Bank loans are also short term obligations which are expected to be self-liquidating and repaid when due, and to refund a trade credit out of the proceeds of a bank loan is much like jumping from the frying pan into the fire. The commercial banker is usually more exacting than the trade creditor, and any con tinued reliance upon him to supply funds for per manent investment invites calamity.
8. Trade acceptance versus the open account.—We have seen that the seller who extends credit upon promissory notes and trade acceptances is in a posi tion to convert them quickly into cash by discounting them at the bank. This keeps the seller's capital free for productive effort, enables him to do a larger busi ness by turning his capital more often, and by extend ing to purchasers longer credit than he would be able to extend out of his own limited resources. In the in tangible form of an open account, on the other hand, this trade credit could not be rediscounted at the bank. It is clear, therefore, that if the commercial banks are to do their part in financing trade transactions, the credits will have to be evidenced by tangible credit in struments, such as the negotiable note and bill of ex change. The general adoption of these instruments in trade will result in a more effective use of the credit machinery of the country. There are many sound economic reasons why the trade acceptance should supersede the open account in general use.
Resulting from the unsound practice of selling upon open account, we have evolved a system of com mercial and bank credit, based largely upon guess work, curtailing the just accommodation of smaller companies and fostering the unscientific and wasteful cash-discount system.
The trade acceptance is the principal instrument of settlement in all foreign trade and in the domestic trade of foreign countries. The foreign trade of the United States is conducted principally upon this basis, and so was our domestic trade until the disturbing in fluences which followed the Civil War led to the gen eral adoption of the open account.
9. Economic advantages of the trade acceptance.— What are the economic advantages of the trade ac ceptance over the open account? In the first place, the resumption of giving and re discounting trade acceptances would restore to the banks their proper function of financing trade credits, liberating that much of the seller's capital for other productive uses. In the second place, it would lead
to the more generous extension of credit to small de serving companies, which are often discriminated against by the present system. In the third place, it would lead to sounder and more discriminating meth ods of commercial banking by placing bank discounts upon a more self-liquidating basis, tending in turn to increase profits, lighten the reserve requirements and decrease the number of failures among commercial banks. It is common knowledge that most commer cial banks which fail are found to have a liberal share of their assets locked up in permanent loans, which would not have been possible in the discounting of two-name trade paper.
In the fourth place, the definite due date of the trade acceptance, and the knowledge that it must be paid in full when presented by the bank, would tend to prevent overbuying and other similar loose prac tices on the part of the purchaser. And lastly, the trade acceptance would tend to abolish cash discounts, since the conditions which were chiefly responsible for introducing them will then have ceased to exist.
Encouraged by the example of other countries, and the policy of the Federal Reserve system and aided by all well-informed merchants and bankers, it is not too much to predict the early and general adop tion of the trade acceptance thruout the United States. On the preceding page is reproduced a form letter typical of those which hundreds of modern concerns are sending to their customers in the effort to assist in this great and much needed reform.
10. Extent of trade credit.—The extent to which any company may safely receive trade credit depends directly upon its size, financial condition, and the na ture of its business.
Generally speaking, the amount of trade and bank credit combined which may be extended to any com pany with safety is determined by the ratio of its liquid assets to its short term liabilities. The current income should be sufficient to meet all operating ex penses and take care of such trade and bank credits as they mature. Liquid assets include everything which, within reasonable certainty, may be converted into actual cash within a few days or weeks. Cash, accounts receivable, finished stock awaiting shipment on existing orders and all other standard products or securities on hand which have a regular market for immediate sale are liquid assets.