This section is from the "Commerce and Finance" book, by O. M. Powers. Amazon: Commerce and Finance.
The wonderful commercial progress and development of this •country during the past century has astonished the old world and amazed even ourselves. In looking about for the moving causes which have produced this great result, we must ascribe a large part to our credit system, extending as it does, to every nook and corner of the land. In no country in the world is credit so easily obtained and so extensively used as in the United States. Capital goes out freely and willingly and takes its chances in all manner of enterprises, so long as they offer fair prospects of returns on the investment. Thus the American people are educated in the use of credit, and have learned to depend upon it, until it has become closely interwoven with our commercial system. In European countries credit is more or less restricted. In Italy and Spain little credit is extended, and accordingly we see a languishing commerce. In Western Europe it is more widely used and commerce shows corresponding vigor and activity. The use of credit is not alone confined to the purchase or sale of goods on time or borrowing or lending money, but extends to innumerable acts of trust and confidence by which the machinery of the business world is kept in successful operation. A borrows money at his bank and the amount is placed to his credit. He owes B and gives a check in payment. The check is deposited in B's bank and passes through the clearing house, where it is offset by some other check of like amount, and as a result the credit is transferred from the account of A to that of B. No money or actual cash is handled in the transaction, but merely a transfer of credit. It is one incident in our credit system. Our clearing houses, stock exchanges and produce markets are all conducted on the same principle - one debt being set off against another, and a small percentage of the transaction actually liquidated in cash. All of our large corporations and their gigantic operations of both a public and private character are possible only through the medium of our credit system. Our whole commercial fabric rests upon it.
Since our credit system forms such an important factor in the problem of business management, it becomes necessary to understand and carefully use it. Losses are imperative under a credit system, and the aim must be to more than recoup for the loss by an increased volume of business. Losses in business are largely the result of carelessness, inexperience and a lack of proper system and discipline on the part of business men, or a lack of knowledge and judgment in giving credit. An experienced credit man is responsible for the assertion that "we have only to take the average business house for the last twenty years and figure up the losses sustained by it and compare the sum total, plus compound interest, with its present financial status, and we shall find that it has lost more than the capital accumulated during the period."
A lack of a prompt and effective credit department where collections are looked after carefully and thoroughly, is sure to result in a stream of losses to the house, with possible failure in the end. So extensive has the use of credit become that large commercial houses have legal departments in connection with their credit departments kept busy with the collection of accounts of delinquent customers. Often the most energetic action is necessary to obtain assets in advance of the sheriff or assignee.
From Dun's Review, New York, we have the following:
Losses Inevitable
Year. | Number of Concerns in Business. | Number of Failures. | Amount of Liabilities. | Average Liabilities. | Proportion of Failures. |
1892.. | 1,172,705 | 10,344 | 114,044,167 | 11,025 | 1 in 113 |
1893.. | 1,193,113 | 15,242 | 346,779,889 | 22,751 | 1 in 78 |
1894.. | 1,114,174 | 13,885 | 172,992,856 | 12,458 | 1 in 80 |
1895.. | 1,209,282 | 13,197 | 173,196,060 | 13,124 | 1 in 92 |
1896.. | 1,151,579 | 15,088 | 226,096,834 | 14,992 | 1 in 76 |
1897.. | 1,058,521 | 13,351 | 154,332,071 | 11,559 | 1 in 79 |
1898.. | 1,105,830 | 12,186 | 130,662,899 | 10,722 | 1 in 90 |
1899.. | 1,147,595 | 9,337 | 90,879,889 | 9,733 | 1 in 123 |
1900.. | 1,174,300 | 10,774 | 138,495,673 | 12,854 | 1 in 108 |
1901.. | 1,219,242 | 11,002 | 113,092,376 | 10,279 | 1 in 111 |
Average | 1,154,634 | 12,440 | 166,057,271 | 12,949 | 1 in 95 |
The period of time covered by this table includes the year of panic, 1893, and the depression which followed, as well as the years of prosperity at the latter part of the table, and may thus be taken as fairly representative of the average working of our credit system. Out of 1,154,634 mercantile and manufacturing firms, corporations and individuals doing business during the period, as shown by the table, 12,440 failed, or one in every ninety-five. Innumerable petty failures consisting of those whose capital is too small for a rating, are not included in these figures. The average total liabilities of the concerns failing are, in round numbers, $166,000,000. This is not a total loss, as a portion will eventually be paid. We may safely assume that not more than thirty per cent will be paid, leaving a net loss to creditors of about $116,000,000 in each year. This makes no account of the injury to trade consequent upon having such a large amount of assets tied up in litigation or pending settlement. Since thirty per cent of the liabilities are realized in cash, after the expenses of conversion of the assets, shrinkage, etc., it follows that the assets of the firms whose failures amount to $166,000,000, as above stated, probably amounted to one-half or two-thirds the liabilities, or, say, eighty to one hundred millions. The percentage of loss can only be ascertained by knowing the amount of business done. Business houses usually compute the rate of loss upon the volume of business transacted and not upon the amount of their capital, and since the capital of a concern is usually turned over several times in a year, the volume of business may be four or five times the capital invested. Without knowing the volume of business done, or the capital invested in mercantile and manufacturing enterprises, it is, therefore, impossible to arrive at the percentage of losses under our credit system, but it is apparent that, beneficial as the system is, we are doing a large amount of business not only for no profit, but at a loss of capital. It is true that within certain limits the merchant adds his percentage of losses to his selling prices, and thus the customer who pays makes good the loss occasioned by those who do not pay, but competition is constantly tending to keep prices uniform, and the merchant who makes the least of bad debts comes the nearest to a successful career, provided the volume of his business is not restricted by too much caution. To what extent credit may be extended to a buyer in any given case is a problem depending upon a combination of factors. Outside of the capital invested, assets and liabilities, is the character of the individual, the conditions surrounding his enterprise which make it a success or failure, his experience, etc., all of which must be carefully weighed by the credit man before arriving at a decision. Mr. P. E. Earling, in his book entitled "Whom to Trust," says: "On the supposition, justified by experience, that the assets of a mercantile firm, in the event of foreclosure or assignee's sale, do not bring over 65 per cent., the limit of credit, to insure us dollar for dollar, must be fixed at 65 per cent, of the inventory of the assets. In the case we have assumed, $10,000 assets would pay liabilities of $6,500, and this amount must be established as the limit, and in all cases this relative proportion should be maintained."
 
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