VIII The Bank Borrower's Statement

CHAPTER VIII THE BANK BORROWER'S STATEMENT: ASSETS The credit worth of a borrower, which may be defined as the amount which he will be able and willing to repay at maturity or to the reasonable satisfaction of the lender, depends upon three factors: capital,1 business ability or capacity, and character. While, from the banker's view point, capacity and character are more essential than capital in connection with small loans, capital more or less liquid is, along with the other two factors, a sine qua rum in connection with loans of large amount, notably loans to corporations, in which the element of personal responsibility is, in comparison with loans to firms and individuals, somewhat less conspicuous. Reference was made in the last chapter to the growing custom of banks in requiring borrowers and those desiring to borrow to submit statements consisting, generally, of a balance sheet and, frequently, an income account, as a means of enabling the banker to pass intelligently upon loan applications. It will be our purpose now to examine the borrower's statement as an index of his credit worth. That statement will 1 Collateral, which is frequently the most important criterion of a borrower's credit worth, is discussed in chapter XII, on secured loans.

161 162 BANK CREDIT be studied with a view to discover what light it throws on the borrower's capital and capacity. From the borrower's statement experienced credit men are able incidentally to make important deductions bearing upon his character. Information concerning the character of the borrower, however, is for the most part obtained from sources extraneous to the statement. In the analysis of a borrower's statement the bank credit man has uppermost in his mind two questions. First, is there a reasonable certainty that the proposed loan will be met at maturity, and, second, if unforeseen circumstances should prevent payment at maturity will the loan be paid ultimately? An answer to the first and most important question is sought largely in the relation of the borrower's quick assets to his current liabilities; an answer to the second, in the relation of his slow or permanent assets to his permanent liabilities. At the very outset, then, the banker divides both the assets and liabilities into quick or current and slow or permanent.1 Current liabilities must be met out of quick assets; permanent liabilities should be fully offset by slow or permanent assets.

The form of statement that banks ask their borrowers to sign varies decidedly.2 It will be advisable 1 Clay Herrick, Borrowers' Statements and the Rulings of the Federal Reserve Board, 25th Annual Convention, Ohio Bankers' Association, 1915, p. 45. 2 Appendix B, containing the report of the committee on credit forms made to the American Bankers' Association, at Atlantic City, N. J., September 28,1917, gives forms designed for (1) farmer, (2) firm or individual (manufacturer or merchant), (3) corporation (manufacturer or merchant). By no means all borrowers consent to fill out forms, particularly those furnished by the banker. Many THE BANK BORROWER'S STATEMENT 163 here to present a statement for study with all but its most essential features pared away. Assets Cash on hand $ Cash in bank Accounts and notes receivable Merchandise: Finished $ In process Raw material Real Estate Machinery and fixtures Other Assets, and of what composed Total Assets > $ Liabilities Bills payable for merchandise $ Accounts payable Bills payable to own bank Bills payable for paper sold Mortgages on real estate Chattel mortgages , Bonded debt Deposits of money with us Other indebtedness, and of what composed $ Net worth or, in case of corporation, the capital stock plus surplus or minus deficit % corporations insist on ignoring such forms and in their place give their own formulated statement.

164 BANK CREDIT Questions are inserted, following this statement, concerning contingent liabilities, insurance, depreciation, total sales for previous year, terms of sale, annual expenses, dividends, etc. Obviously the most liquid asset of a business enterprise must be its cash. Next are accounts and notes of customers, which are only a step removed from cash in the degree of their liquidity. Such receivables constitute the connection between merchandise or manufactured product on the one hand and cash on the other. Merchandise or manufactured product, flowing in a constantly changing stream, is transformed into notes and accounts receivable and, with the progress of time, the receivables are merged one by one into cash. Merchandise or finished product, receivables, cash, are the principal quick or liquid assets. The difference between quick and slow assets may be not only a difference in degree but also one of kind.

The value and quick salability of many quick assets, e. g., merchandise, depends upon the consuming power of the community or market. The value of other quick assets, e. g., United States bonds, has little or no relation to the consuming power of the community at the time. The value of slow or fixed assets, such as real estate, plant and machinery, depends largely upon their present and prospective earning power. Current liabilities consist of accounts and notes payable, wages, interest and other items of a current nature. Slow or permanent liabilities include chiefly such long time obligations as bonded indebtedness, mortgages or liens on real estate and plant, and "deposits of money with us." The last named may, in THE BANK BORROWER'S STATEMENT 165 many instances, be more properly treated as a current obligation. The capital of the borrower, by which is meant the proprietors' interest in the case of a partnership and the net worth in the case of an individual entrepreneur, is equal to the assets minus the liabilities.

When a corporation is concerned the capital, as we are using the term, is equal to the par value of the capital stock plus the surplus or minus the deficit. But deducing the amount of the borrower's assets available for the payment of current debts, as well as ascertaining the aggregate capital, is more than a matter of mere arithmetic; careful scrutiny of the balance sheet is required, item by item. Cash on Hand and in Banks Cash on hand and in banks should be large enough properly to "balance" the statement. The most approved amount varies with the requirements of different lines of business, but, in general, bankers like to see from 5 to 15 per cent of the quick assets in the form of cash. If the cash is very small the concern is in danger of being unable to meet maturing obligations in the event of a falling off in expected collections. An inadequate balance will, at the same time, tend to cause the banker to be indisposed to extend needed credit.

If the cash is disproportionately large the borrower is impairing his ability to meet future obligations by not keeping at work money on which he may be paying interest. The shrewd and far-seeing borrower will reduce the cash item hi fair weather and increase it in advance of the storm. The concern with plentiful cash 166 BANK CREDIT on hand in time of monetary stringency or crisis has an enviable purchasing position.1 The credit man considers cash on hand and in bank from two angles, quality and quantity. In quality the item is likely to be adulterated. Besides the legitimate currency, checks, and bank deposits, there may be found floating memoranda of varying degrees of magnitude and character. A controlling officer may be liberally represented in the cash drawer by his I. 0. U.'s.2 A worthless check of a partner may be kept in the cash drawer over statement day, later to be destroyed.3 A large number of I. 0. ¯ü.'s or other slips of paper representing cash is sometimes found traceable to the use of what is known as the imprest cash system, by which the cashier in branch office or factory is given a fixed working fund out of which to make payments from time to time, it being understood that the sum of the expense vouchers plus the cash on hand is at all times to be equal to this cash fund. These funds are commonly reported at the full amount although a considerable portion of the cash recorded may be in the form of vouchers which are later to be charged to expense or capital accounts.

Cash has been known to be tied up in failed banks, 1 Norman I. Adams, Credit Department, Analysis of the Financial Statement, a lecture delivered before the Boston Chapter of the American Institute of Banking, February 4, 1913, pp. 5, 6. * Frederick H. Hurdman, Credits from the Standpoint of the Certified Public Accountant, Proceedings, Fortieth Annual Convention, American Bankers' Association, 1914, pp. 468, 469. 3 Norman I. Adams, op. cü., p. 5.

THE BANK BORROWER'S STATEMENT 167 and to have been stolen by employees. Cash on deposit at the bank may be tied up by liens against it, or may be in the form of a special deposit which is not to be withdrawn except after a time notice. Cash on hand at the date of the statement has been known to disappear the next day through dividend or other special disbursements.1 While cash on hand is a questionable asset, being so easily transferred from one pocket to another, cash in bank is subject to easy verification where the borrower is a depositor of the lending bank, and must be carefully analyzed in the light of a knowledge of market conditions in the trade of the borrower. Some trades have only one season; some have two; others have four. In the first case the borrower will have a flush season when a large bank balance will be carried followed by a season when such balance will be at a minimum, and when heavy borrowing will be necessary. Where a concern has two seasons and even more emphatically when it has four seasons, i. e., a continuous market, its receipts should approximate its outgo and then a bank balance disproportionately email with reference to obligations would be an element of weakness.2 The shrewd lender does not fail to ascertain whether cash has been "rigged" through the accumulation of receipts and the postponement of expenditures.

For the sake of the good will of his banker a borrower 1 Clay Herrick, Borrowing Statements and the Rulings of the Federal Reserve Board, Proceedings, Twenty-Fifth Annual Convention, Ohio Bankers' Association, 1915, p. 48. * W. Oliver Craig, Banking Credits, Bulletin, American Institute of Bank Clerks, Vol. V, p. 709.

168 BANK CREDIT should maintain an average balance equal to at least 20 or 25 per cent of the loans extended. Such a balance is justifiable on the ground that the bank itself keeps balances in numerous and widely scattered banks as compensation for clearing and collecting items within their territory. Even the largest banks with the most modern facilities use other banks as agents in making collections. Where the borrower maintains that he has only one bank account, it is a good practice for the banker to compare the amount of cash in bank shown in the statement with the bank's records, as a check on the borrower's figures. Although the two amounts will not agree exactly on account of outstanding checks, any gross overstatement may be detected. A bank's records are of value also in throwing light on the cash item at times other than on statement dates. Banks sometimes examine a borrower's deposit account in order to ascertain whether his balance would have been overdrawn had all checks outstanding on a given date been presented for payment on that date. An account potentially overdrawn is a sign of financial strain which the banker justly views with misgiving and concern.

In very few instances should a large sum of money appear under the head of cash on hand. If this item is large, it is very likely to be a sign of lax financial methods. Few businesses in the twentieth century require that any large amounts be paid out in actual currency. Even wages—although the practice is not always socially and economically desirable—are usually paid by check. The careful business man THE BANK BORROWER'S STATEMENT 169 makes it a rule to bank all cash as it is received. The man who does otherwise is likely to be careless about other and more vital features of his business.1 Accounts and Notes Receivable Notes receivable, once an important item in the balance sheet of American business enterprises, have almost entirely given way to open accounts. Only in such businesses as the lumber, some branches of the tobacco business, the jewelry and piano trades, plumbers' supplies, and agricultural implements, does the note persist. The appearance of notes receivable in the statements of concerns engaged in other lines is almost certain evidence that such obligations represent a conversion of slow and perhaps uncollectable outstanding accounts.

Taken together these two items, notes and accounts receivable, should bear a definite and fairly constant relation to the volume of sales, and violent fluctuation above or below the percentage as calculated on statements rendered by successful concerns in the same line of trade or manufacture as well as on the last statement submitted by the borrower should evoke the banker's closest scrutiny as indicating one or more of three conditions.2 In the first pla,ce trade conditions may be abnormal. The extent to which an increase in the ratio of receivables to sales is due to this cause can generally be satisfactorily determined by the banker from his 1 Ernest Reckitt, Commercial Balance Sheets, Bulletin, Amerioan Institute of Banking, Vol. XI, p. 537. > Idem, op. cü., p. 538.

170 BANK CREDIT knowledge of trade and financial conditions. Any reasonable banker would expect an increase in the ratio of receivables to sales during a crisis. In the second place there may have been a falling off in the efficiency of the credit and collection departments of the business of the borrower and more extensive credit may have been extended to customers than formerly. Close inquiry as to the workings of the credit department of the borrower frequently throws strong light on the liquidness of receivables. Whenever a thoroughly capable credit man is in charge of the credit department of the borrower's business it is not only insurance against wide fluctuation in the relation of receivables to sales but is also a presumptive indication of worth in the receivables of the concern. In the third place a marked rise in the ratio may indicate that the figures for either sales or receivables or both have been manipulated. If this supposition arises the banker would naturally be wary about extending credit. He may well insist that competent accountants and appraisers examine the affairs of the borrower in detail.

Book accounts, like notes receivable, are seldom if ever worth par despite a strong inclination among borrowers so to regard them. The foremost question that the banker has to ask in connection with this item has to do with the allowance for bad debts. In addition the banker ought to know to what extent, if any, personal accounts of officers or employees are included. Is the business national in scope and are the accounts widely distributed geographically so as to avoid the THE BANK BORROWER'S STATEMENT 171 likelihood of having the bulk of them in territory where business is depressed? A concern whose accounts were mainly in the cotton states in the fall of 1914 was in an unenviable position. To what extent are accounts in the hands of attorneys for collection? What is the volume of assignment accounts? Have any accounts been sold to discount companies that have presumably taken off the cream? Do any of the accounts represent amounts due from branches or affiliated concerns? All these questions are calculated to enlighten the banker as to essential facts in connection with this important item.1 Occasionally statements show accounts and notes receivable under and over sixty days due. As a general rule this does not explain how the accounts receivable stand, as there may be bad accounts not yet long overdue and large items long overdue that are fully guaranteed. To the banker who can count upon the veracity and honesty of the borrower a statement that shows the accounts that are good would mean more than one that distinguished between those over and those under sixty days due.2 The element of uncertainty in notes receivable is more pronounced than in accounts receivable. Perhaps some notes have been renewed, and others may 1 Clay Herrick, Borrowers' Statements and the Rulings of the Federal Reserve Board, Twenty-Fifth Annual Convention, Ohio Bankers' Association, 1915, p. 49. Also çƒ. Thomas J. Kavanaugh, Essentials in the Granting of Bank Credits, Trust Companies, Vol. XXIII, No. 2, August, 1916, p. 120.

"William Whitfield, Actual Conditions versus Borrowers' Statements, Proceedings, Oregon State Bankers' Association, 1914, p. 43.

172 BANK CREDIT be past due. Let the credit man ascertain whether all the notes have arisen from the regular course of business. Some may represent loans to officers or employees or other individuals. In corporations, shareholders sometimes give notes in payment of capital stock. Notes of subsidiary concerns may be among others. In many lines of business only the less desirable customers give notes, others buying on open account or for cash. A large amount of notes receivable appearing in a statement submitted to a banker would in most lines of trade indicate that the borrower was dealing with weak concerns that were not able to discount their bills. In some businesses, e. g., the piano business, receivables are likely to contain notes payable in monthly instalments, and extending over a long period.1 It is only after taking such matters as these into consideration that a banker can estimate with a satisfactory degree of accuracy whether this item in the balance sheet represents quick assets on which he can rely. When notes receivable are found it is always important, as already indicated, for the banker to ascertain whether they are in the possession of the borrower and not hypothecated.

The note, as compared with the book account, is objectionable from the standpoint of both bank and borrower because of the difficulty of taking quick legal action for recovery, should doubt arise as to the solvency of the signer. If a note is taken for three months and ïn the meantime doubt arises as to the solvency of the maker, quick action for recovery is impracticable. Effective legal action cannot be taken until the note 1 Clay Herrick, op. cit., pp. 48,49.

THE BANK BORROWER'S STATEMENT 173 matures. In the case of an open account, on the other hand, the legal means of recovery are quickly available.1 Where the banker is distrustful of the items of accounts and notes or bills receivable, his suspicions may be confirmed or removed by obtaining an itemized list and establishing the worth of each separate account. Merchandise or Inventory It must be said at the outset that this item frequently gives no end of trouble to the credit man of the bank. "Inventory is the acid test of honesty." The audit of certified accountants frequently throws only a dim light on the character and actual value of the stock of goods,—so easy is it for a concern here to conceal its actual condition. As it is difficult for the accountant to take complete inventories in many large establishments, an official simply certifies to the correctness of the figures. It is true that accountants frequently sample the inventory, making such physical tests as practicable, but old and shopworn goods or those that have lost much of their original 8alability on account of being out of date cause accountants a great deal of difficulty of appraisal. lines very difficult to appraise accurately are women's wearing apparel, millinery, novelties and those in which the style element is prominent.

More and more frequently banks extending heavy lines of credit are having their own representatives 1 William Post, Analysis of Borrowers' Statements, Journal of Accountancy, January, 1906, Vol. I, No. 3, p. 183.

174 BANK CREDIT from the credit department, after becoming thoroughly familiar with the stock of merchandise composing the inventory, not only audit the books of the borrower but make a careful appraisal of assets as well. In many cases an acquaintance in the trade can be relied upon, particularly by bankers in the smaller cities, for expert opinion with reference to the valuation set forth in the statement. Experts in the trade would be familiar with the value of both finished and unfinished goods. When accountants and special appraisers are responsible for auditing a concern's affairs it is always advisable to have the audit follow closely on the heels of the annual inventory as this procedure affords the auditors better opportunity to make physical tests of the inventory as a check on the inventory figures furnished by the concern.1 The location of the goods inventoried is not a negligible factor to the credit man analyzing the statement. Goods scattered in numerous agencies or branches not only require a superior organization at the main office for administrative purposes but also more than ordinary care and vigilance in evaluation.2 If distributed in warehouses, branch offices or sales agencies, merchandise or supplies are accounted for less simply and accurately than when kept in one center.

1 Charles E. Meek, Proceedings, Twenty Second Annual Meeting, Kentucky Bankers' Association, 1914, p. 55, and Financial Age, October 3, 1914. 2 William Post, The Four Big C's, Address delivered at the Meeting of the Philadelphia Credit Men's Association, January, 1910, pp. 48, 49.

THE BANK BORROWER'S STATEMENT 175 The location of goods inventoried, is, however, of much less interest and import to the banker than the method of valuation. Inventories will frequently vary in the ratio of 1 to 6, according to the basis or method of valuation, and allowance for obsolete, deteriorated or second-hand stock. A given stock may be inventoried at as low a figure as $25,000 or as high as $150,000. How the inventory item may mislead the unwary banker, owing to a defective basis of appraisal, will be made plain by an illustration. In the case of concerns dealing in equipment, machines, etc., it may be necessary to take in second-hand stock in exchange for new machines, etc., sold. The second-hand goods may be put on the books at their "trade-in" value, which may greatly exceed their selling value. The relative inventory may be taken from the office records and the banker be misled when he examines the balance sheet accompanying an application for a loan.1 An auditing accountant would be able in a situation of this kind to discover the overvaluation and would probably make such arbitrary reduction as he thought fitting; but auditing and appraisal representatives of the bank, by reason of specialized knowledge, would likely succeed in making the reduction more nearly in accord with the facts.

Although there is some difference of opinion among credit men as to the point, the basis of merchandise valuation, it is pretty generally agreed, should be either cost or market price, whichever is lower. All old and unmarketable goods should be written off the 1 William Whitfield, Actual Conditions versus Borrowers' Statements, Proceedings, Oregon State Bankers' Association, 1914, p. 44.

176 BANK CREDIT inventory. During a period of rapidly rising prices, on the other hand, cost of replacement may justifiably be made the basis of inventory appraisal. Fire insurance conditions on occasion may even make this procedure imperative.1 The banker ought to guard against the occasional and obviously objectionable practice of taking merchandise into the inventory without immediately entering the bills upon the books as a liability. He ought also to insist that there be no omission from the inventory of stock taken into the house, even though the relative liabilities are also omitted from the statement. To leave out both goods and the liabilities therefor, which results in showing upon the statement small stocks and reduced liabilities, distorts favorably to the borrower the ratio of quick assets to current liabilities. To make this clear let us suppose a given borrowing customer of a bank truthfully states his quick assets as worth $500,000 and his current liabilities, including the amount of the loan required, $300,000. The ratio is 5 to 3 and such, perhaps, as to raise serious question in the mind of the banker as to the wisdom of lending.

Now let the applicant for the loan omit from his statement $100,000 worth of merchandise just put in stock and the same amount from his current liabilities and the ratio becomes $400,000 to $200,000 or 2 to 1. The double omission is most common in lines of business handling seasonal goods where the purchasers of one season are designedly separated on the books of the concern from the purchases of another. Convenient, 1J. H. Tregore, Journal of Commerce, February 10, 1917.

THE BANK BORROWER'S STATEMENT 177 perhaps, to the borrower, the practice is fraught with deception to the banker.1 Statements of manufacturing concerns should classify stock as among raw materials, goods in process, and finished products. Haw materials and supplies2 like cotton, wool, metals, fuel, and oil, are commonly so salable that they may be safely appraised at cost. When finished goods have a ready market they are conservatively inventoried at cost, but "cost," it is obvious, should not include any expenses involved in the sale of the goods. Some bankers insist that goods in process be valued at cost of raw materials and some have no objection to a valuation according to the figures contained in cost sheets. The last mentioned practice is unobjectionable to the extent that the borrower is solvent and prosperous beyond question. However, the credit man must always face the fact that unfinished goods require, in the event of failure, heavy expenditures under unfavorable conditions preparatory to marketing.

One of the principal points in the investigation made by the credit department is to ascertain how a concern buys its goods, whether the buyer or buyers are competent to judge merchandise or materials and disposed to buy in accordance with requirements. No one 1 Cf. Frederick H. Hurdman, op. cit., p. 473. 1 It is in place to point out that a large amount of raw material represented in the balance sheet of a manufacturing concern may well indicate that the concern is buying heavily when prices are low,—a circumstance that may promise large profit without great risk of loss, during a period of rising prices. Cf. Louis N. Roe, The Granting of Credit, Bankers' Magazine (New York), Vol. LXXXIII, Nov. 1911, p. 604.

178 BANK CREDIT knows better than the experienced lending officer of a bank how seriously injudicious buying and the accumulation of undesirable stock will impair the resources of a concern. "Goods well bought are half sold." Shrewd buying has its reflection in a clean and salable inventory. It would be a mistake for the reader to suppose that general rules exist for the valuation of merchandise or other assets. Nothing could be more erroneous. The credit man or lending officer of the bank considers each case on its own merits.1 Even in the case of such staples as flour, iron, leather, wool and cotton different grades exist and only an approximation to a correct valuation is possible, albeit daily quotations furnish a record of the market values. Whether in times of peace or war wide fluctuations occur in the value of such necessaries as those mentioned, within a relatively short time. The sagacious lending officer not only makes allowance for such fluctuation but also leans heavily upon the judgment of trade experts.

Should the lending banker become involved in the affairs of a concern whose assets are largely in merchandise he ought to bear clearly in mind that the sale of a stock of merchandise at prices that will cause anything short of a slaughter of the interests of the merchant or banker, where he is concerned, requires considerable time. The failure of a merchant to pay 100 cents may be due in large measure to bankers clamoring for a settlement, and forcing a quick sale of goods in bulk. A merchant in Philadelphia in partner1 William Post, Analysis of Borrowers' Statements, Journal of Accountancy, Vol. I, No. 3, January, 1906, p. 186.

THE BANK BORROWER'S STATEMENT 179 ship with another bought the stock of a bankrupt concern in Boston and cleared one hundred thousand dollars in ten months. The creditors were banks impatient for a settlement. They got it, "reasonably quick and unreasonably small."1 Real Estate, Machinery and Equipment The statement should give full information concerning land, buildings and equipment, including a description, along with data covering any indebtedness against the property in the nature of mortgages or other liens. The apparent equity of a concern in mortgaged real estate may be seriously reduced by back taxes, assessments and other liens of this character. The valuation of property should be compared with the county (or other) assessment figures, and, wherever practicable, the mortgage records investigated. In securing a statement from an individual borrower the cautious banker is careful to have it explicitly stated that the real estate is held in the name of the borrower, and not jointly. Even borrowers of honesty and integrity have a habit of forgetting to mention that realty is held jointly with their wives. This is a point where state laws seem to favor the debtor.2 It is contended in some quarters that the credit man's valuation of the real estate item should be influenced by such a factor as how essential the real estate is to the profitable conduct of the business of 1 William Post, The Credit and Loan Department, Bulletin, American Institute of Bank Clerks, Vol. Ill, p. 136.

>J. H. Johnson, Proceedings, Thirteenth Annual Convention, %íichigan Bankers' Association, 1901, p. 43.

180 BANK CREDIT the borrower. The plant of a manufacturer should be valued higher ordinarily, it is maintained, than real estate owned by a jobber which is not a necessary adjunct to his business. Brick, mortar and equipment which might not realize twenty five cents on the dollar under forced sale should be valued at a much higher price when owned and managed by capable borrowers. The valuation of real estate is thus made a function of the capacity of the borrower. It is also urged that real estate which is extraneous to the conduct of a business should be entirely stricken out or appraised on a nominal basis.1 The cases in which real estate even approaches the character of a quick asset are rare, and its value concerns the lending banker chiefly in connection with a long time view of the credit worth of the borrower. As a basis of appraising real estate employed in manufacturing, cost or cost of replacement is usually unsatisfactory. What the plant would sell for in the event of liquidation is the most vital question. It is evident that the answer to this question will hinge chiefly on location and the nature of the goods for the production of which the plant is equipped. In the case of a manufacturing enterprise, whose plant is not centrally or well located, employed in turning out goods in the production of which few are engaged,—e. g., Jews' harps or paper makers' felt,—land, plant and equipment would have few buyers at the time of a sheriff's or receiver's sale. If an old plant, unfavorably located for the production of a new and different arti1W. Oliver Craig, Banking Credits, Bulletin, American Institute of Bank Clerks, Vol. V, pp. 708, 709.

THE BANK BORROWER'S STATEMENT 181 die, would have to be remodelled and newly equipped before the creditor bank would be able to realize on the capital advanced as a loan, the credit man had better insist on a nominal valuation. If on the other hand the plant is well located in an industrial center and employed in manufacturing a staple like some of the textiles, for example, both plant and machinery might easily be sold on short notice at a price approximating cost of replacement. As the plant is by far the most important single asset, quick or slow, in many lines of manufacturing, the credit man is compelled in fairness to the borrower as well as by banking competition to evaluate this item as liberally as safety will permit. A sharp distinction should be made generally between real estate used for manufacturing and that for merchandising. A business structure if conveniently located for trade and not adapted specially to any one purpose is a good asset. If the business that may now occupy it should be withdrawn the building and lot could be sold and applied to other use. The value of the real estate is easily appraised and the banker is justified in placing a relatively high value upon it.

The situation in connection with a manufacturing plant is entirely different,—if the business fails it is likely to be difficult to apply the premises to other purposes. As a general rule the banker should not value the plant at a higher figure than that at which experts in the line of manufacture concerned would be willing to take it over as a "going proposition." Machinery is almost worthless as security for a bank loan. Unless of very high grade it cannot be sold 182 BANK CREDIT usually for much more than its value as scrap. It is far removed from being a quick asset and can be allowed weight in the consideration of the credit man only when he knows the applicant for the loan is prosperous, is adding to working capital from year to year, and that all the elements of success are present.1 The book value of machinery should be steadily scaled down, unless the concern is known by the banker to carry an offsetting reserve fund for depreciation,— a fund to which is charged the cost of machines bought to replace those going to the scrap heap. It is to be noted that concerns whose practice is to keep machinery at a very high state of efficiency, maintain that continually to charge off for depreciation rather than carry a reserve fund is to invite a reduction in fire insurance below what is equitable and reasonable.2 Whatever the nature of the business of the applicant for a loan, the items of real estate, machinery and equipment should be appraised carefully and conservatively. Machinery and equipment had better be placed on a nominal or, at most, a liquidation basis of valuation, the banker normally assuring himself as to provision for repairs, renewals, and replacements.

Other Assets Among the most important items included in "other assets" are stocks and bonds, patents, trade-marks, 1 William Post, The Analysis of Borrowers' Statements, Journal of Accountancy, January, 1906, pp. 187, 188. 2 William Post, The Loan and Credit Department, Bulletin of the American Institute of Bank Clerks, August 1,1903, Vol. Ill, p. 135.

THE BANK BORROWER'S STATEMENT 183 good will, and such deferred assets as insurance paid, organization expenses, taxes paid in advance. Stocks and Bonds Under the head of other assets, or otherwise, the item of stocks and bonds appears in a large number of borrowers' statements. When the securities are good stock exchange collateral they may safely be included in the quick assets. If the securities are those of companies affiliated with but controlled by the one under review, and are of significant proportion, close study should be made of the relation of the one company to the others in order to disclose, if possible, any contractual obligation or contingent liability under stock ownership, enjoined by the state in which the controlled company was organized.1 The banker who profits from past experience will require a consolidated balance sheet, prepared by competent accountants, of a concern that is financing branches and subsidiaries in order that the standing of the concern as a whole may be revealed.

The reason for holding listed securities, if carefully inquired into, may disclose a speculative tendency in the concern. A bank should have all requisite information in an instance of this kind. The customer may have embarked on some speculation or venture foreign to his regular business which would put him under obligation to pay instalments at successive dates. His statement may show the first one or two payments as an investment, and make no mention of the 1 Frederick H. Hurdman, op. cíí., p. 474.

184 BANK CREDIT liability in connection with the instalments not yet due.1 Unissued stocks and bonds of a borrowing corporation are not an asset and should not be so shown. Treasury stock, or stock which has been repurchased, must be regarded as a slow asset unless a wide market for the stock exists. Even when the securities are listed and active on an important exchange their value, in the event of failure, would be residual and until the completion of liquidation, indeterminate. Serious weakness may easily be concealed in the "investments" item, which, accordingly, should be carefully appraised as to both value and ease and quickness of sale. Trade-marks, Patents, Good Will, etc. Some or all of these items grace the statements of many borrowers. While possessing a positive value as long as the company is a going concern, their liquidation value is likely to be nil. There are exceptions.

To take a concrete case, the makers of Ivory Soap could probably realize substantially on the sale of the name, which is the trade-mark, even if all tangible property of the concern were destroyed by fire with no insurance. The value of this trade mark has been built up in large measure by heavy advertising over a long period of years and that fact would in itself justify the lending banker in allowing the borrower to place a relatively high valuation on the trade-mark as an asset. 1 Journal of the Canadian Bankers' Association, Vol. XXIII, No. 4, July, 1916.

THE BANK BORROWER'S STATEMENT 185 Trade-marks are probably easier of satisfactory appraisal than patents, copyrights and good will. Nevertheless bankers are not infrequently influenced favorably by the known existence of value attaching to such assets as we have under consideration, even though they are listed at only nominal valuations. Many concerns of high class credit standing give evidence of their conservatism by carrying some, if not all, of this group of items in the balance sheet at a purely nominal figure. A case in point is the General Electric Company. Other concerns take full advantage of the vagueness and indefiniteness with which these intangible assets are surrounded. When having little or no value at all, the items may be placed on the books at a high valuation in order to offset a certain amount of liabilities. Patents, trade-marks, good will, and copyrights, when swollen in size, put the credit man on guard.

Deferred assets, such as taxes paid in advance, insurance premiums, and organization expenses make only a casual claim on the credit man's attention. Certainly taxes paid are not likely to be returned to the business of the taxpayer, however prosperous that business may be. It might be legally possible to recover a part of insurance premiums in the event of liquidation, but the amount would be small in any case. Organization expenses are assets in a technical sense rather than actually,—assets that the banker likes to see dwindle and disappear within a few years after the enterprise has been launched. Appraisal of deferred assets is about the least of the credit man's troubles.

186 BANK CREDIT Life Insurance Increasingly banks are including in the blank statements furnished their borrowing customers one or more questions as to life insurance. Life insurance is not infrequently used to support the element of moral hazard. Even insurance that does not carry with it cash value upon surrender is looked upon by bankers as excellent credit support under certain circumstances. If the borrower is a man of known integrity and ability, but without capital, term insurance or insurance in other form on the life of the applicant for a loan may be acceptable to the banker in lieu of capital. In the event of failure of one project, insurance on the life of the borrower enables the banker to await with confidence the outcome of another more successful venture. By the same token life insurance is in many cases a satisfactory substitute for endorsement. Men with otherwise excellent prospects of success and entitled by character to great confidence would be barred from a successful start and advancement in business but for this form of support or endorsement.1 It is just as essential to credit when great reliance is placed on the integrity and business capacity of the borrower as is fire insurance where the chief reliance is on the value of merchandise or other similar assets. As most unsecured loans ought to rest on all three bases of capital, capacity, and character, it follows that life insurance in being employed as a foundation of credit serves a 1 William T. Gage, Life Insurance as Collateral, Proceedings, Twenty Seventh Convention, Michigan Bankers' Association, 1913, p. 129.

THE BANK BORROWER'S STATEMENT 187 useful and proper purpose. life insurance is contingent capital. Policies are now being written, frequently in large amounts, to cover losses contingent upon the death of partners, the managing geniuses of corporations, inventors connected with business enterprises and others upon whom success is largely dependent.1 The death of a member of a firm may involve, not only the loss of his active cooperation in the management, but also the withdrawal of his capital from the business. Bankers often, in checking corporations and firms selling paper in the open market, find the suggestion that this or that banker, owing to the death of the founder or manager of the business under investigation, has discontinued purchasing its paper until such time as the new organization will have shown its ability to manage its affairs successfully. The situation would be materially improved, if in response to the banker's inquiry, he were informed that the company, while losing a capable officer, had collected a large amount of insurance.2 life insurance is a stabilizing force, destined more and more to reduce and absorb the shocks of those financial vicissitudes to which business is everywhere subject.

1 A. Barton Hepburn, The Relation of Life Insurance to the Credit Fabric of Business, An Address delivered at the Eighth Annual Meeting of the Association of Life Insurance Presidents, New York, December 10, 1914, p. 6. 2 W. W. Smith, Necessity for Credit Statements and Desirability of Uniformity Thereof, Proceedings, Forty Second Annual Convention, American Bankers' Association, 1916, p. 519.

188 BANK CREDIT We have dwelt at length on the treatment of the assets side of the borrower's balance sheet because there concealed are most of the banker's pitfalls. What a borrower's assets amount to is, as we have seen, largely a matter of appraisal. His liabilities, on the other hand, need only to be fully listed in order to be accurately known. The discussion of the borrower's liabilities, as viewed by the banker, may therefore be put into brief compass.