In connection with the preceding section, the Hendee Manufacturing Company may be cited as a typical example of American practice; this is a relatively small but prosperous, rapidly growing, and evidently well-managed corporation, which specializes in the production of motor-cycles. In the year ended August 31, 1914, this company earned profits of $711,566, out of which it paid dividends of only $131,250; a sinking fund of $150,000 for the retirement of preferred stock was also deducted, leaving the amount of profits for the year carried into the surplus account, $430,316.

By way of contrast we may take at random a well-known and well-managed English company - Harrison and Cros-field, Limited - which has been earning profits of about the same amount as the Hendee Company. During the four years 1910-1914 net profits averaged about 150,000, from which have been normally deducted:

Dividends on 5 1/2 % cumulative preferred shares.

27,500

Dividends on the 10% preferred ordinary shares.

30,000

Dividends on management shares....

30,000

to

67,500

60,000

to

25,000

However, this balance is reckoned before providing reserves for depreciation and other charges and after they have been taken out there is ordinarily remaining only a small accumulation of surplus. This is cited, not as an unusual, but as a typical, case of English practice.

Sometimes the American policy is carried to an extent which creates a remarkable disproportion between the capital account and the surplus account. The Storey and Clark Piano Company, for example, which owns fifteen retail stores, is reported to have outstanding capital of $100,000 and a surplus of over $2,000,000. The Ford Motor Company at the end of the fiscal year 1914, had capital stock of $2,000,000 and a surplus of nearly $49,000,000. However, these unusual relations are to be ascribed, not so much to an unusual amount of savings out of income, on the part of these two corporations, as to their omission to follow the usual practice of revising their capitalization from time to time to conform to the increasing assets and earnings. Most prosperous American industrials save the greater part of their earnings, but through stock dividends and other processes of "watering," their prosperity appears in the form of enlarged capital accounts rather than enlarged surplus accounts.

The Pennsylvania Railroad Company, in applying the principle that has been stated in the preceding section, has endeavored for some years to put a dollar into the surplus account for every dollar that has been paid in dividends. In other words, it aims to divide its balance of earnings, after providing for fixed charges, about evenly between dividends and surplus. During the eleven years ended June, 1913, the company maintained dividends at 6% with an occasional extra dividend of 1%. During these same years the additions to surplus as compared with capital stock were as follows:

1903

8.45%

1904

4.42%

1905

5.71%

1906

7.92 %

1907

6.76%

1908

5.91 %

1909

5.79%

1910

6.64%

1911

4.47%

1912

4.24%

1913

3.97%

In spite of the Pennsylvania's accumulating surplus and highly conservative policy the price of the stock has been in recent years seeking a lower level. This is probably due in part to general economic conditions, but in part also to the apparent belief on the part of investors that the surplus of the company, great as it is, is no more than is required to secure the maintenance of the present rate of dividends.

Railroad companies under English influence, no matter where they may be located, seldom accumulate any considerable amount of surplus. For instance, the Buenos Ayres Great Southern Railway, in 1913, out of a total available surplus for the year of 3,157,500, after paying interest and dividends, carried forward only 473,600. The next year, out of 2,891,-200 the company carried forward only 316,100. In 1913 the Buenos Ayres Great Western, out of net revenue of 1,246,500, carried forward 125,100. In 1914, out of 1,041,400, they carried forward only 47,100. The Central Uruguay Railroad, out of available surplus of 384,500, in 1913, carried forward 29,900; in 1914, out of $329,900 it carried forward 54,100. In all these cases, the railroads were paying fair to good rates of dividends on their ordinary shares.

"Rainy-Day Funds"

Some companies make it a practice to invest a portion of their saved earnings, in securities or readily salable property held outside the business, as an insurance that dividends will be maintained. This practice is much more common abroad than in this country, although not wholly unknown here. At the end of the fiscal year 1914, the directors of George Newnes, Limited, an English publishing house, proposed to carry 25,000 out of the profits of the year to a "Dividend Equalization Account" which would then amount to 50,000. It is to be presumed, though it is not so stated, that this "Dividend Equalization Account" would be represented on the asset side of the balance sheet by a surplus fund consisting of cash or securities set aside and available for quick sale in case of need. Unless there are assets available for quick realization in cash, corresponding to such a fund, it is nothing more than a name.

The great English steamship companies, which are peculiarly subject to heavy losses through the sinking of their vessels and similar accidents, have for many years made it a practice to build up surplus funds consisting of outside investments. These funds are intended as a kind of insurance against marine losses that cannot otherwise be insured, and also for the purpose of "dividend equalization".

One trouble with this policy is that it necessarily results in tying up a portion of the capital of the company in assets which yield only a small return. If the surplus fund is to be of any value for the purpose intended, it can be invested only in the best grade of marketable securities. Most companies which are prosperous and expanding do not feel that they can afford to take cash away from the business where it would bring profits of perhaps 10%, 15%, 20%, or more, in order to put it into securities that will yield at best 4 or 5%. Another objection is the fact that even this low yield does not necessarily guarantee that the company's capital put into investments will remain intact. The officials of a manufacturing enterprise are not expected to be investment specialists.

A s6mewhat striking instance is given in the record of the Boston Belting Company, a long-established and substantial New England institution, which has for many years kept up an 8% dividend on its stock. Some years ago the company received in settlement of a suit which it had brought against the City of Boston, a sum of approximately $1,000,000. Inasmuch as the cash was not needed immediately in the business, and as it was not thought best to distribute it to stockholders, it was decided to invest it in certain securities, which were then considered high-grade. These securities included 1,000 shares each of the stock of the New Haven Railroad and of the stock of the Boston and Albany, besides other shares and bonds. In 1914, as a result of the drastic decline in all securities, and especially in those which had been purchased, it was necessary to charge off over $400,000. Later an additional $100,000 was written off. It is true, of course, that the stockholders, if they had received the cash, might themselves have made exactly the same mistake and would today be in no better position financially. But the feeling exists, it is understood, that hereafter it will be better for the company to distribute whatever cash is not needed and to remain strictly a manufacturing, rather than become in part an investment, institution.

In general, American thought and practice are not inclined to favor the diversion of capital and energy away from the essential and legitimate business of a company into outside investments. It is generally agreed that regular dividends combined with large - or at least adequate - savings out of annual income should be features of the financial management of most corporations. However, this belief is based upon the assumption that the surplus thus credited is needed for the development of the business and should in fact constitute the chief source of new capital. Wherever this assumption is unjustified, the general opinion would probably favor distribution of profits even though the rate may be irregular.