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1 This PDF is a selection from an out-of-print volume from the National Bureau of Economic Research Volume Title: Industrial Demands upon the Money Market, : A Study in Fund-Flow Analysis Volume Author/Editor: Wilson F. Payne Volume Publisher: NBER Volume ISBN: Volume URL: Publication Date: 1961 Chapter Title: Financing Working Capital Chapter Author: Wilson F. Payne Chapter URL: Chapter pages in book: (p )

2 3 Financing Working Capital The circulation and net change of working capital and the manner in which these transactions are financed are so familiar as to require very little discussion here. Working capital as a net asset is almost invariably the group of accounts employed by accounting authors in their treatment of the "Statement of Sources and Applications of Funds." Working capital is important from the short-term lender's point of view, for it marks a fairly liquid sum which no creditor, existing or potential, can reduce for twelve months, thus restricting the lender's risks to faults of management, bad markets, and lawsuits. So much of our business thinking, in fact, revolves around this serniliquid sum that one is forced sometimes to check himself as to whether he means cash or working capital. CHANNELS OF WORKING-CAPITAL FLOWS The form in which the transactions affecting working capital are classified is given in Table 6, using company data for As in the case of cash, with working capital also it is possible to trace three main channels of flow, under the headings of operating, capital-budget, and moneymarket transactions. In operations, most of the goods sold by Allis- Chalmers in 1948 represented a conversion of inventory into cash and accounts receivable and, hence, added nothing to working capital. A portion of the plant, and certain of the deferred charges (the amount of which has been lost to view in this case and, therefore, is ignored), were the only previously existing noncurrent assets transferred to working capital. These and profits make up the $29,345, added to working capital via operations. Cash dividends of $5,193,, and a tax bill for $io,8oo,ooo due within the year, offset the receipts, leaving $13,352, as the net addition arising in operations. Nonoperating expenditures, principally for plant, absorbed $7,387, of working capital. Among the 45

3 TABLE 6 TRANSACTIONS AFFECTING WORKING CAPITAL: ALLIS-CHALMERS MANUFACTURING COMPANY, 1948 (thousands of dollars) Payments Dr. Receipts Cr. Business transactions Operating budget Net income before tax Depreciation Other transfers to or from noncurrent accounts, net Income tax liability incurred Dividends declared 1,8 5,193 26,242 3,13 15,993 29,345 13,352 Capital budget Investments and advances Plant expenditures Deferred charges Other assets 7, Total business transactions Difference Money-market transactions Notes payable, long-term Bonds Preferred stock Common stock Total payments and total receipts 7, ,387 23,43 29,368 5,965 1, 1, 1, 23,43 39,368 Effect on working capital 15,965 SOURCE: Annual reports of the company. 46

4 money-market transactions only the term loan of $1 million is entered; neither the company's purchase of marketable securities, nor its shortterm borrowing of $t5 million, altered the working capital. In all, payments of $23,43,, diminishing working capital, and receipts of $39,368,, adding to it, brought about a net increase of $15,965,. ORIGIN OF CALLS UPON THE LONG-TERM MONEY MARKET Chart 7 (based on Table 7, given at the end of this chapter) shows the net effect of operating, nonoperating, and money-market transactions on the working capital of Allis-Chalmers annually over the period Since, on the money-market side, only long-term transactions affect working capital, the close correspondence between the curve for these transactions and the one showing changes in net working capital is noteworthy. It appears that funds from operations largely offset plant expenditures, etc., and that the long-term money market is employed by the company to support the fluctuations in working capital. This observation reinforces one made earlier: that the company's contact with the total money market seems influenced more by net operating payments (receipts) than by nonoperating expenditures. COMPARISON OF EFFECTS OF OPERATIONS UPON WORKING CAPITAL AND UPON CASH It is interesting to compare. the effects of operations alone upon working capital and upon cash. The net payments or receipts of each in the operations of Allis-Chalmers, , are shown in Chart 8. Working capital gained from operations alone shows an accretion in all years save In contrast, operations had a depleting effect on the cash fund in ten years of the twenty-one.

5 CHART 7 Effect of Operations, Capital Expenditures, and Money-Market Transactions on Working Capital, Allis-Chalmers Manufacturing Company, Millions of dollars (I) 4-. V 1 U, 4- C E 1 2 I 3 4 Table 7. 48

6 CHART 8 Effect of Operations on Working Capital and on Cash, Allis-Chalmers Manufacturing Company, Millions of dollars 5 MiIROnS of dollars 5 CD 2 C, CD 1" 1 1 C CD E 2 2 rn C, CD. Ui 5 1:: '35 '39 '4 7 '41 '42 '43 '44 '45 '46 '47 '48 '49 '5 '51 '52 53 '54 '55 '56 '57 Table and Table

7 TABLE PAYMENTS AND RECEIPTS OF WORKING CAPITAL, (thousands Dr. Cr. Dr. Cr. Dr. Cr. Business transactions Operating budget Net income before tax Depreciation Other transfers to or from noncurrent accounts, net Income tax liability incurred 3,6 Dividends declared 6,23 1,847 1, ,534 1, ,19 2,663 2,22 5,929 1, Subtotal 9,29 11,984 3,643 4,862 3,329 7,36 2,775 1,219 3,977 Capital budget Investments and advances Plant expenditures Other assets Deferred charges Subtotal 5,445 4, , , ,53 3, Total business transactions 14,747 1,992 7,672 4,946 4,295 7,314 Difference 3,755 2,726 3,19 Money-market transactions Notes payable, long-term Bonds Preferred stock Common stock Subtotal Total payments and total receipts 25, ,47 25,47 14,747 37, ,672 4,957 4,295 7,314 Effect on working capital 22,715 2,715 3,19 5

8 7 ALLIS-CHALMERS MANUFACTURING COMPANY, of dollars) Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. 8,678 1,292 15,689 1,342 28,595 1,619 45,256 2,154 2,518 2, ,6 2, ,4 1, ,25 2, ,182 1,74 11,264 17,216 23,176 3,282 4,47 47,486 4,892 5,952 7,16 7,16 1,22 2,438 3,174 2, , ,479 3, , ,188 2,479 3,352 2,813 6,386 1,9 13,743 17,216 26,644 3,398 43,299 47,52 3,74 3,473 3,754 4,23 1,98 9,25 25,75 15, 1,98 9,25 25,75 15, 1,658 25,75 15, 6,386 1,9 24,651 26,466 26,644 56,148 43,299 62,52 3,74 1,815 29,54 19,23 5'

9 TABLE Dr. Cr. Dr. Cr. Business transactions Operating budget Net income before tax Depreciation Other transfers to or from noncurrent accounts, net Income tax liability incurred Dividends declared 42,667 3,697 54,853 2,523 23,199 4, ,757 4,34 46,364 57,618 21,97 27,572 Capital budget Investments and advances Plant expenditures Other assets Deferred charges 11,254 6,475 3,958 4, , ,64 Total business transactions Difference 3,565 5,322 58,11 7,689 5,64 26,161 27,572 1,411 Money-market transactions Notes payable, long-term Bonds Preferred stock Common stock 1, 15,627 28,993 14, Total payments an4 total receipts 25,627 28,993 3,366 75,949 87,4 14,441 14,441 4,62 27,572 Effect on working capital 11,55 13,3 52

10 (Continued) Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. 25,84 2,168 9,72 2,62 26,242 3,13 33,25 3, ,316 25,4 3,65 5, ,8 5,193 14,45 6,199 3,126 27,568 8,842 11,719 15,993 29,345 2,649 36,677 2,558 2,877 13,352 16,28 12,419 8,367 7,19 4, ,511 8, , ,393 12,511 8,32 7,387 4,393 4,469 25,4 17,29 11,766 23,43 29,368 25,42 36,677 15,69 5,443 5,965 11,635 25,572 14,962 17,329 17,678 1, 2,5 15, 25,572 49,969 1, 2,5 15, 24,397 1, 12,5 66,41 75,369 17,29 11,766 23,43 39,368 27,542 51,677 9,328 5,443 15,965 24,135 53

11 TABLE Dr. Cr. Dr. Cr. Business transactions Operating budget Net income before tax Depreciation Other transfers to or from noncurrent accounts, net Income tax liability incurred Dividends declared ,9 9,345 47,2 3,526 47,5 1,5 69,917 3,393 33,786 5,546 57,55 73,31 Capital budget Investments and advances Plant expenditures Other assets Deferred charges 16,76 15,76 4,583 7,477 1,4 22 7,499 14,587 Total business transactions Difference 7,499 4,744 5,5 9,261 14,587 72,137 73,31 1,173 Money-market transactions Notes payable, long-term Bonds Preferred stock Common stock 4,5 33 4, otal payments and total receipts 4,5 33 4,467 45,244 5,38 4, ,265 76,637 73,545 Effect on working capital 4,794 3,92 54

12 (Continued) Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. 65,983 4,77 43,448 5,746 5,12 7,62 5,15 8,728 41,525 12,6 21,54 12,855 23,882 14,526 25,3 16, ,585 7,6 34,359 49,194 38,48 57,632 41,768 59,69 16,475 14,835 19,224 17,31 15, , ,636 9,893 1,781 12,56 1,794 15,68 21, ,31 13,85 15,68 21,83 13,31 13,85 69,265 7,6 55,712 49,464 51,718 57,632 55,618 59, ,248 5,914 3,451 42, 14,75 15, , , ,878 15, , ,878 14,968 69, ,282 55,712 49,568 51,718 17,51 7,868 59,351 43,17 6,144 55,792 11,517 55

13 TABLE 7 (Concluded) Dr. Cr. Dr. Cr. Business transactions Operating budget Net income before tax Depreciation Other transfers to or form noncurrent accounts, net Income tax liability incurred Dividends declared 22,45 16,68 42,85 8,596 17,325 16,84 35,144 9,5 39,13 51,41 34,165 44,194 Capital budget Investments and advances Plant expenditures Other assets Deferred charges 12,271 1,29 4, 3,117 14,431 16, ,888 19,891 Total business transactions Difference 18,888 58,18 51,41 6,617 19,891 54,56 44,194 9,862 Money-market transactions Notes payable, long-term Bonds Preferred stock Common stock 14, Total payments and total receipts 15,217 15,217 58,18 66, ,36 44,471 Effect on working capital 8,6 9,835 SOURCE: Annual reports of the receipts, in credit column. company. Payments are entered in debit column;