IX The Bank Borrower's Statement: Liabilities

CHAPTER IX THE BANK BORROWER'S STATEMENT: LIABILITIES Liabilities have already been classified and we may pass at once to their analysis and interpretation, following the order of the liability items of the balance sheet given near the beginning of the previous chapter. Bills Payable for Merchandise This item should normally be small; otherwise it would indicate failure to take discounts. Such failure might be traceable to carelessness, overtrading or backward collections,—in any event an unfavorable indication. In certain trades like the lumber, building trades, some branches of the tobacco business, etc., it is customary for the buyer to give notes in settlement of accounts. Unless it is the custom of the trade to settle in this way, bills payable, if large in amount, are an almost certain sign that the concern is "skating on thin ice." Bills Payable to Own Batiks It is a distinctly unfavorable sign if a firm borrowing heavily from a bank allows its bills to run to maturity or past maturity. Cautious bankers make trade investigations and revise their credit files every six months or every year; and if they learn, as a result of 189 190 BANK CREDIT inquiries, that their borrowers are not taking advantage of the best trade discounts, the matter is brought to the attention of borrowers at once. There are times of course when abnormal business conditions prevent the banker from being exact in enforcing this rule.

Usually its enforcement is prompted by good banking and business logic.1 It is advisable for the banker to know the maximum amount borrowed from all sources during the previous fiscal year because most concerns close their books and make up annual statements between seasons when their business is employing a minimum of borrowed funds, or none at all. Between the dates when liabilities are at a maximum and at a minimum, the proportion of quick assets to current liabilities changes markedly. Bills Payable for Paper Sold Many cases have occurred in recent years, notably a decade ago, where borrowers discounted their paper through note brokerage houses and deliberately omitted from their statements an appreciable part of such liability. This deceptive practice has been checked, chiefly, by more painstaking work on the part of bank examiners. Clearing house bank examinations have been particularly effective in checking this practice.

Although the clearing house examiner does not come in touch with paper held by outside banks, the borrower can never tell when the brokerage house or possibly * Joseph B. Martindale, The Business of a Commercial Bank and How to Safeguard the Investment of Its Funds, Proceedings, ThirtySeventh Annual Convention, American Bankers' Association, 1911, pp. 702,703.

THE BANK BORROWER'S STATEMENT 191 country bank may resell paper to one of the banks over which the clearing house examiner has supervision. There is at least a moral effect. Open Accounts Bankers should ascertain how the amount of accounts payable is ascertained. When this item is small it may be explained by the bookkeeping practice of keeping no record of the accounts payable until the accounts are paid. The item, under those circumstances is placed on the statement at an estimated amount, which may not fully represent this class of indebtedness at the statement date. Accounts payable may also be reduced in the statement as a result of the bookkeeper placing no bills upon the books until they have been audited and approved.1 It is not an uncommon practice to offset accounts payable by accounts receivable. When a statement is made showing accounts payable net, after deducting certain of the receivables there has been a misrepresentation. A liability almost invariably represents one hundred cents on the dollar, but an asset represents only what can be realized on it. Any offset of liabilities against assets is misleading unless that offset is clearly shown in the statement. In the same category should be placed such accounts as represent, for example, investment in foreign branches. The statement may reveal only the net investment, whereas to be of positive value both the assets and liabilities should be given.2 This practice, while apparently not 1 Frederick H. Hurdman, op. cit., p. 476.

•Cƒ. ¾*,rit., p. 471.

192 BANK CREDIT changing the net worth of a concern does give its statement an improved appearance. Many borrowers believe, with some reason, that they have presented a stronger statement when they show assets of, say, $150,000 with nominal liabilities than if they showed assets of $200,000 and liabilities of $50,000. Chattel Mortgages The existence of a chattel mortgage is so evidently an unfavorable sign as scarcely to deserve emphasis. "Indebtedness for back rent or a chattel mortgage on fixtures or horses and wagons is a sure sign of financial weakness."1 Bonded Debt and Interest Thereon With reference to bonded debt and interest thereon the banker should know, among other things, the redemption date and the amount of interest accrued. The early maturity of a mortgage or mortgage bonds should not escape attention, especially if the prospect of renewal or refunding is unfavorable. If the redemption date of the bonds is near at hand and provision for their refunding doubtful the banker may feel justified in regarding the principal as a current liability. Accrued interest, when it amounts to a large sum, is obviously a clear sign of weakness. Sinking fund provisions which have not been lived up to represent unquestionable impairment of strength.

1 Herman Flatau, Financial Statements, Their Form and Analysis, in Mercantile Credits, A Series of Practical Lectures delivered before the Young Men's Christian Association of Los Angeles, California, 1914, p. 78.