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 assets of every business enterprise fall into three natural divisions:
1. Fixed tangible assets, which are essential to the proper conduct of the business.
2. Current assets, which consist of cash and of such property as can readily be converted into cash.
3. Intangible assets, which have previously been defined as the capitalization of the earning power which cannot be attributed to the other assets.
There is a relation between these classes of assets and the security issues of a corporation, which may be stated in the following form:
The actual value of fixed assets (not merely the book value) should exceed by at least 25 to 50% the bonded obligations outstanding.
The actual value of the fixed assets, plus the value of net current assets (after deduction of current liabilities) should at least equal, and generally considerably exceed, the outstanding preferred shares, income bonds, or other contingent obligations.
The actual value of tangible assets, plus that of intangible assets, should equal or preferably exceed, the combined value of fixed obligations, contingent obligations or shares, and common shares outstanding.
Quite a large number of industrial corporations have followed the principle of issuing bonds and preferred shares up to the net value of their tangible assets, and issuing common shares exactly equal to the value of their intangible assets. Cluett, Peabody and Company, the well-known manufacturers of collars and shirts, carry an account called "Good-will, Patent Rights, Trade-Names, etc," of $18,000,000, against which the corporation has outstanding $18,000,000 of common stock. The F. W. Wool worth Company, has good-will $50,000,000, and common stock $50,000,000; the Kaufman Department Stores, Inc., of Pittsburg, carries "Good-will, Trade-Marks, Contracts, and Leases" at $7,500,000, and has outstanding common stock of $7,500,000. The George A. Fuller Company at its incorporation in 1901 presented a balance sheet showing net quick assets of approximately $5,000,000 and "Tools, Machinery, and Good-will" of $10,000,000; $5,000,000 of preferred and $10,000,000 of common stock were issued.
In most other cases the correlation between the different forms of securities and the three classes of assets is not so direct and readily visible. But there is, or should be, some measure of relation. We shall find further illustrations both of acceptance and of rejection of this principle as we proceed.