The chapters preceding have dealt with such subjects as the financial forms of business enterprises, the various types of shares and of obligations that may be issued, the selection of securities that are adapted to all the needs of the corporation and to the security market, the construction of a correct financial plan, the promotion and initial financing of a new enterprise, the various methods of selling securities and thus raising the capital required, and the principles which determine the investment of that capital in fixed and in working assets. This completes our study of the various stages in the creation and financial organization of a concern. The remaining chapters deal with the management of companies that are already established and with the exploitation and reorganization of companies that are unfortunate or mismanaged.

The first questions that arise in the financial management of a going, profit-making concern have to do with the determination and distribution of its income. The determination of income may be regarded as primarily a problem of accounting, but it is also a financial problem. As was pointed out in Chapter I, the line of distinction between financial and accounting questions is not always to be sharply drawn. We will not be trespassing, then, on the exclusive territory of our friends, the accountants, if we take up for brief review the question of how corporate income is and should be determined.

For purposes of illustration the following two statements of income are reproduced. The first from a recent report of the American Locomotive Company is in the following form:

Gross Income...........

$29,987,438

Operating Expenses, Including Manufacture, Maintenance, and Administrative Expenses and Depreciation charge................

27,425,187

Net Income...........

$2,562,251

Interest, Taxes, and Other Fixed Charges..................

486,124

Surplus for the Year.............

$2,076,127

Preferred Dividends...............

1,750,000

Surplus Available as Earnings on Common Stock.............

$326,127

Equivalent on Common Stock to..................

1.3%

Dividends on Common Stock...............

.............

Carried to Surplus Account............

$326,127

A much more detailed income statement is that of the Union Pacific Railroad Company, which is as follows:

Freight Revenue...........

$59,253,344

Passenger Revenue.......

18,817,047

Mail, Express, and All Other Transportation Revenue....

6,726,317

Incidental Revenue...........

2,161,587

Total Revenue...........

$86,958,295

Maintenance of Way and Structures.........

$10,900,925

Maintenance of Equipment..........

12,101,212

Total Maintenance.......

$23,002,137

Traffic Expenses............

2,061,971

Transportation Expenses..........

23,108,140

Miscellaneous Operations Expenses..........

1,313,189

General Expenses............

2,811,421

Transportation for Investment - credit...........

160,143

Total Operating Expenses.............

$52,136,715

Taxes............

4,641,474

Total Operating Expenses and Taxes..........

$56,778,189

Revenues Over Operating Expenses and Taxes............

$30,180,106

Other Operating Income............

1,276,138

Total Operating Income.................

$31,456,244

Fixed and Other Charges..............

15,028,285

Surplus from Transportation Operations After Deducting all fixed and other charges...............

$16,427,959

Income from Investments and Other Sources............

11,964,064

Total surplus.....................

$28,392,023

Less Dividend on Preferred Stock at 4% Per Annum...........

3,981,740

Surplus After Deducting Dividend on Preferred Stock.......

$24,410,283

Equivalent on Common Stock to...........

10.98%

Amount Required to Pay Dividend on Common Stock at

Rate of 8% per Annum..................

$17,783,328

Surplus After Deducting all Fixed and Other Charges and Dividends on Preferred and Common Stock......

$6,626,955

The above examples show the essential steps in calculating income, which are as follows:

1. State gross earnings.

2. Deduct operating or manufacturing expenses, including selling, administrative, maintenance, and depreciation.

3. The result is net earnings from operation.

4. Add income from other sources.

5. The result is total net income.

6. Deduct taxes, interest, rentals, sinking fund charges, and other fixed charges.

7. The result is surplus for the year applicable as earnings on shareholdings.

8. Deduct preferred dividends.

9. Deduct common dividends.

10. The result is surplus from the year's operations to be credited to surplus account.

It seems hardly worth while to point out that income and expenditure are by no means identical with cash receipts and cash disbursements, though this elementary distinction is not always grasped, even by learned judges and lawyers. It has been pointed out, for instance, by an English authority, that among the legal judgments which have been delivered in the courts of the United Kingdom are such absurdities as the following: *

Profits for the year, of course, mean the surplus in receipts after paying expenses and restoring the capital to the position it was in on the 1st of January in that year.

Fixed capital may be sunk and lost and yet the excess of current receipts over current expenses may be applied in payment of a dividend.

It has been only a few years since the Attorney-General of the United States interpreted the law imposing a tax on corporate income, which had just been passed by Congress, as meaning that a tax had been imposed on the cash receipts minus cash disbursements. His decision was promptly overruled, but among accountants it has not been forgotten.