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Home -> Neil H. Jacoby -> Business Finance And Banking -> Part 2 Chapter 1

Business Finance And Banking - Part 2 Chapter 1

1. Preface

2. Summary

3. Part 1 Chapter 1

4. Chapter 2

5. Part 2 Chapter 1

6. Chapter 1 - continue

7. Chapter 2

8. Chapter 3

9. Chapter 3 continue

10. Chapter 4

11. Part 3 Chapter 1

12. Part 4 Chapter 1

FROM 1900 TO 1940

Chapter 5

WITH BUSINESS: 1900-1940

CHANGES SINCE 1900 IN the relations between commercial banks
and nonfinancial business enterprises have resulted from numerous
economic tendencies. One of the most important is the shift in the
structure or composition of the economy, reflecting the fact that all
segments of the economy have not grown at the same rate. An in-
creased relative importance of industries showing a less than average
dependence on bank credit tends to weaken business demand for such
credit while, conversely, the growth of industries with higher than
average dependence on bank credit strengthens the demand. From
the point of view of this study, the significant structural changes are
those relating to the industrial and size composition of the business
population ; as indicated in Chapter i , these changes directly affect
the demand by business enterprises for credit.


Changes in the industrial composition of the American economy
appear to have been such as to prevent bank credit to nonfinancial
business from sharing fully in the growth of the whole economy.
This is certainly true of developments after World War I. A break-
down of national income by major industrial divisions for the
period 1919-38 reveals marked declines in the relative importance
in the economy as a whole of agriculture and manufacturing as
sources of income; somewhat less significant declines in mining and
construction; and definite increases in the service industries and
government (Chart 12). Data covering the distribution of gross
national product by industrial origin also reveal that the relative
importance of manufacturing and agriculture decreased after
the service trades,
which despite their growth are a minor element in the business
credit market. Industrial divisions like transportation and other
public utilities, which held their own over the period, were sig-
nificant borrowers only in the open market and were interested
primarily in long-term rather than short-term funds.

Since most of the data bearing on changes in industrial composi-
tion go back only to 1919, it is difficult to be certain whether the
shifts were movements that set in after World War I or were con-
In general, the manufacturing industries that made the greatest
strides between 1899 and 1937 in their relative contribution to
total manufacturing output were those that in 1937 were the least
dependent on bank credit for the financing of assets.
tinuations of changes that were operating before the war. There is
some evidence, however, which leads to the following conclusions:
first, that the shifts in the relative importance of agriculture,
government and, in all probability, service industries began prior to
World War I, and, second, that the declining importance of manu-
facturing was mainly a postwar phenomenon reflecting the read-
justment of production from the high level of output elicited dur-
ing the war by the needs of the military services. In any event, the
fact that the changes cited occurred in the period after 1919 is
sufficient for this study, since it was only after 1919 that the growth
in direct bank loans to business was interrupted.

Paralleling changes in the relative importance of the main indus-
trial divisions of the economy were changes in the relative contri-
bution of selected manufacturing industries to total manufacturing
output (Chart 13). The significant fact about these data is that, in
general, the manufacturing subdivisions which showed the greatest
percentage increase in output-contribution after 1899 were among
those industries that relied least on notes payable for the financing
of their assets. On the other hand, the manufacturing subdivisions
that tended to depend most heavily on banks for their financing
showed only a moderate rate of expansion, or even some decline.


As pointed out in Chapter I , the small and medium-sized concern
provided the major market for bank loan credit around 1940.
Doubtless the demand from this size group of enterprises was even
greater in 1900, and, therefore, it is of interest to ask what hap-
pened to the average size of business concern between 1900 and
1940. Over these years a decreasing proportion of the number of
business concerns was accounting for an increasing proportion of the
total volume of production and trade. For part of this period,
1923-27, this is indicated by the fact that sales of a sample of large
manufacturing and trade corporations increased 67 percent while
the value of product of all business enterprises increased only 6 per-
cent. 1
For each major type of business, corporations with assets of $5 million
and over comprised a larger percentage of all corporations with bonds
outstanding in 1939 than they did in 1900.

Other evidence regarding changes in the size composition of
business during this period is more indirect. Of the relevant and
available information, the most comprehensive and useful is that
relating to the sizes of concerns having corporate bonds outstand-
ing in 1900 and 1939. These data reveal a shift toward larger
average size in each of the major industrial divisions (Chart 14).
The real changes that occurred may have been greater than indi-
cated, however, since the data are probably more representative of
the small and medium-sized concern in 1940 than in 1900.

A shift toward larger size in business enterprises is indicated also
by data based on a sample of business listings drawn from the


Reference Book of Dun s? Bradstreet, Inc., for 1900, 1920, and
1940, showing what percentage of the total number of concerns had
net worth in excess of $200,000, and by data prepared for the
Temporary National Economic Committee, giving percentage dis-
tributions of establishments in 1914 and 1937 according to the
number of wage earners employed. The Dun & Bradstreet data
(Table 10) reveal a shift toward larger average size between 1900
and 1 940 in every industrial division except wholesale trade, with
the shift particularly marked for manufacturing and mining con-
cerns, two categories which are of major importance in the total de-
mand by business for credit. The tendency for the average size of
wholesaling concerns to decline is especially important, since this is
the one type of concern for which dependence on bank credit in-
creases in relative importance as asset size increases.

The TNEC data reveal that establishments employing fewer
than twenty-one employees constituted 73.6 percent of all establish-
ments in 1914 and 69.2 percent in 1937. In the field of retail trade
notable changes were brought about by the growth of mail-order,
chain, and department stores. These types of merchandising were of
negligible importance at the turn of the century 5 by 1935, however,
chain stores, for example, were making nearly one-fourth of all
retail sales, selling over a third of the groceries, half of the shoes,
and over nine-tenths of the variety goods.
From this scattered evidence, and from the relationships ob-
served in Chapter i namely, that larger concerns are in general
less dependent on banks for credit than are smaller concerns it
may be concluded that business demand for credit in general, and
for bank credit in particular, was weakened in the period 1900-
1940 by shifts in the distribution of nonfinancial businesses by asset
size classes.


Changes after 1 900 in the asset structure of nonfinancial business are
of significance, since (as pointed out in Chapter i) the types of assets
held by a business enterprise strongly influence the amount and kind
of funds which the management uses for financing. Unfortunately,
data on assets for business as a whole do not exist back to 1900, but
several samples of corporation financial statements have been
assembled extending back to 1900, 1914, or 1916. These samples
cover (i) large manufacturing and large trade enterprises, (2)
small and medium-sized manufacturing and trade concerns, and
(3) a combination of large manufacturing and trade concerns
termed an "industrial" group 5 2 other tabulations are for public
utilities and railroads. Findings based on a study of these samples
will be stated here in a general manner, indicating the broad char-
acter of the changes that occurred in assets and the relation of these
changes to credit demand.

Fixed Assets*

In general, a tendency for fixed assets to grow in relation to total
assets would be expected to produce a shift in favor of long-term

8 The sample data for large manufacturing and trade corporations are described in
Albert R. Koch, op. cit. y pp. 10-15, and Charles H. Schmidt and Ralph A. Young, The
Effect of War on Business Financing; Manufacturing and Trade, World War I (Na-
tional Bureau of Economic Research, Financial Research Program, Our Economy in
War, Occasional Paper 10, November 1943) Appendix A. For information covering
the large "industrial" group and small and medium-sized concerns, see footnotes 5 and
6, below.

8 There is, of course, no escape from the fact that on the asset side of the balance
sheet the valuation of fixed assets may reflect more closely accounting conventions than
financial conditions j nor equally the fact that the element of arbitrariness which this
involves is reflected among business liabilities in the net worth item. While it surely is
wise to view data on fixed assets and net worth with reserve, it is nonetheless possible to
utilize these data to increase our understanding of the financial process and particularly
of the changing role in business financing of funds acquired on a debt basis.
For large corporations, the marked rise in noncurrent assets, consist-
ing primarily of fixed assets and investments in other companies, from
World War I to the thirties served to place increasing emphasis on
long-term financing. The greater liquidity of corporations as meas-
ured by the proportion of assets held in the form of cash and market-
able securities also affected the demand for funds.
as against short-term financing. What is the evidence with respect
to this matter?

Fixed assets of both large manufacturing and large trade con-
cerns during the twenties showed a marked tendency to grow in re-
lation to total assets, and subsequently declined from the level then
attained (Chart 15). An analysis of large manufacturing concerns
by industrial groups reveals that in most cases the trend was much
like that for all groups combined; only in a few industries par-
ticularly food manufacturing did fixed assets tend to become less
important during the twenties. It is especially notable that the
petroleum industry, which was one of the most rapidly growing
segments of the manufacturing economy, showed marked increases
in its proportion of fixed to total assets.

At least during the years from the end of World War I to the
early thirties, the effect of an increase of considerable magnitude
in the relative importance of fixed assets was probably to shift the
focus of interest from short-term to long-term financing. 4 How-
ever, there is no basis for concluding that it also strengthened the
demand for long-term debt relative to the demand for equity
Greater bank indebtedness of small and medium-sized corporations, com-
pared with large corporations, after World War I may be explained in
part by the marked differences between the two groups in changes in as-
set structure.

The fixed asset component of public utilities showed virtually no
change over the period, and that of railroads increased only mod-
erately. In view of these facts it is likely that the changes in the de-
mand for credit by public utilities and railroads, compared with
demands from other businesses, were due primarily to the relative
growth of public utilities and railroads within the economy as
a whole. An implication of this relative growth is that the average
ratio of fixed assets to total assets for the whole economy was raised,
thus tending to promote a shift toward the use of long-term funds.

Investments in Other Companies

Investments in other companies (as distinct from marketable
securities) are asset items that a company would be expected to
finance with long-term funds. It is significant, therefore, that
among large manufacturing corporations investments in other con-
cerns grew rather steadily throughout the entire period studied,
increasing from around 5 percent of total assets in 1914 to about
10 percent in 1940 (Chart 15). This is also true of various manu-
facturing subgroups, and, from 1920 to 1930, of large trade com-
panies. For a sample of small and medium-sized Wisconsin manu-


facturing concerns, investments (which in this case include market-
able securities) rose fairly steadily in relative importance from 1916
to 1935, but those for the small and medium-sized trade concerns
remained about constant. Thus the tendency for business concerns to
hold investments in other companies, reflecting the growth of the
business concern as a financing agency as well as the consolidation
movement of the period, increased after 1914, and was especially
marked during the twenties. As in the case of fixed assets, this tend-
ency served to place increasing emphasis on long-term financing.

Total Concurrent Assets

In order to obtain a measure of what may be termed total "non-
current" assets, fixed assets may be combined with investments in
other companies and with the relatively small item "other noncur-
rent assets." Ratios of noncurrent to total assets for samples of large
manufacturing and trade concerns are available for the period from
1914 to 1940, and for a sample of large industrial corporations be-
ginning in 1900. These data suggest an important conclusion,
namely, that for most of the period from 1900 to 1932 total bank
loans to business moved inversely with the ratios of noncurrent to
total assets; during the twenties both bank loans to business and the
ratios of noncurrent to total assets were nearly constant. This rela-
tionship between the asset structure of business and outstanding
bank loans to business reflects the broad causal connection between
the character of business assets and the types of funds which have
been used in their financing.

Cash and Marketable Securities

Since the demand for financing facilities is affected by the holding
of cash and its equivalent (i.e., marketable securities), considerable
significance attaches to the changes between 1900 and 1940 in this
measure of business liquidity. The analysis is complex, however,
and can best be presented as changes that took place in three aspects

6 The sample for large industrial corporations is a changing sample based on large
manufacturing and a few large trade corporations taken from Moody's Manuals.
Because of the changing composition of the sample, the median of individual com-
pany ratios is used for the analysis of the sample of large industrial concerns, rather
than a ratio of aggregated balance sheet items which is used in the analysis of other
samples of large manufacturing and trade corporations.


of the cash position of corporations: the ratio of cash to total assets;
the relation between cash holdings and the volume of transactions
calling for the use of cash (which determines whether a business has
"free" cash) } and the role of the cash account in supplying and ab-
sorbing funds for corporate enterprises during periods of expansion
and contraction.

Over the period 1900 to 1940 the ratio of cash to total assets for
the sample of large industrial corporations tended generally up-
ward, with the rise particularly marked after 1937 (Chart 15).
For samples of industrial subgroups of large manufacturing con-
cerns, which extend from 1914 to 1940, it is found that in certain
cases e.g., tobacco, textiles, and meat packing the ratios of
cash and its equivalent changed very little; in other cases e.g.,
automobiles, chemicals, food, and machinery the ratios rose
fairly steadily. Among large trade corporations the trend was gen-
erally upward after 1916. On the other hand, small and medium-
sized Wisconsin manufacturing and trade concerns showed no
strong tendency to hold an increasing proportion of their assets in
the form of cash (Chart 16).

A tendency for concerns to hold "excess" amounts of cash, if it
did prevail, clearly would suggest a weakening demand for external
funds. Examination of the relation between cash holdings of cor-
porations and the volume of transactions calling for the use of cash
reveals that "(i) in the twenties transaction needs appear to have
determined the level of cash balances of large manufacturing cor-
porations, if year-to-year fluctuations are neglected . . . (2) in the
thirties a large part of the cash balances of large manufacturing
corporations was *f ree j cash an increasing part in recession and a
decreasing part in expansion, (3) for medium-sized and small
manufacturing corporations, 'free' cash increased after 1929, but in
relation to transaction cash it was not so great as in the case of large
manufacturing corporations." 7

Finally, it is found that the process of accumulation and deple-
tion of cash by business concerns is significantly related to their use
of outside funds. The data indicate that during periods of business
contraction in the thirties, when ratios of short-term debt to total

7 Friedrich A. Lutz, Corporate Cash Balances, 1914-43: Manufacturing and Trade
(National Bureau of Economic Research, Financial Research Program, 1945) p. 50.
For description of method of estimating "free" cash, see Lutz, pp. 40-41.


assets were low, large companies could hardly avoid accumulating
large cash balances, since even a modest rise of the cash ratio was
sufficient to provide the means for extinguishing debt. For these
companies the only alternatives to cash accumulation during periods
of contraction were retirement of long-term debt and the disburse-
ment of unearned dividends.

As a result of cash accumulation, a subsequent increase of sales
could be handled by a transformation of cash into inventory and
other assets. Only when activity had risen to a level at which an ex-
pansion of assets was required, and even then only when asset expan-
sion was prolonged and at a high rate, was substantial recourse to
outside sources of funds essential. Thus, if the depression were
severe and the contraction of operating assets led to very large
accumulations of cash, the effect on the demand for short-term
credit would be prolonged as well as immediate. In some such
fashion the depression of the early thirties served not only to reduce
the demand for bank credit during the contraction years but limited
the demand for credit during the subsequent expansion below what
it would otherwise have been.

The cash holdings policy of small and medium-sized concerns, at
least as illustrated by the sample based upon Wisconsin corpora-
tions, was quite different. Since corporations of this size group had
ratios of notes payable to total assets that were higher than those of
large concerns, a greater transformation of noncash into cash assets
was required before any ultimate increase in the ratio of cash to
total assets could take place. As cash was released from operating
assets during a period of business contraction it was used to retire
debt and, therefore, the concerns were more needful of outside
financing facilities when an expansion of assets was called for. The
general result was that small concerns were, relatively speaking,
both more heavily and more persistently indebted to banks than
were the large concerns.

Trade credit used by manufacturing and trade enterprises was
far less affected by varying cash conditions than was bank credit.
The use of trade credit seems to have been determined almost auto-
matically by purchases. This relative immunity to cash conditions
partly accounted for the fact that trade credit was a more persistent
element than bank credit in the short-term debt structure of manu-
facturing and trade companies.



On the whole between 1914 and 1940, the structural and proce-
dural changes in American business affecting receivables were such
as to weaken the demand for short-term bank credit to busi-
ness. From 1914 to 1920 an expanding volume of business and
sharply rising prices caused receivables of large corporations to in-
crease relative to total assets, and encouraged the greater short-term
bank financing which marked this period. The deflation of the
receivables item in 1921-22 coincided with declining business bor-
rowings from the banks. And, finally, the failure of receivables to
grow commensurately with other business assets during the twenties
was doubtless a significant factor in preventing bank loans to busi-
ness from rising appreciably during that period of general economic
and financial growth. As indicated in Chart 17, the only receivables
to total assets ratio showing a tendency to advance during the
twenties is that for small and medium-sized trade concerns. A fur-
ther point of interest is that throughout the entire period studied
the relative importance of receivables among assets was greater for
small and medium-sized concerns than for large companies.

The ratio of sales to receivables reflects the same general struc-
tural change in business assets as does the ratio of receivables to total
assets} the sales ratio, however, has the advantage of being a direct
measure of the increasing tendency for sales to be made on a cash
basis. For large manufacturing concerns the period 1920-37 was
one during which cash selling (or sales on increasingly shorter
credit terms) became more extensive, especially in the early part of
the period when readjustments were being made following World
War I. For large trade companies the ratio rose sharply during the
early and middle twenties and then declined between 1927 and
1940, reflecting greater extensions of consumer credit. Further-
more, within this size group those industries whose financial growth
was most marked either evidenced an especially strong tendency
toward a higher ratio of sales to receivables or held persistently to
a ratio considerably higher than that characteristic of industries
growing less rapidly.
For large manufacturing corporations especially, receivables tended
to become less important relative to total assets during the twenties,
and sales volume tended to generate fewer receivables. Inventory as
a proportion of total assets for this group showed little over-all
change, while for trade corporations the relative importance of in-
ventory increased somewhat. For the period as a whole no change
in the turnover of inventory is apparent, but during the twenties in-
ventory was used with increasing efficiency by both groups.


nonfinancial business. For large manufacturing corporations, inven-
tory as a proportion of total assets showed little over-all change
between 1914 and 1940, although some decline did occur in the
twenties and early thirties (Chart 17). The situation was different,
however, for large trade concerns j in this case the relative impor-
tance of inventory grew somewhat during the whole period, and
markedly in the twenties and again in the middle thirties. As for
small and medium-sized concerns in both manufacturing and trade,
the ratios were distinctly lower at the end of the period than at the

The quantitative degree to which this structural change in assets
influenced the business credit market cannot, of course, be assessed
definitely. But it is clear that a reduction in the relative importance
of the current asset most closely linked to the use of short-term
credit would tend to produce a decline in the requirements for
short-term financing. Stated differently, the decrease in the rela-
tive importance of inventory, together with changes in other asset
items, doubtless prevented short-term bank credit from sharing
fully in the business expansion of the twenties.

Confirming these findings are ratios of sales to inventory, which
reflect the efficiency of inventory use (Chart 17). In nearly all
branches of manufacturing the efficiency with which inventory was
used increased somewhat during the twenties, but when ratios for
the beginning and the end of the period 1915-40 are compared
there is no indication of long-term improvement. Among large
integrated trade concerns there was no tendency toward increased
efficiency in the use of inventory during the twenties, with the excep-
tion of large department stores.


During both World War I and the period of continued price in-
crease ending in 1920, changes in the asset structure of business
such as a declining proportion of fixed to total assets and increasing
ratios of receivables and inventory to total assets and to sales
clearly strengthened the demand for short-term credit which oc-
curred at that time. Asset changes from 1920 to 1922, also respon-
sive to reductions in the price level, contributed to the short-term
debt liquidation of those years.


The fact that bank loans to business did not increase in the expan-
sionary period following the price decline after World War I may
also be explained in part by certain structural changes in business
assets. Fixed assets grew in relative importance, while the assets
normally associated with the use of short-term funds, namely,
inventory and receivables, became relatively less important ele-
ments in the business asset structure. That these changes were
especially marked in the industries which were growing most
rapidly, thus affecting the average asset structure of the economy
as a whole, further enhanced their effect on the demand for short-
term financing.

Finally, while the decline in short-term credit which began in
1929, and the increase that followed during the recovery of the
middle thirties, were dominated by cyclical changes in economic
activity, changes in asset structure also contributed to changes in
the demand for credit by business during those years. This fact
is indicated by the increase during the early thirties in the amount
of "free" cash holdings, and by the continued decline in the ratio
of inventory and of receivables to total assets. Likewise the re-
covery of bank loans to business after 1935 seems to have been
affected by asset-structure changes calculated to promote the in-
creased use of short-term funds.


The liability structure of nonfinancial business that is, the divi-
sion of business liabilities into net worth and debt, and of the latter
into various classes of debt reflects all forces influencing the
financing policies of business. Among these forces are changes in
asset structure, discussed above, and also changing preferences on
the part of business management as to financing methods, which
may be quite independent of changes in the character of the assets
to be financed.

Net Worth

The outstanding feature of corporate financial structure in the
entire period 1900 to 1940 is the preponderance of ownership funds
increase was followed by a decline through 1940. These findings,
in general, are confirmed by other samples of financial statements
(Chart 19), and by the industrial subdivisions of these samples.
To be sure, the tendency for equity funds to increase in rela-
tive importance during the twenties was sharper in some indus-
tries than in others. The rise was especially evident for concerns
in meat packing and tobacco and to a mild extent for machinery
manufacturers, but an increase did not occur among companies in
the building materials, rubber, and petroleum industries. For these
industries the failure of equity to show any noticeable growth in
importance may be attributed, to a great extent, to the fact that it
had already reached a higher than average level. For large trade
companies the decline during World War I was much more marked
than for large manufacturing companies and it continued until
1920$ but after the sharp deflation of current liabilities in 1921-22
there was a growth in the importance of equity funds, although it
was somewhat less for large trade than for large manufacturing

Data on the liability structure of small and medium-sized Wis-
consin concerns, taken as a whole, indicate an upward drift in the
percentage of equity funds to total assets among trade concerns and
a downward drift among manufacturing companies. This attrition
of net worth shown by manufacturing concerns is confirmed by data
for a sample of Massachusetts corporations of small and medium
size and by TNEC data for small and medium-sized concerns in
five manufacturing industries over the years 1926-36. The impor-
tance of this development to credit extending institutions is
heightened by the fact that the level of the ratio of net worth to
total liabilities for small and medium-sized concerns is persistently
below the level characteristic of large concerns.

Among railroad and public utility companies, where equity
funds have traditionally been less important than long-term debt
funds in comparison with other industrial groups, the role of
equity funds increased after the end of World War I. The change
was not marked, however.

At least for large industrial corporations, the corporate financial
history of the first half of the forty-year period under review was
significantly different from that of the second half. In the first
twenty years, broadly speaking, large manufacturing and trade
concerns financed an increasing, though always modest, proportion
of their total assets with borrowed funds (Chart 18). While this
increase in debt was not continuous and was confined within rela-
tively small limits, the direction is nonetheless clear. From 1920
until the early thirties the general drift of the ratio of debt to total
liabilities was downward, reflecting the increase in the relative
importance of equity funds commented on above. After 1932 the
tendency for debt to increase was most noticeable for accounts pay-
able and "other" current liabilities.

Among small and medium-sized trade concerns there was also a
general tendency for the relative importance of debt to contract
after 19205 but for small and medium-sized manufacturing cor-
porations the importance of debt relative to equity showed a fairly
persistent rise from 1916 to 1940, a fact which is in sharp contrast
to the results for other sectors of the business economy.

The implications of these facts for the business credit market
are clear. In the first twenty years of the century the demand for
debt funds was promoted by two expansionary forces: first, the
growth of the economic system as a whole, and second, the tendency
for business management to rely increasingly on debt funds in
financing assets. From 1920 to the early thirties, on the other hand,
the opposite was true: not only did the rate of growth of the eco-
nomic system moderate considerably, but debt became a less
important element in corporate financing.

Within the general category of debt, what changes occurred in
the relative importance of short-term and long-term debt and,
within the limited category of short-term debt, between notes and
accounts payable? For the sample of large industrial companies,
which is heavily weighted by manufacturing concerns, the ratios
of both long-term and short-term debt to total assets increased from
1900 to 1914, although the course of the former was the more
erratic. During World War I the short-term debt element gained
considerably while long-term debt was reduced, a development


that would be expected in view of the financial problems of war
production} while in the twenties and early thirties the ratios of
both elements to total assets declined. 10

The ratios for the two categories of short-term debt i.e.,
notes and accounts payable which may be taken to be broadly repre-
sentative of bank credit and trade credit, respectively increased
between 1900 and 1920, with that for notes payable rising the more
sharply, to a level above accounts payable. In the declines that
occurred during the debt deflation of the second twenty years of the
century, notes payable fell to, and remained at, a lower level than
accounts payable.

At several points in the analysis of the 1940 business credit mar-
ket, in Chapters I and 2, it was remarked that accounts payable
represented a far more frequent and quantitatively important form
of business financing than did notes payable. The data in the
present chapter reveal that this has always been a feature of large
manufacturing and trade corporations and probably also of small
and medium-sized concerns. Our materials at present are so limited,
however, that it is impossible to say what proportion of trade credit
is substitutive for some other form of financing, and what part
merely reflects the fact that it is convenient and conventional for
business concerns to buy merchandise on open account, with the
result that even though concerns take up these accounts promptly
there is always a substantial "float" of trade debt in the business
system. For a thorough understanding of the business credit mar-
ket, more detailed data are essential on trade credit, and on its rela-
tion to other forms of asset financing at different times and for
different types of concerns.

Self-Financing by Business

Since the business credit market would be adversely affected by a
tendency toward financial self-sufficiency among business concerns,
any long-run changes that may have occurred in the comparative
importance of what may be called "external" and "internal" funds
are significant. The term "external" funds means those acquired

10 Among large trade concerns long-term debt practically disappeared, which
accounts in part for the difference between the sample of large industrial corporations
(including several large trade concerns) in Chart i 8 and the sample for large manu-
facturing companies shown in Chart 19.


from sources outside the business, and "internal" funds, those
acquired through the retention of corporate earnings. 11

The first observation suggested by the data in Chart 20 is that
the tendency or "propensity" of corporations to retain earnings
which may be termed the rate of earnings retention changed
very little, when measured by the ratio of earnings retained over a
given year to total assets at the beginning of the year} 12 in fact it
might be described as showing a slight downward drift. Second,
the rate of total asset expansion, measured by the ratio of asset
expansion over a given year to total assets at the beginning of the
year, was a more variable element in corporate finance than was
the rate of earnings retention. Third, since the use of funds
acquired externally is measured by the difference between these
two rates, it follows that changes in the degree of dependence on
external funds was more nearly determined by changes in the rate
of total asset expansion than by changes in the propensity of busi-
ness to retain earnings.

Manufacturing and trade concerns apparently did not become
more independent of outside financing to meet their needs for asset
expansion. On the contrary, it appears that whenever asset expansion
proceeded at a rapid, and particularly at an accelerating, rate, a
vigorous demand for external funds was generated; but this de-
mand was not sustained by the mere maintenance of a given rate
of expansion, even at a relatively high level. In the early stages
of expansion business concerns may overestimate their needs for
external financing} furthermore, in such a period it is almost cer-
tain that profits will be high and that retained earnings will increase
more rapidly than dividend disbursements.

These generalizations regarding the relation between retained
earnings and the need for external funds are broadly confirmed by
the record from 1915 to 1 940. Among large manufacturing cor-
porations, retained earnings as a source of funds for business expan-

11 Granted that in certain instances a concern may achieve a higher degree of produc-
tivity through the investment of depreciation accruals, no expansion of assets results.
Since the present study is concerned with the financing of asset expansion, depreciation
accruals are not viewed as a means of self-financing. It may be noted, however, that
gross property expenditure, inclusive of depreciation outlays (replacements), shows
a remarkably constant relationship to sales from 1924 to 1942 for our sample of
large manufacturing concerns.

12 This is the most significant measure for the present study because it relates
retained earnings directly to business assets, which comprise the quantity to be financed.


sion were most important in the twenties, since the financial prob-
lem for these concerns, as measured by total asset expansion, was
far less in the twenties than in the war years. For large trade enter-
prises, the rate of asset expansion in the late twenties was as high as
in 19 1 5-20 y consequently, in both periods these concerns showed
about the same degree of dependence on outside funds. In the
thirties, however, both asset expansion and earnings retention were
at low levels, and except in 1936, 1939, and 1940 large trade
corporations made virtually no use of funds other than those
accumulated through earnings retention.

The retention of earnings ceased to be an important source of
funds for small and medium-sized companies at the outset of the
depression in 1930. During earlier years internal funds had persist-
ently supplied the major part of the funds needed for asset ex-
pansion. In the thirties, however, these smaller companies were
using up rather than accumulating funds; outside funds acquired
were largely in the form of short-term bank borrowings.

All types of external funds shared the broad demand created by
the high rate of asset expansion during World War I. This fact
is reflected especially in the rising importance of notes payable
among the liabilities of large corporations. During the twenties
and early thirties, when the balance shifted definitely toward
equity financing, the debt funds acquired were increasingly of the
long-term variety. The experience of large and small concerns
differed somewhat. Over the whole period, 1916-40, short-term
external funds, as a means of financing asset expansion, were more
important for small and medium-sized trade concerns than they
were for large corporations. This was also true for small and
medium-sized manufacturing corporations, although for this
group long-term funds showed a tendency to increase in importance
during the twenties.

Summarizing, the business credit market during the twenties
was affected by two principal developments: first, business assets
expanded at a slower rate from 1923 to 1928 than during the
preceding war period, which meant that there was less scope for
external financing; and, second, a shift toward equity financing
occurred, especially among large concerns, which was an important
reason for the failure of bank loans to business to increase. In the
years 1929 to 1935 the dominant forces affecting the business credit
Asset expansion varied considerably more than retained earnings. As a
result, access to external funds was needed mainly in years in which
asset expansion was high.
market were the contraction of total business assets and the tendency
for contractive forces to have a greater effect on notes payable than
on other business liabilities. Following 1935 there was a reversal of
this situation ; and it is interesting to note that large manufacturing
corporations in 1937, when the rate of total asset expansion was
nearly as high as in 1929, depended as much on external sources of
funds as during any year of the twenties.


Relation of Bank Credit to Trade Credit

After the early twenties total short-term credit to business came to
consist increasingly of trade credit and decreasingly of credit ex-
tended directly by banks. Among large manufacturing companies
in the twenties accounts payable, which may be taken as a measure
of trade credit, fell less in proportion to total assets than did notes
payable. This tendency for trade credit to grow relative to bank
credit continued during the recovery years of the thirties when, as
would be expected, indebtedness on accounts payable rose more
promptly and more substantially than did the notes payable of
manufacturing concerns. The same general experience seems to have
been shared by large trade concerns, including department stores,
but not so markedly as among large manufacturing companies.

The small and medium-sized manufacturing corporations fol-
lowed fairly well the same pattern as the large manufacturing con-
cerns j that is, trade credit grew relative to bank credit. But for
small and medium-sized trade concerns the ratio of accounts to
notes payable fell during the twenties, indicating an increasing
relative dependence on bank credit as contrasted with trade supplier

As pointed out above, the importance of trade credit as an
element in corporate financial structure and the fact that it exceeds
bank credit in magnitude make it particularly unfortunate that so
little is known about its character and composition. Because of this
gap in our knowledge the remainder of this discussion must be
limited to changes in that section of the short-term credit market
represented by notes payable.


Industry of Borrower

The earliest date for which information is available on the indus-
trial characteristics of commercial bank borrowers is 1920. In that
year the Comptroller of the Currency requested all national banks
to furnish, as of November 15 ". . .a statement showing the
amount of loans and accommodations granted by them to certain
classes of borrowers arranged according to the occupation." Reports
received covered only 70 percent of the total loans and discounts
of national banks, but unreported loans presumably were not of the
types indicated in the Comptroller's classification, since banks were
requested to report on all loans in "certain classes." For comparison
with this early cross-section, commercial bank borrowers in 1940
can be classified by industry on the basis of estimates made by the
Financial Research Program (Table 1 1). Margins of error doubt-
less are present in both distributions, but they probably are not
large enough to destroy the value of the data for indicating broad
changes since I920. 18

The first major change to be noted is the decline in the rela-
tive importance of manufacturing and trade borrowers. These two
classes combined accounted for close to 50 percent of total loans
and discounts in 1920 and only about 20 percent in 1940.

Secondly, finance companies which were borrowers of negligible
importance in 1920, occupied a position of prominence in 1940,
when they accounted for nearly 9 percent of all loans. This change
is doubtless related to the declining importance of manufacturing
and trade borrowings, since cash is substituted for the receivables of
selling enterprises through finance company operations.

Thirdly, the growth of the public utility group nearly equaled
that of the finance companies; public utilities accounted for slightly
more than 7 percent of total loans and discounts in 1940, compared
with less than 2 percent in 1920.

All these changes in the composition of the borrower clientele
of commercial banks conform to the general findings reviewed
above relating to the industrial composition of the economy.

18 Both distributions include agricultural and real estate loans. Since these are not
strictly "business loans'* in the sense in which business loans have been taken for the
purposes of this study, it might be advisable to exclude them from both distributions,
but this procedure would not alter the main conclusions drawn from the distribution
of total loans as given below.

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