Insolvency is the condition in which the assets fall short of the liabilities other than capital. The capital balance is intended to prevent this very calam ity; it is for the express purpose of guaranteeing the value of the other lia bilities—those to bondholders and other creditors.
These other liabilities, for the most part, are fixed blocks of property, carved, as it were, out of assets, the value of which property the merchant or company has agreed to keep intact at all hazards. The fortunes of business will naturally cause the whole volume of assets to vary in value, but all the "slack" ought properly to be taken up or given out by the capital, the surplus, and the undivided profits. A man's capi tal thus acts as a safety fund or buffer to keep the liabilities from overtaking the assets. It is the "margin" he puts up as a guarantee to others who intrust their capital to him.
The assets may comfortably exceed the liabilities, and yet the cash assets at a particular moment may be less than the cash liabilities due at that moment. This condition is not true insolvency, but only insufficiency of cash. In such a case, a little forbearance on the part of creditors may be all that is necessary to prevent financial shipwreck.
A wise merchant, however, will not only avoid insolvency, but also insuf ficiency of cash. He will not only keep his assets in excess of his liabilities by a safe margin, but he will also see that his assets are invested in such a manner that he shall be able, by exchanging them for cash, to cancel each claim at the time and in the manner agreed upon.
There are three chief forms of assets; namely, cash assets, quick assets, and slow assets. A large part of the skill of a business man consists in marshaling his assets so that he always has enough cash and enough quick assets to provide for impending debts, while maintaining at the same time enough slow assets to insure a satisfactory income from his business.
Since the liabilities of one man are also the assets of another, when one man fails and is able to pay only fifty cents on the dollar, the unlucky man who is his creditor—who has the first man's notes as asscts—suffers a shrinkage in his own assets which may in turn mean embarrassment or even bankruptcy to him. It is usually true in a panic that the failures start with the collapse of some big firm, involving a shrinkage in the assets of others.
We have seen how the capital account of each person in a community is formed.
Our next task is to express the total net capital of any community. This is the sum of the net capitals of its members, i. e., all the innumerable assets of all the persons less all the liabilities of those persons. This net sum will be the same, of course, in whatever order the items are added and subtracted. There are two ways in particular.
The simplest is, first, to obtain the net capital balance of each person by subtracting the value of his liabilities from that of his assets, and then to add together these net capitals of different persons to get the capital of society. This method of obtaining society's net capital may be called the method of bca ances; for we balance the books of each individual. The other method is to can cel each liability against an equal and opposite asset, which equal and opposite asset, as we shall see, must exist some where in another individual's account, and then add the remaining assets. This method may be called the method of couples; for we couple items in two dif ferent accounts. The method of couples is based on the fact that every liability item in a balance sheet implies the ex istence of an equal asset in some other balance sheet. This is true because every debit implies a credit. A debt may be owed to somebody, as well as from somebody, a debtor, and the debt of the debtor is the credit of the creditor. It follows that every negative term in one balance sheet may be can celed against a corresponding positive term in some other. Each of these two methods—of balances and of couples—is important in its own way.
If, then, we suppose balance sheets so constructed as to include all the real and fictitious persons in the world, with entries in them for every asset and lia bility—even public parks, and streets, household furniture, and other posses sions not formally accounted for in or dinary practice—it is evident that we shall obtain, by the method of balances, a complete account of the distribution of capital value among real persons; and, by the methods of couples, a com plete list of the articles of actual wealth thus owned. In this list there will 1),?, no stocks, bonds, mortgages, notes, or other part rights, but only land, build ings, and other land improvements, and commodities. All debit and credit items being two-faced—positive and negative —cancel out in the total.