This section is from the book "Business Finance", by William Henry Lough. Also available from Amazon: Business Finance, A Practical Study of Financial Management in Private Business Concerns.
The special problem that we have just been considering - the problem of converting current assets into cash - comes up in nearly all lines of business, and in many different forms. While it is not necessary to consider all possible variations, one problem in this field which is somewhat peculiar and which is also illuminating, may be described. The problem can best be stated in the words of the man who is facing it:
I am engaged in a paving contract for the city of .... payment for which is given to me, not in cash, but in special tax bills issued against the property along the streets that are being paved. These tax bills are evidence that an assessment has been levied against the property.
They are delivered to the contractor who may make his own collections on certain conditions; or the tax may be paid to the City Treasurer who will transmit it to the owner of the tax bills. The bills bear 7% interest after maturity. In case of non-payment, the owner of these tax bills must, at his own expense, bring suit within two years and, inasmuch as the tax bills take precedence over everything except general state, city, and county taxes, may readily enforce collection. However, suit cannot profitably be instituted until toward the end of the second year, and many property owners who are aware of this fact allow them to run throughout nearly the whole period. The average length of time before the tax bills are paid is about five months.
These tax bills are not readily salable either to bankers or to investors; although they are exceptionally well secured and draw 7% interest, the time of payment is so uncertain that no one desires to have his money tied up in them unless he is compensated by an exceptionally heavy discount, which usually amounts to 10%.
On the other hand, in my contracting business I need to turn over capital quickly, and find that tying up money in these slow bills cripples my capacity to handle work.
Here is a problem that is unusually difficult because of the non-commercial character of these tax bills, and also because of their uncertain maturity. It was suggested that the only solution in this case is to use the tax bills as collateral for notes either to be discounted at banks or to be sold to private investors. It would be necessary that the arrangement as to collateral should be sufficiently elastic so that as rapidly as some of the bills were paid off, others would be substituted. The contractor would then be able to give his personal notes of a definite date of maturity and, in case the tax bills were not paid with sufficient promptitude to meet the notes, he would then have left the recourse of selling the remaining tax bills at a heavy discount, thus enabling him to take care of his own notes. At the worst, this method should be less expensive than the usual method of selling the notes outright. Unless there were some unexpected failure on the part of a number of taxpayers to meet their obligations, the contractor would probably be able to borrow funds required in his business at no more than the usual bank discount rates. It is understood that this suggested course of action has been followed and that by this method of converting some of his current accounts into cash the contractor has been able to proceed with the normal development of his business.