Another distinction in the nature of expen ditures, which needs to be made to get an un derstanding of the business situation involved, is the difference between the cost of carry ing on the operations of the business itself and the cost of maintaining the plant in a condi tion for the efficient conduct of the business, and generally the maintenance of the capital investment unimpaired. This distinction is usually made in accounting as between the cost of "Conducting Operations" and the cost of "Maintenance." Fixed charges do not present the same kind of essential differences. They include any costs which the management of the business cannot cut off of its own volition. The man agement must meet them, and they do not diminish on a diminishing scale of business. Interest and rentals are the essential fixed charges; both incurred for the sake of addi tional capital in the business on the general principles discussed in the chapter on "Trad ing on the Equity." With these remarks we have our income account recast into the following form: — Such a form of accounts applies especially to a corporation conducting a transportation business. It is a skeleton adopted from the form of report required by the Interstate Commerce Commission. It would present the essential facts of a public service enterprise of the nature of an electric light or power company, a telephone or telegraph company. A gas company has some of the aspects of a manufacturing enterprise.
In our previous discussion we have taken for our operating ratio — that is, the propor tion of earnings consumed in the cost of oper ating — the whole of operating expenses in cluding the cost of conducting operations, the cost of maintenance and taxes to boot. As a single figure summarizing certain totals this percentage serves a useful purpose. For fur ther analysis we need to know about the items included in the total. To form conclu sions about the combined efficiency of the management and the plant, we need to know specifically the cost of conducting operations. We say advisedly the combined efficiency of the management and plant. Consider the case of a railroad. Its location, the manner of its construction, and the nature of its traffic fundamentally affect its cost of conducting operations. If its grades are low, its curva ture slight, and its construction heavy, it can use heavy, powerful locomotives and haul long trains at a minimum of expense for fuel and labor. If its traffic is dense, it gets the reduced cost of doing business resulting from a large volume and a full utilization of its capital investment. The percentage of grades and curvature, the weight of rail, and vari ous other figures serve to indicate at how great an advantage or disadvantage the man agement operates due to the nature of the construction of its plant. The traffic density shows the advantage it has owing to the loca tion of its plant, the territory the road runs through. The kinds of traffic carried show
whether or not the management has the ad vantage of high-grade traffic paying the higher rates or must haul a heavy tonnage at small profits. All these things help to show the efficiency of the plant and do not go to credit of management except in so far as the management brought these conditions about. If the management can claim credit for the conditions, it must first discount the cost of bringing them about and deduct the capital charge before it can make a showing of busi ness wisdom. No single figure expresses these advantages or disadvantages due to plant. These conditions can be taken into considera tion only in a general way in checking up the percentage of earnings expended for the cost of conducting operations. If we make allow ance for plant conditions, we can then take the percentage of earnings consumed in the cost of conducting operations as indicating the efficiency of management. If it is low as compared with the average under similar conditions, we may draw the inference that the management displays a high degree of efficiency.
Cost of maintenance indicates whether or not the management is returning enough of the earnings to the property to maintain the efficiency of the plant. If it is not doing so, the operating ratio -- - that is, the percentage of earnings expended in operating expense does not afford a proper index of the condi tion of the business. A showing of net earn ings is being made essentially out of capital. During dull years corporations commonly do this, and even maintain dividends in this way. Paying dividends out of capital has to take some more obvious form in order to be con sidered reprehensible and to run counter to the legal prohibition. If a business, which is not essentially a "capital business" in its nature, makes a full allowance for mainte nance, it is returning enough to the property to take care of depreciation. In the words a "capital business" we have coined an expres sion for our immediate purpose. By the term we mean some business in which the labor and other costs are not greatly significant in comparison with the capital cost. For example, the proprietorship and conduct of an apart meat house may well be regarded as a busi ness. The cost of capital in such a business, if it be considered one, far outweighs other costs. If the business consisted of conducting a single apartment house, the management probably could not advantageously expend enough in maintenance to cover the full amount of depreciation. If the case were that of a large corporation owning and operating a considerable number of apartment houses, it might conceivably consider some new con struction as essentially in the nature of main tenance, and amply provide for depreciation in that way out of earnings.