Per cent Per cent Per cent Per cent Per cent Per cent Per cent Per cent Per cent

65.21

1 Adapted from table in Federal Reserve Bulletin, Vol. 5, p. 243.

THE CASH BALANCE

149

well be smaller. The rule of thumb proportion that one commonly hears is "two for one."

At the present time credit organizations are making analytical studies of thousands of accounts to draw from experience the proper proportions that should exist between certain items of the accounts of a particular kind of business in certain parts of the United States. Illustrative of this movement is the report of an investigation by the Federal Reserve Board 2 which has inspired further researches in this field. In the table which is here reproduced the ratios of quick assets and quick liabilities and six other ratios are shown for many companies in nine different businesses. These companies greatly exceeded the "two for one" rule.

113. The cash balance. Too much cash on hand denotes idleness and a wrong adjustment of cash to loans, but every other business as well as a bank should have a cash reserve (see 49). How much, depends. The banks with which business is done may require compensating balances for both loans and collectional services (see 70, 123, and 126). If a money broker is used to handle loans, he likes to point to a good supply of cash from which at any moment a large part of the maturing liabilities might be paid. If the nature of the business is such that the sales are seasonable, say twice a year, just after the busy selling periods cash (or notes, or accounts receivable) will be large, and the stock of merchandise small; while just before the rush periods, the opposite condition would be normal. The statements of such businesses are usually made after the sales are made and the profits show.

114. Receivables. Notes and accounts receivable, trade acceptances, and mortgages, due in six months, or less, are, next to cash items, the most liquid assets one

2 Alexander Wall, Credit Barometrics, Federal Reserve Bulletin, March 1919, p. 229.

can have. They represent goods already sold and in process of payment. Their value lessens, if more than a small proportion are past due; represent advances to officers, stockholders, partners, relatives, employees, or subsidiary companies; or are for goods on consignment which may not be sold. The trade practice determines whether notes receivable, trade acceptances, or accounts receivable, shall appear. If sales are for cash neither will be present. If sales are on open account, any notes will appear to have been taken for doubtful accounts. Their value will be discounted, for a large proportion of such notes are never paid. The nature of the business again determines whether at certain seasons these items might be large and at other seasons almost, if not entirely, paid up. If the annual sales are $600,000, and notes, or acceptances, for three months are regularly taken from nearly all customers, one expects to find one-fourth of the annual sales in such paper, provided it is a yearround business. If the season occurs once annually, these items are few in the off season and nearly equal the sales toward the close of the active period. If the selling terms of a continuous trade are thirty days, the receivables will aggregate from one-twelfth to one-sixth of the annual sales; if cash in ten days, less than one-twentieth. When a person has a notion of what the ratio of cash to credit sales is, he can judge the proportion of annual sales, beyond which it is dangerous for the receivables to go. Too much paper, or too many accounts, indicate slow collections and cloud their worth as good assets. It is an axiom among accountants that no business is properly managed that does not create a reserve for bad debts. Into this bad accounts are closed. The balance helps insure the cash value of all the others. Another way to strengthen the quality of the receivables is to carry credit insurance. If the ratio of receivables to merchandise increases, the ratio

INVESTMENTS

151

of quick assets to quick liabilities ought also to rise, since merchandise is accounted for at cost while receivables include the profit.

115. Investments. These should be described separately, to make them mean anything. They may be good, or doubtful. Bonds and stocks listed on the New York Stock Exchange are the quickest assets. They should be valued at no more than the market price, or the bid price, if there have been no sales. As ready marketability diminishes, investments fall from quick assets into slow assets.

116. Inventories. The inventories merchandise, farm products, live stock, raw material, goods in process of production, or finished goods should show that they are being used, that they are being sold, that the business is a success in selecting, or making goods that will and do sell. Goods bought, or produced, from the proceeds of notes pay for themselves only as they leave the factory, the farm, or the store. The amount of merchandise fluctuates according to the selling periods. If it is a seasonal business, the stock should be great or small accordingly. The great effort should be to decrease the amount of the stock carried in proportion to annual sales by increasing the number of times the stock is turned over (bought and sold) during the year. The meat packers make less than two cents on each dollar that turns over, but they make the same dollar turn many times during the same year. The lender finds out how many turnovers a particular line of business in a given section has and divides the borrower's annual sales by this figure to determine how much stock at the selling price there ought to be on hand. If sales are $600,000 a year and the turnover is six, the expected stock is $100,000. More than that might mean poor selling and old and non-salable goods. If the line were seasonable the lender judges how much the stock should be bought up,

or sold down, at the date of the statement. Some goods on hand are as good as money, others are not. Staples like pig iron, cotton, cereals, and live stock can be easily converted into cash. Goods which vary with fashion, or are perishable, may soon become scrap, waste, or garbage. When the flow from goods to cash ceases, credit withers. All goods should be valued at cost unless the present market value is less. Old goods should be inventoried at decreasing values; unsalable, obsolete, or unfit goods should be charged off. Inventories should not be by estimate, but by a physical inventory, or by a perpetual book or card inventory. At proper intervals a physical count needs to be made as a check upon a perpetual inventory. When goods on consignment are included in an inventory, a proper liability is set up against it. Protection by insurance increases credit, else fire, or other calamity, against which insurance is possible, may in a day wipe out a good part of the borrower's paying power.

117. Current liabilities. - Quick liabilities are chiefly notes, acceptances, or accounts payable. Merchandise in some lines is purchased by notes, or acceptances. To that extent these will appear. In proportion as goods are bought on open account, the notes, or acceptances, should be small. A note given to close an account looks suspicious. A common practice today in the United States is to buy at thirty days, with 1%, or 2%, off for cash in ten days, or by the tenth of the month; or, if the terms are sixty, or ninety days, a relatively larger discount is given. The buyer then borrows on his notes and pays cash. His notes item will be large, and his accounts item small, representing goods which have just been received. It is a sign of poor credit, or ignorance, not to take cash discounts. These notes will be due to banks, brokers, officers, or stockholders. Loans

3

3 Sometimes the price for 30 days is so close that only 1% discount is offered for cash.