A bank account of reasonable size is required prin cipally for the following purposes: 1. To maintain adequate banking and credit facilities 2. To meet periodical payrolls 3. To pay for seasonal or irregular consignments of stock 4. To pay for seasonal or extraordinary replace ments 5. To meet unusual expenses and losses, or to bridge over unusual delays in the collection of accounts.
A very small bank account would suffice, except for these irregular demands, all of which are either self evident or are elsewhere explained in this chapter.
5. Outside investment of working capital.—Work ing capital should be invested outside the business only in certain rare contingencies when earnings are subject to extreme fluctuation.
If the investment in securities is for the purpose of exercising control over another company, it can scarcely be called working capital, but is rather in the nature of a fixed or semi-fixed asset. The amount invested in subsidiaries or outside competitive re sources resembles closely the company's investment in its own plant, except that the securities perhaps may be more readily sold in liquidation than the fixed assets of the holding corporation. For this reason such securities are classed as semi-fixed assets, and are not working capital. • 6. a general sense depreciation means a decrease in value; appreciation an increase. Decrease in value may be caused by: 1. Deterioration in physical condition, due to use or corrosion 2. Obsolescence 3. Adverse business condition or declining market 4. Destruction by accident or catastrophe.
In the chapter on Amortization these factors have been quite fully discussed. Not only does all physi cal property require constant repair, but it wears out in spite of repairs and must some day be entirely re placed. Improvements in the industry may render equipment valueless, in competition with newly in vented devices which render the old equipment obso lete. Changing styles, the competition of a new or superior article, or any causes which affect the market of the product, depreciates the value of the plant which produces it. A new law may render many mil lions of dollars' worth of equipment practically use less. A prohibition amendment to the National Con stitution, for instance, would depreciate distilling and brewing machinery many millions of dollars at one stroke. Earthquakes, lightning, floods, fires, riot, or war may cause serious depreciation which is both un foreseen and uncontrollable. Of these four causes of
depreciation, all except the first are contingent or extraordinary, and cannot be closely determined or wholly guarded against by insurance.
Every part of a company's equipment or stock pre sumably enjoys a period of valuable service. The impairment of its value may be offset on the balance sheet by a depreciation reserve which makes good the loss within this period of service. It is true that good care, and prompt and expert repairs will lengthen the service, and thereby reduce the rate at which such property depreciates. It should be noted, however, that if the repairs are counted upon to lengthen the life of the asset, and the depreciation rate is adjusted ac cordingly, the cost of such repairs cannot be properly charged to the depreciation reserve, as it is to cover replacements only.
Care should be taken to distinguish between repairs, replacements and betterments. Repairs refer to cur rent upkeep. Replacement means the substitution of new equipment for old. Betterments consist of im provements which are intended to directly or indi rectly reduce the cost of production or increase pro ductive capacity. Repairs are chargeable current expense of operation. Replacements should be charged to reserves accumulated for that purpose, or to surplus. Expenditures for betterments may reach the balance sheet thru any of these accounts, or by in creasing the capitalization.
7. Rate and amount of the ac tive life or period of service of any given asset is known, or may be closely estimated, the rate of depre ciation may be had by dividing the number of years of active service into one hundred. The result is a percentage, which will, when multiplied by the cost of the machine, give the amount that should be set aside each year to provide for its ultimate replacement. This system takes no account of compound interest, but is considered accurate enough for most practical purposes. To illustrate.—If a certain machine costs one thousand dollars and has an estimated usefulness of eight years, by dividing eight into one hundred, we get 12.5 per cent as the rate of depreciation. On one thousand dollars 12.5 per cent is $125; the reserve which should be set up each year against its ultimate replacement. Repairs are in addition to this reserve, and are counted upon to maintain the machine in working order during the eight years.