INVESTMENT AND MAINTENANCE OF CAPITAL 1. Gradual and efficient investment of capital funds.—Many corporations sow the seeds of their fail ure in the first year of business by the unwise invest ment of capital funds. Many others, having tasted a brief success, gradually fall into the habit of careless capital expenditure.
Upon the productiveness of the investment depends the earnings and the success of the company. Experi ence and good judgment should guide the investment of capital. Many errors to be avoided are mentioned thruout these chapters. The financial considerations governing the extent and distribution of capital in vestment relate principally to: • 1. The nature and size of the business 2. Productive capacity of assets 3. Flexibility of investment 4. Organization expenses and losses 5. Sufficiency of initial capital 6. Ability to interest additional capital as required.
Naturally the capital is invested in assets that are 206 appropriate to the business from the viewpoint of its size and scope. A large trunk-line railroad, for in stance, would be likely to buy heavier locomotives than a small branch.
The productivity of assets is equally important. In certain districts and certain lines of business, for example, the motor truck may be economically em ployed for heavy hauling, but under other conditions horse-drawn vehicles are best.
The flexibility of capital investment is also import ant. If the company, for instance, is to manufacture a certain specialty which is subject to rapid change in market demand, it is wise to equip the factory so that other things may be produced with the same equipment. This makes it possible to convert the capital readily from one purpose to another to meet changing conditions. The more highly specialized the equipment the less it is worth to others and the greater the reserve required against its depreciation in value.
Capital investment cannot be most effective if a large part of the original capital is consumed in or ganization expenses and in meeting operating losses during the early years. The management, therefore, is interested in seeing that all unnecessary interest and cumulative preferred dividend charges are eliminated during the period of construction and early operation.
Sufficient capital must be provided, but not an ex cessive amount or at a more rapid rate than needed.
If the amount required can be definitely estimated in advance, subscriptions may be made payable as needed. If not, an elastic plan of capitalization is re quired which will prevent either an excess or a short age of capital. As explained in Chapter II, assess able stock is unpopular and should not be issued if it can be avoided. Ventures of uncertain capital re quirements are naturally quite speculative. In such cases, unless the company is to be intentionally over capitalized, the advisability is suggested of offering common stock up to the estimated minimum require ments, and redeemable preferred stock for the balance up to the estimated maximum needs. If the demands for capital prove to be light, the preferred may be withheld entirely, or having been issued, may be re tired at a slight premium. If legitimate capital re quirements exceed the highest estimates, the excess may usually be borrowed.
The scheme of capitalization should preserve an avenue for expansion by leaving a way open for the issue of future attractive securities. If the company is profitable, or holds out good promise, this is not always difficult, unless the original investment of capital funds or scheme of capitalization has been bungled.
2. Danger of large fixed most usual mistake of an inexperienced management is excessive investment in fixed assets, with consequent shortage of working capital. Ordinarily, a business is not judged by the appearance of the building which it oc cupies, but rather by its balance sheet and earnings. Fine buildings, expensive office furniture, or special equipment will not constitute a good basis for loans and cannot easily be converted into cash. For this reason, great care should be exercised not to overin vest in fixed assets at the beginning. This mistake may often be avoided by renting at first only the necessary space and equipment. Especially is this good policy if the company begins business with lim ited capital. Permanent investment may be more safely made after the business has been established and a reasonable surplus created.