The more complete the statement the better and more per fect analysis of a given condition can be made. The more the statement is proved by corroborating evidence and an indepen dent audit the surer the conclusions that may be drawn. The more recent the statement the less the possibility of dangerous changes in the character or amount of assets and liabilities. And the greater the number of statements, that is, the more the borrower's history is shown, the greater the value of the state ment, since it gives knowledge of the tendencies of the business and its management and policies.
Classification of Assets and Liabilities The assets of a borrower are classified as quick, or current, assets, and slow, or fixed, assets. Current assets consist of cash, accounts receivable, bills receivable, merchandise, goods in process, raw material, and supplies. The slow assets comprise real estate, plant and equipment, machinery and fixtures, good will, patents, delivery equipment, investments in other concerns or subsidiary companies, treasury stock, and deferred assets, such as interest and insurance paid in advance, organization expenses, and discounts on bonds.
Liabilities are similarly classified. Current liabilities include accounts payable, notes payable, amounts due to officers and stockholders for money lent, wages, interest, and other expendi tures. Fixed liabilities are its bonded indebtedness and the mortgages on its real estate or plant. A third class of liabilities considered by credit men is contingent liabilities, which include bills receivable which have been sold and accommodation indorse ments. Neither of these liabilities is likely to be presented for payment provided the discounts are self-liquidating and drawn by strong makers and provided the company has not been too free in lending its good name by indorsements.
Ratio of Current Assets to Current Liabilities In analyzing a statement with a view to extending unsecured credit, greatest consideration is given to those assets which are quick, or quite readily convertible into cash in the ordinary course of business, and to the liabilities which are current, or whose maturities are turning daily. The purpose of the classification is to provide a margin of assets which will guarantee the continuity of business and ability to liquidate current claims. All assets shrink in the process of liquidation, the shrinkage being deter mined by the degree of organization as well as the breadth of the market. Certain assets are self-liquidating, that is, they provide the debtor with funds within the period of the credit, and these shrink but little in the process of collection. But other assets,
such as accounts receivable, are subject to great shrinkage. By reason of the shrinkage of assets credit men have determined upon a more or less fixed proportion that should obtain between current assets and current liabilities in each trade. This ratio is a matter of opinion, varying with the trade and the borrower and the credit man between ry2":i and 3: r, and averaging about 2 : 1.
Every trade borrower must be considered on his own merits. The margin of safety can be determined only by experience, and generalizations are dangerous. Consideration must be taken of the business, the management, the general business conditions, and the time when the statement was prepared. Only a very low margin need be required from any business for whose product there is a steady inelastic demand and quick turnover and cash payment. Likewise, any concern which meets its current liabili ties without demur and which takes advantage of the cash dis counts offered may borrow with a lower margin than a slow-pay ing concern, for the slow payments are prima facie evidence of poor business conditions—immobile merchandise, poor collec tions, overstocked shelves, or overextended business. The margin may be lower in the case of those borrowers who handle the prod uct in the later rather than the earlier stages of its progress from raw material to finished product; and the longer the process of production or the more lenient the terms of sale as to period or extensions of time the higher should be the margin.
The comparative rate of turnover is quite as important as the absolute rate. A high absolute rate warrants a low margin of current assets over current liabilities, for the stock on hand, in the ordinary process of business, can be liquidated soon. A high comparative rate of turnover indicates that the dealer who shows this rate, compared with others in his trade, has higher business capacity, buys his stock wisely, is not overstocked, has fresh stock, and that, therefore, the margin may be comparatively lower. The ratio of average monthly collections made by a concern to the average monthly maturities which it must pay is an important factor in determining the margin of safety, for if the ratio of cash receipts, from cash sales and from collections, to liabilities maturing, is high, liquidation is assured. By these and other determinants a proper ratio of current assets to current liabilities is established, and in the hands of careful credit men and bankers it is the most effective curb on loan inflation and is the guardian rule of the bank.