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 history of the Westinghouse Electric and Manufacturing Company offers some of the clearest and most striking illustrations of the necessity of using care in the investment of capital funds, and especially of the advisability of keeping on hand an ample supply of working capital. The illustrations are especially apt, because this company has always carried on an extensive and profitable business and, so far as industrial processes go, has been conspicuously well managed. Yet it became financially embarrassed in 1890, and again in 1907, both embarrassments being the direct result of rapid expansion of business, leading to a large investment in fixed assets and a relative diminution of working assets.
When it was realized by the officers of the company in 1890, that the steady growth of the business was leading to a dangerous financial situation and larger and larger current obligations which could not be met were piling up, it was decided, as an emergency measure to increase the stock from $5,000,000 to $10,000,000 and to offer the additional $5,000,-000 to previous shareholders at the bargain price of $40 a share. Radical proposals of this kind, being obviously intended to relieve pressing demands, naturally arouse distrust. The net amount realized by the company from this sale was only about $1,400,000, which was not enough to create an adequate working capital. In fact, the situation rapidly became worse. In the summer of 1890 the company had outstanding about $2,000,000 of notes covering merchandise purchases and bank loans. By the early part of 1891 the floating debt had become $3,300,000. A financial reorganization, with its attendant frictions and losses, was then recognized as inevitable.
After the reorganization of 1891 the company continued to expand its business and as a result continued to meet serious financial problems. These problems were not wholly the outgrowth of internal development, but were in part a necessary feature of the electrical industry as a whole. The progress of electrical invention required continual and extensive investment of capital for generating stations, transmission lines, and electrical machinery. Throughout the country small lighting, power, and traction companies were endeavoring to sell their securities, frequently without much success. Yet, it was evident that their projects in most cases were sound and it seemed to be necessary for the Westinghouse Company, in order to keep up and develop its sales, to assume a portion of the burden of financing its customers. This it did by accepting in payment for equipment the notes of these local companies, generally secured by a deposit of their bonds and stocks as collateral. The Westinghouse Company then relied on discounting these notes, which in normal times could readily be arranged for. At periods of credit restriction, however, the notes became unmarketable and the Westinghouse Company itself was hard pressed for funds with which to meet its own obligations.
Between 1891 and 1907, this growing problem was successfully solved by repeated sales of capital stock. In 1896 the authorized capital was increased from $10,000,000 to $15,-000,000, and in 1901 from $15,000,000 to $25,000,000. At the same time, the company was putting out several million dollars of collateral and debenture bonds. Nevertheless, notes payable grew steadily until they aggregated $5,000,000 in 1901, and $14,000,000 in 1905.
Dewing has calculated this company's ratio of current liabilities to current assets, of current assets to total assets, and of current liabilities to total liabilities, for a number of years, as follows:*
Current Liabilities to Current Assets
Current Assets to Total
Current Liabilities to Total Liabilities
Feb. 29, 1892
Mar. 31, 1894
Mar. 31, 1897
Mar. 31, 1901
* Dewing's "Corporate Promotions and Reorganizations," pp. 165, 200.
Mar. 31, 1902
Mar. 31, 1903
Mar. 31, 1904
Mar. 31, 1905
Mar. 31, 1906
Mar. 31, 1907
Oct. 31, 1907
When the company was finally compelled in 1907 to confess its inability to meet current obligations and a receiver was appointed, it was at once agreed on all sides that the prime cause of the failure was the lack of sufficient working capital.
There were, however, some differences of opinion as to the extent of the remedy that should be applied. The creditors were inclined to demand not only an immediate relief, but a radical change of financial policy. Mr. Westinghouse, on the other hand, did not believe that there was anything fundamentally wrong with the previous financial policy of the company and sought only to extricate it from its immediate entanglement. It was finally agreed in the interest of the creditors and of all those who were disposed to insist upon sound financing, that a new management should take the reins.
There are not many instances of large enterprises where miscalculation and recklessness in financial affairs were combined with so much unquestioned ability in handling mechanical and industrial affairs as in the case of the Westinghouse Company. Most large and successful companies have a better-balanced management. In small corporations, however, almost the same situation is frequently found. The proprietor and manager of a business, through his personal energy and resourcefulness, makes it move ahead and earn good profits. To take care of his increasing business he extends his plant or builds up his store or in some other form enlarges his fixed capital investment and fixed expenses. Thereupon he suddenly wakes up to the surprising fact that, on account of his prosperity he is pressed harder and harder for funds. Unless there is a sudden change in his methods, it is more than likely that he will drive rapidly ahead into bankruptcy. A sad and constantly recurring spectacle in business life is that of a strong man beaten into failure through his own energy and ability in producing and selling.