Mr. Alexander Wall, at the request of the Federal Reserve Board, under the general supervision of its Division of Analysis and Research, has made an extensive study of this ratio between current assets and liabilities. His greatest contribution is the emphasis upon the advisability of analyzing the current assets from a qualitative point of view. He outlines seven ratios in an attempt to analyze the current ratio, the capitalization plans, and the vitality of the subject business. Since merchandise inven tories are figured at cost or less and accounts and bills receivable at cost plus profit, the conversion of merchandise into accounts receivable should increase the ratio of current assets to liabilities. The liquidity of the receivables is a most important factor, as the rapidity of their turnover and the ease of their collection vitally affect the import of the ratio. The ratio between sales and mer chandise has a similar bearing. An improvement of these ratios in the qualitative sense may offset a decrease in the quantitative sense. The non-current assets should be contributed by the in vested funds of the owners of the business; therefore the ratio between invested funds and non-current assets discloses how much the owners have put into the current part of the business. If the ratio of net worth to fixed assets falls it indicates that the plant is absorbing more of the capitalization and the working capital; such a condition is not healthy. The ratio of sales to net worth indicates whether there is undercapitalization and a fever ish condition in the business, or the reverse. And the ratio be tween the total debt and the net worth discloses the proportions of the total capital that are supplied by creditors and by owners of the business.
The Analysis of Current Assets Cash should be exactly what it implies, that is, currency in the company's safe and its balances with its bankers. All restricted cash items should be listed separately; they include all moneys held for the purpose of meeting specified payments not actually a part of the company's every-day operations. An example would be sinking fund cash. The working balance should be sufficient to assure its ability to meet demands made on it for cash. This amount may be low if the concern is a regular customer of one bank on which it can depend for accommodation; but if it borrows through the open market and has no assured bank connections a higher cash balance is necessary. Too large a balance indicates idle money and too small a balance is inconvenient or dangerous; the adjustment between these limits depends upon the business and conditions. In reporting its indebtedness a concern should not deduct its cash on hand from its net indebtedness, since it creates the wrong impression of the concern's condition.
Accounts Receivable represents amounts due for goods sold on open account and should comprise only accounts which are good, undisputed, collectible, of recent date, and free from pledge. Old accounts should be charged off, and a reserve carried for all doubtful accounts. If the terms of sale are, say, 6o days the sum of Accounts Receivable and Bills Receivable should not be in excess of go days' sales; this ratio acts as a guide to determine whether credits are too freely extended and collections too slow.
In a merchandising business the item of Bills Receivable as a rule is not large, inasmuch as the custom of transacting business upon open account has become so general. There are exceptions
to this where the custom of giving notes is the regular method of settlement, as in the agricultural implement, jewelry, piano, tobacco, and lumber trades. With the development of the trade and bank acceptance, this form of asset is becoming more impor tant. In those trades where notes are used in settlement it is important to determine the proportion of the assets that is com posed of notes. The proper normal proportion varies with the trade; any trade which used long-term notes might be expected to have a higher proportion than one with shorter term notes, and a higher proportion than the normal would suggest that the firm's collections were slow and would be a warning to the credit man. It is also important that a firm which sells on open account should have relatively few bills receivable, as their presence would indicate extensions of credit beyond the custom of the trade.
In some cases there are found in Bills Receivable amounts due from stockholders, representing money lent by the corporation on notes given for the purchase of stock; such receivables should be carried in the statement under separate headings. Special notice should be taken of the notes of the officers, employees, or other interested parties, which could be collected only with difficulty. The items should be analyzed to find which of them are renewals, which are pledged, which rediscounted, and which received from subsidiary concerns, and the total scaled accordingly. It is impor tant that the notes be based on commercial transactions, for goods sold and delivered, and, therefore, self-liquidating. It is quite necessary to have some knowledge of the ability of the concern's managers in order to determine whether they are careful in select ing their credit risks and in being properly secured in cases where collateral is obtained or a lien held against the goods for which the notes are taken.
Merchandise should include only the goods on the shelves or in the storehouses, and, in case of manufacturing concerns, goods which are ready for market. Goods in transit usually are in cluded in the Merchandise item, but it is an advantage to have them listed separately. The appraisal of the Merchandise item requires especial attention, as it is an avenue for the gross over valuation of assets and for the exercise of fraud. To appraise goods at their cost results in overvaluation, particularly in the case of old and seasonal and fashionable goods, since goods are only worth what they will sell for. To estimate the selling price, however, is still more difficult. The best method is to carry goods at cost unless the market price is lower, in which case the market price should be used. All old and unmarketable goods should be charged off, and a reserve established to cover depreciation. In manufacturing concerns, goods in process of manufacture should be carried at the amount which, according to the cost sheets, has been expended upon them up to the date of the inventory. Raw material and supplies, such as coal, oil, etc., which are in the nature of working assets and are readily salable, are carried at cost price; but raw materials for specially made wheels for certain kinds of machinery, special devices for particular kinds of plants, or specialized materials should be carried at nominal or liquida tion value.