overhead expense. Today that company is making more money than it ever did before, its organization isless than one-half what it was before the war, and its selling ex- pense is ridiculously low. The emergency proved a god- send to an alert and resourceful management. Heroic measures, of course, should be resorted to only in extreme cases. In general, foresight and proper pro- tective measures make such action unnecessary, but some- times, as in the case of this concern, a surgical operation is necessary to/ save the patienlt. Sometimes a new location, particularly for a retail business, helps to reduce overhead and solves an emer- , gency difficulty. A western store was located in a bank building, but the eonunodities it carried would not allow for so much expense in rent and overhead. The whole- saler who had been selling goods' to the concern investi- gated and found a vacant store more adaptable to the bi^siness a little distance down on the other side of the street, and arranged with the owners for rental on a basis favorable to the dealers. He also sold the former lease for the dealer without difficulty and helped him get Protective and Emergency Measures 329 settled in the new location. From that moment the retail merchant began to make money. The change saved him from going to the wall. Borrowing on Accownts Receivable / Occasionally when capital is tied up in credit sales and bank loans have been exhausted, it is feasible to borrow on open accounts. There are a number of financial con- cerns that make a business of loaning money on good ac- counts receivable. The usual practice is to advance cash up to about 80 per cent of the face of the live accounts, the creditor turning over the returns from the outstand- ing accounts as fast as they are collected. The financial house, of course, charges a discount for its services, but this may be less than the creditor would be willing to offer to his customers if they would pay cash. While this is a perfectly conservative transaction and in no way changes the net worth or affects the financial condition of the concern, it is likely to be expensive, and in this connection it is well to know that sometimes your banker will handle the transaction more advantageously to you than would some outside financial house. The fol- lowing experience of one business man will illustrate this. This man sought out his banker and asked his advice on pledging accounts receivable for a loan from one of these credit companies which had solicited this business. The banker, altho his customer had already exhausted his line of unsecured credit, volunteered to loan cash up to 80 per cent of the good accounts receivable, taking these ac- counts as security, and charging only 6 per cent for the transaction. Payments were made to the bank as the accounts were collected and the whole transaction saved the company a tidy sum in interest. 330 Financing a Business "It usually pays to talk things over with your' banker," says this man. ^ These are a few only of the many steps that may be re- sorted to by business concerns in meeting emergencies. Anyone who investigates the financial tribulations thru which practically all business concerns have parsed at one time or another, must be impressed by the resourceful- ness which characterizes successful financial management in emergencies. An emergency does not necessarily mean failure. Every means should be considered before con- senting to admit failure. After all, by playing the gam(^ wisely and carefully, as outlined in this book, it should be possible for every worth-while concern to plan its finaiices so well that an emergency serves only as an opportunity for proving its permanent strength, and the efficiency and resourcefulness of its management. SELF-TEST QUESTIONS 1. TRAINING AND PROMOTION OF OUR MEN. Is this ad- visable from a financing point of view? 2. DEATH OF AN EXECUTOR. What are the various methods of reducing the loss resultifag from this? 3. SELLING TERRITORY. Is it advisable that this be extensive or concentrated, and why? 4. CULTIVATION OF BANKERS' GOOD WILL. What are the -reasons for this when times are good? 5. LOAN ON ACCOUNTS RECEIVABLE. Where would one go for securing such a loan? CHAPTER XIX WHAT TO DO WITH YOUR SURPLUS The importance of building up a surplus fund as an aid to financing a business caniiot be overestimated. IJnexpected demands on the treasury of a concern — due to one cause or another — ^may show a surplus fund to be a financial bulwark whose value may even prove to be of the life-saving kind. Experience has demonstrated its life-saving qualities, from a business standpoint, in numerous instances. Building up a surplus fund really means "business insurance." It means providing against any emergency that may arise, developing every possi- bility for making greater profits, and placing the busi- ness on a surer financial foundation. It not only means providing something to fall back on in case of financial stress or unforeseen catastrophe, but something to keep going on, when every other provision for funds fails. Not that the surplus fund should be looked upon as a salvation for the ordinary financing of a business, but rather as a safety device, as one might say, to protect the business against possible misfortune. BnriDENDS After the profit has been made, the management should carefully consider the expediency of the dividend policy. In declaring dividends the directors are, of course, gov- erned by the charter, by-laws, and stock contracts of a 331 332 Financing a Business corporation. If there are any back dividends on pre- ferred stock they must be taken care of first. Dividends may be paid (1) in cash, (2) in scrip, (3) in stock, (4) in property. Cash dividends, may be paid in a lump sum, semi- annually, or quarterly. The question may arise as to whether the company can spare the cash, in which event a distribution may be made in scrip, which is nothing more than a promise to pay. Ct'ock dividends simply redistribute the accumulated assets of the corporation, but in the fprm of invested capital which shares in the rights to dividends along with the previous issue of stock. The United States Supreme Court has decided that stock dividends are not taxable as income. They are regarded simply as book adjustments of the assets. Property dividends usually come in the form of securi- ties. During the period of the war^ for example, several dividends were distributed in the form of Liberty bonds or securities of foreign governments. Most corpbrations find it desirable to keep the dividend rate uniform year after year. A steady dividend rate insures : , 1. Higher and steadier prices on the outstandimg se- curities of the company 2. Eeadier sale of new securities 3. Better credit. . i Thus when more funds are available than are needed for regular dividend requirements, it is generally the practice to pay tfye regular dividend rate, and distribute the additional funds as an extra dividend. On the other hand, when earniiigs are insufficient in any one year to meet the regular dividend requirements, it is frequently What to Do With Tour Surplus 333 the practice to draw upon accumulated surplus to make up the deficiency; and often a special reserve fund is set aside for this purpose. , The stability of profits depends to a large extent upon the control of markets. The Board of Directors may well consider whether a larger percentage of the surplus should be expended in market research, or advertising to insure the dominant position of the product. Changes in the requirements of working capital should be anticipated. An increase in the stock of raw materials and supplies and an increase of wages requires larger working capital. Ebsebves It is good financing practice to set aside a reserve out of surplus, in order to take care of special or contingent needs. We have already seen that a dividend reserve is useful in maintaining a uniform dividend rate. Some other obvious purposes for which reserves may well be created are such contingencies as losses from bad debts, abnormal losses from declining inventory values, deple- tion of natural resources, etc. Usually these reserves should be kept in the form of cash or easily liquidated securities, so that when the emergency for which they are intended arises they may be readily available. What Is Subplus Having made provision for taking care of dividends and the proper reserve requirements it is the next care of the financial management to provide for the proper use of any surplus that may remain. ' Before going any farther, it is important to note just The Net Income and How It May Be Divided TOTAL NET INCOME The entire loaf of bread here shown represents the total net income of a corporation. DIVIDENDS The dividends usually get first consideration, since regu- larity in dividends means satisfied -shareholders and en- hances the reputation 'of the company. RESERVE After the dividends have been divided off, a part of what is left may well be set aside as a "reserve" for specific needs. GENERAL SURPLUS After dividends and reserve are set aside, what is left is the "general surplus." The uses to which it may be put are described on pages 336-353. Pio. ^4.-1116 Net Income and How It May Be Divided What to Do With Your Surplus 335 what we mfian by "surplus." It is simply the value of the assets owned by the concern over and above the amount necessary to meet all outstanding obligations both to outsiders and to the owners of the business. The normal source of surplus is, of course, the profits that arise from transacting the business, and therefore it may be in the form of cash, of bills receivable, of materials, or of some other sort of asset. There often exists in the mind of the ordinary man or investor ,the popular misconception that the term "sur- plus" in corporate financial statements is something rep- resenting cash. He cannot understand the need of so large an amount, or why it is not paid out to the stock- holders in addition to the modest dividends ^ received. This misunderstanding may be attributed to the lack of knowledge of accounting principles. The fact is, surplus is uot cash, but it is the balance left over from the earnings of a corporation, after the payment of expenses and other charges and the distribu- tion of dividends; and such remaining balance is then carried to an account designated as surplus on the lia- bility side of the ledger in the same manner as capital stock, while cash would necessarily appear on the asset side. In most corporations, part of the surplus may be in- vested in materials and supplies, in new construction, in bills receivable, or other investments. Some of the asset items may be convertible, while others may be of a permanent nature and not readily convertible into cash. The convertibility of assets is of prime importance to the banker who makes a loan. In a corporation the Board of Directors controls the use and distribution of the surplus. Increase in the sur- plus may originate from the following sources : 336 Fincmcmg a Business 1. Profits 2. Transference of reserves 3. Donations 4. Revaluation of assets 5. Sale of 'assets at a profit over book value 6. Sale of stocks or bonds above par 7. InsuflScient allowance for depreciation, maintenance, etc. It is evident that- not all of the funds so transferred to surplus should ordinarily be distributed as dividends. Revaluation of assets, for example, furnishes a dangerous an alL These periods do not coyer equal periods of time. A panicky period, for instance, may occupy only a few weeks, while the period of depression following may cover several months. The chart is valuable in that it helps you to identify the kind of bnsiness period yon are now in, to foresee what business conditions will likely follow, and to act wisely in the circumstances. Pio. 65.— The Prosperity Cycle 342 Financing a Business instances are' made for only two or three months and draw the usual rate of interest — ^that is, the figure cur- rent in banking circles at any particular period. Because of their early maturity they are desirable for investing "between-times," and furnish a readily adaptable method for getting a good income from idle money during a short period. For example, one western company always invests its surplus in these notes. Even tho it may need some money before the paper falls due, it finds the plan profitable. When money is needed, say in October, and a note is not due until November, it borrows at the bank just enough money to bridge the slight gap and still makes a profit on the commercial paper. "We lik^ these notes, rather than stocks, because there is no fluctuation in their value," says the president of the company. "Besides we know that the paper is good, so that we do not have to worry about any probability of loss." Above all else, bankers urge men not to speculate in any form with business funds. Many concerns have been wrecked because the officers have used company money for speculative investments. Instance after instance could be cited where speculation has finally crippled and even put out of running the best paying enterprises. "The number of men who go into wild-cat schemes is astounding," remarks one banker. "They are only tying up their surplus permanently and are thus jeopardizing their business when emergencies or special demands come. This subject is worth a whole book. Many manu- facturers, wholesalers, and retailers have yet to learn the necessity of keeping their money where it can be got on short notice. When they buy stocks of uncertain value and indefinite maturity they simply lose the ability What to Do With Your Surplus 343 to finance their business affairs rightly. So often men who exercise good judgment otherwise will buy unknown stocks from salesmen they have never seen before, just because wonderful profits are promised. Usually they put their money where it cannot be got at quickly, if at all." A manufacturing concern which had an unfortunate experience some years ago in tying up all its surplus in plant and building for rapid expansion, nov has accumu- lated a substantial amount of ready money by putting it in listed industrial stocks. These investments are widely diversified as to the kind and the locality of the concerns behind them. Thus it is possible at any time to sell on short notice a certain amount of the stocks with- out sacrifice. Safety is considered first, so that any emergency can easily be taken care of. This same con- cern also believes in putting surplus money into indus- tries turning out materials or parts used in its own jplant. For instance, it has purchased a half -interest in a foundry nearby. This foundry is doing a good business and fur- nishes considerable material for the larger concern. Thus, by having a part ownership in it, the concern makes two profits on the work and is well satisfied with the investment. One important point here is that the foun- dry is only a short walk away. Every official of the fac- tory is able personally to investigate and oversee the whole proposition. Each one knows the quality of the foundry's output and the exact condition of its finances. Therefore there is no element of speculation in the in- vestment. SAFETY In the purchasing of any securities, it is vitally im- portant to know if they represent a real value — that they 344 Fmancmg a Business are backed by definite assets. It is also important to know that the company whose securities you purchase is in a financial condition to take care of every dividend or every item of interest promptly. Especially in dull times is this a feature to look out for. Unless a concern is so financed that it can take care of every dividend promptly, it is dangerous to buy its securities. It should have a reasonably large surplus itself, in order to insure taMng care of all these needs. If you invest in any stocks be sure to learn whether or not they are assessed, or carry any extra liability. In, some states the law provides for a double stock lia- bility should a company have to raise more funds to carry on its business, or in case of inability to pay its debts. Under ordinary circumstances, it is obvious that no busi- ness man would want to be assessed above par on any stock which he might purchase simply as an outside investment. All stocks should show plainly on the stock certificate whether they are subject to a,ssessment or not. TIBLD Surplus funds well invested, of course, become cumu- lative and rapidly increase if carefully handled. One question may eventually arise as to what may profitably be done with some of this surplus, whether to enlarge the business or improve it. In the event that it is desired at any time to dispose of some of the securities in order to realize funds to put into the business, it would be wise to invest in gilt-edge but low yielding securities, for which there is always a market. Highly prosperous concerns with a country-wide market, of course, do not always feel it necessary to divert much of their money from routine use because they consider their business well pro- What to Do With Your Surplus 345 tected. Therefore, they regularly declare a stock divi- dend from their surplus and keep right on expanding their volume of sales on a carefully planned schedule. Other concerns having a more limited field and requir- ing less money for constant development may find it dif- ficult to make use of their line of credit at the bank. Yet to borrow at least a little is always considered wise, for it keeps your credit line active. One concern, having lit- tle requirement for extra funds, decided that it could borrow on its line of credit at an attractive rate of inter- est and then reinvest these borrowed funds in good securi- ties at a slight advance in rate. The treasurer handled the arrangements satisfactorily and th^ company now secures a small extra profit in this way, and finds a new method of keeping its available funds active. Another concern which sells to dealers on instalment is constantly building up a surplus fund to use in financing these sales. On the other hand, where money is not needed quickly the surplus is invested for longer periods to be used later in part for various purposes. MABKETABHilTY Marketability of securities is of great importance. For instance, if you buy a bond or a stock which you cannot convert readily into money, in case you should need to do sOj you are then worse off than ever unless you can borrow a good percentage of the amount you have in- vested from your bank, giving your investment as col- lateral security on the loian. Outside of the return on the investment, the security and the marketability should be kept in the foreground. Some business men who do not care to spend a lot of time investigating securities will buy nothing but stocks listed on the New York Stock 346 Financing a Business Exchange. They are sure then of a constant market for whatever investment they have purchased. All securities so listed are not likely to vary much in their value. Usually by taking a small loss in price in case of a special need, you can readily get your money on any of these stocks. As one man puts it : "Surplus investments should be easily salable in times of panic, or should at least be strong enough to use as collateral for a loan. A man should not invest in a penny's worth of stock, no matter how rosy it looks, until he has thoroly and personally investigated the property behind it, and has taken the subject' up with his regular banker or investment broker. Were this procedure followed there would be fewer business failures." DIVBESITY One point to keep clearly in mind is : Never place your surplus capital where it will be beyond quick reach. No man knows when his business may be greatly in need of funds on short notice, and he wants to be sure that he can raise money on his securities whenever this need arises. For instance, a business man in San Francisco who bought bonds and stocks of local concerns before the great fire, afterwards found all his resources pretty well wiped out, at least temporarily. This brought financial embarrassment to him just at the time when he had hoped his securities would prove a real bulwark. Concerns that had distributed their investments over a wider area, including various middle-western cities, found themselves much more fortunate, for they were able to realize quickly on their holdings. Still another point to keep in mind is to buy securities of businesses in some line other than your own. For What to Do With Your Surplus 347 instance, if you make a certain type of machinery, it probably would be unwise to invest in stocks or bonds of a similar company, for the reason that unforeseen trade conditions might cause a slump in your particular line, affecting not only your business but other concerns of the sanie kind. Under these circumstances you might be unable to realize on your surplus, just when you most need it in an emergency. It is much better, therefore, to scatter your investments in lines so dissimilar that a financial papie would not make it impossible for you to realize quickly on the sum of these investments. Both short- and long-time bonds, stocks, or notes should be included in your purchases. If you have some of your securities maturing in a short time and some in a long time, then your capital will be much more mobile, for, if you need some extra money, you are likely to be able to get it quickly on the short-time investments and still have the other for any future needs. Above all things it is inadvisable to buy only one security, just as it is inadvisable to have all of your money tied up in one business. It may seem unnecessary to repeat the old saying, "Do not put all your eggs in one basket," yet it is important to consider this in your investments. While a responsible investment banker considers that all of the sequrities which he sells are absolutely good, yet some unusual occurrence mi^ht make it hard to realize on one particular investment. If you have your investments scattered, however, you are almost bound to realize quickly on some of them. TIME FOB rNVBSTING Maay men make it a point to handle their surplus in such a manner as to buy their securities when the markets 348 Financing a Business are low. "Where this is possible an extra income may be realized. Whenever it Ls necessary to purchase an invest- ment at a premium, the income, of course, is reduced. A lot of business men, however, consider the yield as of secondary importance. In fact, some men even confine their outside surplus investments to savings deposits. Here the yield is only 3 or 4 per cent, yet the business man who does not want to go into the investment activity on a large scale may find that the putting of his surplus into savings deposits is very satisfactory. Sometimes a surplus is put into a "certificate of deposit," -which may be used as collateral at the bank in obtaining a tem- porary loan. ^ I Thus we see the value of having a surplus fund and of investing it wisely. Sopae money should always be readily obtainable from sound securities, no matter what your line of credit at the bank may be. Either you should be able to sell them outright in an emergency ox borrow something on them from the bank or individuals. Frequently the surplus can be used to advantage by putting it back into the business, and it is well to consider some of the ways by which this may be done. Using a Surplus in the Business Everyone will agree that one of the most frequent dis- appointments business men have to face is to see an attractive opportunity before them for making increased profits and to have no surplus on hand with which to finance the undertaking. Lack of ready money has com- pelled many a concern to pass up what later proved to others a golden opportunity. Thus the importance of having surplus funds and of using them with discretion when the proper plan presents itself becomes clear. What to Do With Your Surplus 349 Often the man who prides himself on putting "every penny back in the business" is the one who later comes to see the fallacy of not having some extra money ready for quick use. Having funds to use in the business when you want them is, therefore, a big point in financing, as indicated earlier in the chapter. Surplus may be used in the business for a great many purposes, such as: 1. For experimental work in developing and perfect- ing specialty products 2. For testing the demand for promising articles or merchandise 3. For larger construction 4. For added equipment 5. For larger working capacity 6. For acquiring additional plants 7. For building up departments, one at a time 8. For establishing branch organizations 9. For developing foreign markets What, then, are likely to be these demands on the sur- plus and how shall it be used? A survey of individual needs will usually show what can safely and advantage- ously be done with so-called idle funds. The fact of course remains that all the cash required properly to conduct the business should be kept at work. The amount necessary may be comparatively limited, providing the company's surplus funds in the past have been invested in quickly marketable securities, for then, even if you run short of cash, yon can always jaise funds from your investment in bonds, stbck, or notes. Too much cash on hand has its dangers just as much as too little. To have a lot of it at oae's eonnnand and not to be planning systematically or its profitable use 350 Financing a Business or investment is likely to lead to over-expansion along an ill-advised line or to actual speculation. If not so expended, it maly at least result in unnecessary extrava- gance. Thus the question is raised as to how much of a bank balance a business should maintain. Because of varying types of business no hard-and-fast rule can be given, but ordinarily your banker can indicate a mini- mum balance for you, based on the line of credit you are entitled to. By figuring on how much working cap- ital is necessary to enable you to carry on each/ month and then balancing this with the banker's minimum al- lowance, it is possible to arrive somewhere near the amount advisable always to have on hand. The usual tendency with concerns that have reached a profit-mak- ing point is to run their balances a little too high — ^to ^eep more cash in readiness than necessary — ^when they could be investing it in short-time bonds or commercial paper at a small profit. Often it has been found that this important feature of financing has not been analyzed and worked out so thoroly as it might be. Every busi- ness man can profitably analyze his cash account and arrive at a proper basis for its size in proportion to his needs. In so doing it is well to consider some of the possible uses of ready money. Uses of Ready Monet With ready money a man can take advantage of a sud- den faU of prices in securities. He can buy, in other words, when the market has dropped, without waiting to raise funds otherwise or even to get a loan at the bank. The business with a cash surplus has a number of other pos- sible advantages. An_ unexpected bargain in raw mate- rials can instantly be snapped up, while another, buyer What to Do With Your Surplus 351 may be endeavoring to raise the money for it. Above even the advantage of the profit obtainable is the fact that the business, thus ready for opportunity, is much more alert and normally is financed more profitably. Buying a bankrupt stock is often a profitable move — but the cash purchaser is the one who wins out. Thus, by having extra money on hand, opportunities arise that mean unusual profits. Located in a farm community, a progressive merchant was able to take discounts in season and out of season, because he had analyzed his business and his location and saw that he must provide a surplus to take care of lean collection times. Extra money used wisely at the right time enabled him to take advantage of profitable discounts. As pointed out in another chapter, the taking advantage of discounts is too important ever to be "passed up" or overlooked. While collections should always be kept up to the mark, yet there are instances when, by granting an unfortunate dealer time and by giving him a financial lift, you save a worth-while outlet for your goods and do a valuable service besides. This you can do when you have extra funds to use. There are nimaerous other channels for using extra money profitably and wisely, but individual opportuni- ties of business men vary so widely that it is necessary only to suggest methods of employing the surplus to make clear how profitably it may be used anywhere and by any type of concern. For instance, a store which had accumulated an amount above what would be needed for expansion or emergen- cies! used it in trying out a new line of goods, otherwise considered too risky to handle in the regular course of merchandising. In tliis way the concern often was able 352 Financing a Business to "spring" something novel that made a big hit and that advertised the store's enterprise. This idea could be carried practically, no doubt, into many other lines of business — ^manufacturing, and so on. Any losses that result from experimenting in this way have no adverse financial effect on the business. Some concerns put aside a certain percentage of extra money for unusual publicity tests. To illustrate, one firm displays its wares at every convention and bazaar it can gain access to. If any business is forthcoming from this plan, it is counted as so much gain. The money expended is simply surplus assigned to that type of ad- vertising. A wholesale house puts away its extra funds until it has enough to establish a new branch. Then it builds the required warehouse and equips it properly. "We carefully invest in safe bonds or stocks at a rea- sonable rate of income," says the general manager. "Then as fast as this surplus builds up to the point where we can use part of it for branch expansion we go ahead without any financial strain." Another wholesale house puts some of its surplus into pensions and betterments for employees. WhUe the in- vestment return on this method is not measured in actual dollars and cents, yet it is considered worth while in the greater loyalty and enthusiasm engendered. Other purposes for which extra money can be used profitably include searching out and securing a better location; maldng unusually advantageous cash pur- chases ; testing out a new product ; investing in a side-line proposition or hobby; meeting ruinous competition; get- ting options on va/luable property, .and proving up a new experimental department. There are plenty of uses for surplus funds ; the point is to use them most wisely. What to Do With Your Surplus 353 In considering the subject of ready money, three pos- sible methods of handling it are apparent : 1. Depositing cash in bank 2. Purchasing short-time securities 3. Purchasing long-time securities. These methods provide for two distinct uses : seasonal excess funds and permanent excess funds. In other words, the cash on hand and the short-time securities will naturally serve for uses at seasonal times when some urgent improvement or unexpected purchase is found necessary. The long-term securities may be con- sidered permanent excess funds because they are invested for the plant or for otherwise expanding the capacity of the business. However, it is well to point out that even well-chosen, long-term securities may be available on short notice if some unforeseen circumstance arises. Either they can be sold outright at a slight reduction below the market value or they can be used as collateral for a loan. If a quick turn of merchandise for profit can be made, then it might be much better to keep the securities and borrow on them, for the short time they are drawing interest will be slight compared to the advantage gained. Statistical Financial Analysis The character of financial management is finally fo- cused in the net profits and surplus. For that reason the entire financial results of the organization should be analyzed statistically, not only for the bearing that this may have on dividend policies, but also for its bearing on financial management. Ordinarily both sources of income and profit are the sales dollar. Every cost and 354 Financing a Business expense of the business, as well as the profit, must come out of that sales doUar. Therefore, an analysis of the sales dollar for the year, and from year to year in com- parison, is desirable. Such a plan for division follows : Division of a Sales DotLAtf Administrative Divisions Subdivisions Tears Production Raw Materials Labor Expense Salaries Commissions Expense Advertising Financing Office Insurance Taxes 1917^1918-1919 Mlarketinflr Administration Fio. 66.— Division of a Sales Dollar In addition to such a tabular form, a circle graph (Dollar- Illustration, Fig. 52, p. 255) is often inter- esting in which the entire circle represents the sales dollar or 100 cents. Each item of expense then repre- sents a certain number of cents of the sales dollar, and each sector represents this fractional distribution of the sales dollar. Another illuminating comparison can sometimes be made by taking these figures in comparison with those of leading competitors. In a certain year, for example, the allowances of two firms of about equal size and prac- tically controlling production in their line were as fol- lows: Depreciation and deductions- Dividends ,. Interest Surplus for the year Firm 1 9.8 per cent 7.2 per cent 0.12 per cent 5.1 per cent Firm 2 0.2 per cent 7.5 per cent 4.8 per cent 2.0 per cent Fio. 67. — Allowances of Two Firms Compared . What to Do With Your Surplus 355 Such an analysis carried on over a period of years might reveal some exceedingly vital information regard- ing the relative strength of concerns. Other statistical analyses can be made in either tabular or graph jform. For example, a chart showing the total current assets, the net working capital, and cash on hand might be kept over a period of years. A statistical table is of importance in showing the analysis of the net income, the dividends paid on both preferred and common stock, the percentage earned on each, and the surplus. Again, an interesting chart may be prepared to show the relation between gross sales, net income, and surplus after dividends have been paid. Another point often of value to be considered is what is known as operating ratio. This is simply the percent- age of operating efficiency. The operating expenses di- vided by the total gross income give us this percentage figure. The financial problems and financial safety of a business are vitally affected by the fluctuations in the relationship between gross income and operating ex- penses. The relationship is conveniently expressed in the form of a percentage; arrived at as above, this percentage figure furnishes a very sensitive and simple comparison from year to year. If it is 6.3 per cent this year and 79 per cent next year, it is evident that there has been a tremendous change in the operating conditions of the business. The percentage of gross income used in operation varies considerably with different types of business. In a manufacturing or retail business with a large turnover, the percentage of gross income used in paying operating expenses may be from 80 to 100 per cent. In a railway business, where the working capital is less, and the fixed The Operating Ratio how You Determine It Cross Income Operdtiitg Expense Operalind Ratio 2 4 0,0001 1 80, OQQ.QO 175 166 000 ^ •1200000 1200000 Its Value in a Graph -V ^>. ^3 m "l^£rj| esf ^ 03^ 75 1 70% 50 g 19 \ ^-•x^ -•^ V 15 1916 !<: )I7 1918 1919 1920 19 21 .; - J Fig 68. — The Operating Ratio. Described on Pag* 855. What to Do With Your Surplus 357 investments are larger, the percentage of gross income used in paying operating expenses may run somewhere between 60 and 70 per cent. In a hydro-electric power plant in which the operating expenses are rela- tively low, but the fixed charges on capital very high, the operating expenses may be less than 25 per cent of the gross income. From a financial standpoint, it is important to analyze what part of the operating expenses vary with the gross income. As a rule operating expenses do not decliae so rapidly as gross income. A business subject to great fluctuations in the operating ratio cannot carry so large a proportion of borrowed capital as a business whose operating ratio is fairly constant. Eailroads and public utility companies, for example, can afford to borrow very heavily, even for capital requirements. A specialty manufacturing concern subject to great fluctuations in the operating ratio cannot tie itself down with a heavy interest charge, because in some years its income will not be large enough to meet the interest charges. To sum up, the plan of building up a surplus has a far-reaching effect in a normal, healthy business. In- vesting and usiiig extra funds wisely cannot help making easier' the financing of a business, and it makes the "game" a lot more interesting. In the long run it means more profits and less worry, and for the most part in- sures a continued successful enterprise. Concluding Obseevations It has been the purpose of this volume to remove the curtain of mystery that has hung before the subject of finance — ^to reveal it as a subject not of magic formulae but of common-sense principles, and to indicate the wide 358 Financing a Business range of its scope, compreliending the entire field of industry and commerce. In closing, we should emphasize one momentous fact: Valuable as is the knowledge of the principles of finance, yet far more valuable are those human qualities without which all financial rules are useless. These qualities are vision, mastery of details, and that courage which carries the wise policy thru to its inevitable success. SELF-TEST QUESTIONS 1. MY SURPLUa How shall I use it? 2. WHAT IS SURPLUS? A concern has a large amount of profits left over after paying expenses, dividends, etc. Is this surplus ? 3. BORROWING ON BONDS. Part of your surplus is in govern- ment bonds, and part in bonds of other corporations. Upon which class of bonds will the bank give you the larger loan? 4. INVESTING THE SURPLUS. You have a large amount of surplus to invest. Will you prefer an investment which yields a larger return but is not readily salable to one with a low yield but which can be sold at any time? 5. NATURE OP INVESTMENT. Is it usually best to invest your siirplus in other businesses of the same nature that you are in? Is it also wise to invest in businesses in the same locality? 6. PUTTING THE SURPLUS IN THE BUSINESS. You have surplus which you want to put into your business. In what ways can you do this? 7. INCREASING THE BUSINESS. How may you use your sur- plus to establish new branches or to establish new lines of work ? 8. KEEPING TRACK OF COSTS. How may you split up your "sales dollar," to show what the relative amounts of your expenses are? INDEX Acceptances. See Trade Acceptance. Aamlnistration, relation of indi- vidual business to, 4 Advertising appropriation to be watched, 238 Advice, expert, needed, 320 Anailysis, financial statistical, 353 Appearance a factor in drawing: trade, 5 Bank collateral loans, 158 considerations influencing n, choice of, 136 financial statement to, 145-59 gen"eral services rendered by, 142-43 handling of drafts by, 309 location of, effect of, 135 maintaining a proper balance at, 158 part played by, in financing pri- vate enterprises, 1, 2 relations of customer with, 123- 44 strength of, important, 135 various kinds of, 141 Bankers approaching the, for accommoda- tion, 165 co-operation with, 138 cultivating good will of, 181 relation of business man to, 36, 114, 120-21, 123-44. See also Capital, Financing "Blue Sky" laws, 25 Bonds classes of mortgages to secure, 103 collateral trust, 108 convertible debenture, 109 coupon, 99 debenture, 109 denominaition of, 99 determinaition of class or issue, 102. guaranteed, 107 income, 110 indenture, details of, 97 interest payments on, 101 Investor in, 110 Issue of, for extension of busi- ness, 118 mortgage securing, 95 open vs. closed mortgages secur- ing, 98 registered, 99 repayment of. 111 represent a form of borrowing 94 sale of, for additional capital, 9* secured by lease, 108 terms of, 100 trustee lor, 96 types of, in general use, 103 underwriting, 107. See also Bor- rowing, Financing Borrowing accounts receivable as security for, 329 assets available as security for, 34 banking connections, 114 borro"wed capitad, 29 curtailing of, unnecessary, 259-6S financial statement to bank a? basis for, 145-59 influences affecting, 172 location, effect of, on, 166, 232 long-term, 34 methods of, 30 note broker, the, 208 on bonds, 94-111, 118 on private collateral, 118 personality of borrower in, 157 planning, effect of, on, 233 purpose of, 169 risk factor in, 170 short term, 31 short-term notes to be avoided, 238 sources for, 208-26 supervision of business, effect of, on, 231 time factors, 163 trade acceptance, 174-207 when profitable. 160-72. See also Capital, Financing Budget plan, the, 287. See also Financing Business capital, how interested In, 68, 73 comprehensive grasp necessary, 10 cost of, 63 expenses, 264 factors in, to be considered, 13 launching a new, 9 preliminary considerations in starting a new, 13, 15/ 27 protecting the, against depres- sion, 120 relation of capital to volume of, 66 type of, material question in con- nection with borrowing, 167. See also Capital, Financing' 359 360 Index BuslnesB advisers bankers, 36, 114, 120-21. 123-44 public accountants, 36 Business standards, 324 c. a. t quotations, 297 CaplUI , ^ ,. amount of, required, 48 > banking connections, 36, 114, 123- 44 control demanded by, when, 39 conversion of working assets into cash, 119 , . „- corporate, dlfCerent classes ol, 3» details affecting, 66 estimating additional require- ments of, 116 factors affecting working, 65 fixed, 62 . , ... Increase of capital stock for, IK InltlaJ investment of, 63 long-term borrowing, 30 methods of borrowing, 30 needs for, 60, 1 113 organization expense, 61 owned and borrowed, 29 relation of, to volume of business, ee short-term borrowing, 31 stock, classes of, 41 sufficiency of, 322 when good business to borrow, 160 wisdom of consulting business advisers, 36. 36, 114. See aho Borrowing, Capitalization, Financing, Stocks working, auracient, necessary, 2 Capitalization basis of, 27 of a corporation, 38 of Individual proprietorship, 37 of partnership, 37 plan of, for a business, 27. See also Corporation, Financing, Stocks Chattel Mortgages, £28. See alto Borrowing e. I. f. quotations, 294 c. i. f. and e., 297 Collections, 266. See also Financing Competition, consideration of, 13 Corporation as a form of organization, 15, 21 "Blue Sky" laws as affecting the, 26 formalities of organizing the, 22 See also Stock, Bojids, Capital, Financing Cost accounting as a basis for borrowing, 154 budget system In, 241 correct analysis vital for, 239, 243 Sezlbllity needed, 245 fundamentals of Oosts, 252 in relation to general account- ing, 246. See also Borrowing, Financing Credit organizations, 60, 221. See obo Borrowing c*redttors, dealing openly with, 327 Customers as a source of loans, 226 factor of the, 277. See also Bor- rowing, Financing Demand, consideration of, 13 Discount as a source of profits, S of bills, 235 selling stock at a, 76 Distribution methods of, and of selling, 70 relation of Individual business to. 4 Dividends conditions governing declaration of. 331 debts to be paid before, 286 uniformity of note, 332 Drafts. 305. See also Foreign Trade Executives, insurance of, 322 Expenses, control of, 264. See also Financing Expansion, abnormal, to be avoid- ed, 283 Exports financing of. 292-317 use of trade acceptance in flnanc- ' ing. 196 t. a. 8. quotations, 294 Finance, mea'Uing of term, 8 Financial statement to bank, 145-69 Financing accounting methods in, 6, 204, 353 affected by terms of sale, 65, 59 analysis, financial statistical, 353 attracting investors, 71 banker as adviser in, 35, 114, 120- 21, 123-44 balance at bank to be main- tained, 168 banking connections in, 114, 120- 21 bonds, use of. In, 94-112, 118 borrowing, 5, 29-34, 94-111, 114, 118,. 160-72, 329 budget plan in, 287 business conditions and habits as affecting, 79, 238 capital, amount required, 48 capital, methods of borrowing, 30 capital, needs for, 60, 113 capital requirements; 116 capital, sufficiency of, 322 capitalization of a business, 27, 115 checking accounts, 132 collections, 266 conversion of working assets Into cash, 119 cost methods In, 6 cost system an aid to, 240 • credit organizations, 60 curtailing unnecessary borrow- ing, 269-68 day-to-daiy requirements, 4 debts payable before dividends, demands made by capital, 39 Index 361 f'inancine (continued) depression In business, protection against, 120 discounting bills, 235 discounts a, factor in, 5 drafts, 305 expenses of business, 264 exports, 292-317 financial statement to bank, 145- 59 foreign exchange, 312 funcuon of lending money, 126 funds kept at work. 237 good will of banker, 161 grasp of details of individual business necessary in, 10 harmony in organization, 257 helps to successful financing, 270-80 Imports, 292-317 Integrity, importance of, 318 Interesting capital in a business, 68 keeping pace with business growth, 281-91 knowledge of facts necessary for, 4 labor problem in, 287 leases, importance of, 286 letters of credit, 300 location, importance of, in, 286 money market, consideration of, in, 13 overbuying, danger of, 266 personality, influence of. 257 preliminary planning for, 11, 13, 16; 27, 233 profitable practices In, 227 profits left in business, 284 ready money, uses of, 360 reserve accumulation, 119 right viewpoint on, 1 selling and distribution of goods, simplicity of, 6 size of business Immaterlail In connection with, 6 size of stock, 262 sources for borrowing, 208-26 stocks, classes of, 41 stocks, sale of. 74-92 surplus, accumulation of, 116, 321, 331-58 trade acceptance, the, 174-207 turnover, increasing the, 236 what is involved in, 1-2,^ See also Borrowing, Business, Capital, Capitalization, Corporation, Foreign Trade, Production, Selling, /Stocks, Trade Ac- ceptance f. o. b. quotations, 294 Foreign exchange, 312. See also Financing Foreign trade, 292 cash on delivery. 300 cash with order, 300 c. 1- f. quotations, 2B4 confirmed order, 300 drafts, 305 f. a. s. quotations, 294, 298 financial status of country, 31E t. o. b. quotations, 294 letters of credit, 300 local customs, 311 proper information needed, 391 sales on open account, 303 Friends, making use of, 326 Imports financing o& 292-317 use of trade acceptance in, 189 Individual proprietorship advantages of, 18 as form of business organixation, 15, 18 drawbacks of. 18 Insurance as a basis for a loan, 220 types of, 322. See also Borrowing Integrity, importance of, 319 Investment Initial, in launching a business, 52 service and advice on, by bank, 137 Investors in capital of concern affected by form of organization, 73 several classes of, 71. See aln Capital, Financing, Stocks Instalment-plan selling, 59 Judgment notes, 224. Set alto Bor- rowing Labor market consideration of, 13 problem of, 287 Leases, influence of, in financing, 286. See also Financing Letters of credit, 300 Loans, collateral, 168. See alto Bank, Bankers, Borrowing, Financ- ing Location consideration of, 13 effect ot on borrowing, 166, 232 importance of, 286 ana leases, 286. See also Financ- ing Management importance of, 4 training of subordinates for, 31> Managerial factors, 274. See also Financing Market, consideration of, the pro- spective, 13 Markets, diversified, 323 Materials market, consideration of 13 Money, function of lending, llo Money, ma^rket. consideration of, IS Mortgages, securing bond issues, 95-99. See also Bonds. Note broker, the, 208. See also Bor- rowing Organization, the capital interested in form of, 73 corporate form, 21 expense of, 61 individual proprietorship, 18 partnership, 19. See also Capital, Capitalizartion 362 Indei Overbuying, 260. See also Fmans- ing Overhead, reduction of, 327 Partnership, as form of organiza- tion, IB, 19 Personal factors, 271. See also Fi- nancing Planning, preliminary, 11, 13, 15, 27, 233, 282. See also Capital, Capitalization, Corporation, Financing, Stocks Prl^^s, consideration of, 13 Production preliminary consideration of cost of, 13 relation of Individual business to, 4 Proilts left in business, 284 Ready money, uses of, 350 Short-term notes to be avoided, -when, 238 Shipper, financing of, by trade ac- ceptance, 198. See also Bor- rowing Sellihg financing as affected by terms of sale, 63 on instalment plan, 59 methods of, and of distribution, 70 on consignment, 62 preliminary consideration of cost of, 13 unsalable stocks, 63. See also Fi- nancing Shares,^ 5e« Stocks Stock backing behind stock offering, 69 bonus, 76 book value of, 46 different classes of, 41 common, 44 form of certificate of, 74 founders', 44 future needs of corporation to be considered with reference to present stock Issues, 78 liability of stockholders on bonus stock, 75 of no par value, 46 par value of, 45, 74 preferred, 41 rights of, 74, 76 "rights" to stockholders, 75 terms of selling, 74 —Sale of additional, by established con- cerns, 92 additional securities, 116 increase of capital stock, 116 '.methods of, reviewed, 90 thru mail, 86 thru salesmen, 83 thru underwriters, 89 thru advertising, 84 to "insiders," 81. See also Capital, Capitalization, Financing Stockj carrying too large a, 262. See also Financing Stockholders good will of, 286 making customers out of, 324 "Supplier," the, 214. See also Bor- rowing. Supply and Demand, law of, 313 Surplus accumulation of, 116, 321 Increase of, 335 investment of, 338 making use of, in business, 336 reserves from, 333 usds of, 331, 348 what it is, 333. See also Financ- ing Time factors in borrowing, 163 Trade acceptance, the, 174-207' accounting methods for, 204 advantages and disadvantages of, 176 compared with notes and drafts, 180 credit standing an important ele- ment, 183 defined, 174 introducing its use, 178 opposition to use of, 186 practices violating principle of the, 184 typical uses of the, 189 use of, in financing exports, 195 use of, in financing imports, 189 use of. In flnancig shipper, 198 See also Financing Turnover, Increasing the, 236 Wareho'ise receipts, 223. See aire B irrowing