agencies and credit managers. This is inconvenient and often unpleasant, and may result in injury to credit standing through unwarranted rumors which may be circulated. While the firm which borrows from its bank knows that its financial condition will be held in strict confidence, the condition of the firm which borrows from the note broker is open to the world, so to speak.

The competition among the brokers, and the availability of easy money markets tend to decrease the bank's rate of interest on loans. Commercial paper brings a lower rate of interest than straight loans to customers.1 The open market works a hardship on borrowers who have not met the bank's requirement and who can get no further accommodation from the note broker, and then turn to the banker and expect him to carry them over the tight period.

Concluding Estimate.-On the whole, the commercial paper houses have been conducted on a highly efficient and sound basis. There are, however, certain correctives proposed, the purpose of which are to increase the efficiency of the system. The commercial paper houses have never been subjected to any legislation. It has been proposed that there be a central agency where all commercial paper must be registered. This would help to do away with the evil of excessive amounts of paper of one firm-an evil which helped to cause the failure of the H. B. Claflin Company of New York. The movement for registration has not met with great success.

Borrowers' statements should be very carefully audited, and their financial condition should be very thoroughly investigated. This is a very positive way by which weaknesses of the system may be overcome.

If the banker and the broker cooperated more closely, there would be less overexpansion, less misunderstanding between

1 Phillips, Bank Credit, Chap. 16.

banker and customer; in fact, the whole financial system would benefit by such action on the part of two important links in the credit chain.

In spite of the weaknesses and disadvantages of the system of borrowing through note brokers its advantages are numerous enough for its justification. As a means of distributing capital, as a means of equalizing the rate of interest, as a means of providing funds for business firms and forms. of investment for banks, its economic usefulness is evident. The borrower should never consider the open market as a permanent means of obtaining funds. If the open market is used under certain conditions, and if cordial relations are maintained with the bank, there are times when both the bank and borrower will profit by its use. Used judiciously, and with the cooperation of the bank, the note brokerage system has an important place in our financial and economic scheme. Used to an extreme, it can naturally injure this scheme.

REFERENCES

Kniffin, W. H., Jr. Commercial Paper.

Lincoln, Edmond E. Applied Business Finance, Chap. XVI. Chicago, A. W. Shaw Co., 1923.

Moulton, Harold G. The Financial Organziation of Society, pp. 427-436.

Phillips, Chester A. Bank Credit, pp. 139-141 in Chap. VII and Chap. XVI.

CHAPTER XXX

FACTORING AND THE DISCOUNTING OF
RECEIVABLES

Marginal Credit Demands.-The discussion of the bases upon which credit is granted both by banks and by commercial houses has indicated the limits which face the average business organization in its attempt to get under way. Proper relations between owned and borrowed capital may not always be present in an enterprise which deserves help of some kind. The old "two to one" relation may be entirely absent at a given moment yet all the innate possibilities of success may be present. Earning power may be visible and yet banks may not be justified in extending a loan.

It is in a situation of this kind that a business organization must find other means of financing its operations. Two important methods of securing working capital under these circumstances are through factoring, and through selling accounts receivable. Factoring has to do with the supplying of capital on the basis of the goods produced and the distribution of those goods; while selling open accounts goes a step farther, and has to do with the borrowing of money on the security of open

accounts.

Factoring and Its Functions.-By the time a new business has its plant and its machinery, often a large part of the original investment has been spent. In order to begin and to continue operations, funds must be had to pay for raw materials, labor, and distribution. The firm may be able to turn out some product, but the working capital left after plant and machinery have been secured, is not sufficient to carry the

business over the period from production to payment of accounts. It is a matter of great importance in such a case whether the proceeds of sales may be counted on as being paid exactly at maturity. If accounts owing to the firm are not paid, the firm cannot pay its own accounts, and its credit standing is placed in jeopardy. Some means for supplying this necessary working capital must be found.

In such a situation factoring becomes a vital element. The factor, on the basis of goods shipped from the mill, rather than upon the current ratio of assets and liabilities of the business as a whole, places himself in a position where he allows the borrower to draw on him for a percentage, possibly 50% of the value of the goods as they are shipped from the factory. Thus the manufacturer has immediately available money to replenish his stock of raw materials instead of having to wait for it until his customers pay him at the end of their terms.

Under this plan, and without depriving his customer of the benefits of credit, the manufacturer is placed in a position to do practically a cash business, thereby "facilitating and increasing production, accelerating rate of turnover, increasing volume of sales, and so producing a larger net result on actual capital invested."

There are other benefits accruing to the manufacturer as a result of the practice of factoring. The factor relieves the manufacturer of all problems connected with the distribution of the merchandise-production and selling are left to the manufacturer; collection and credits are delegated to the factor. The manufacturer is relieved of all financial worries; he is able to concentrate on the production of goods.

The factor has a specialized department of credit and collections and assumes all credit risk. He accepts this re

1 Goldwasser: "The Factor, the Bank and the Factored Account," in Bulletin of Robert Morris Associates, October, 1922.

sponsibility with the knowledge that experience along this line will enable him to effect settements more promptly and with less friction than the manufacturer himself. Furthermore, the factor is engaged in performing this same function for a number of individuals and can take advantage of a more economical organization. The manufacturer reports orders to the factor, just as he would to his own credit department; when the orders are approved, shipments go out. Invoices are rendered payable to the factor. Proceeds are made available at once by this "merchandise banker," as the factor has been called.

The progressive factor is able to aid his client by giving information about business conditions in general, conditions in the particular industry, in world markets, etc. The factor, because of his larger field of service is often in a position to get information which the manufacturer might not otherwise be able to procure.

The factor's charge for this service is a percentage on the volume of business he handles-possibly three, four, or five per cent above the bank rate. Out of this percentage he pays for his office, storage space, insurance, light, heat, power, telephone, deliveries, bookkeeping, and credit and collection facilities, all of which are highly specialized.

As the profits of the factory accumulate, and are put back into the business, it is no longer necessary to secure loans through a factored account. However, some firms prefer to pay the charge of the factor, and retain his services. This is partly due to sentiment and the fact that the factor has meant prosperity in the past; and partly due to the fact that the factor separates the manufacturer from financial worries, including the assumption of all credit risk, so that the manufacturer may concentrate on the production of goods. If the manufacturer can turn his stock rapidly, he more than makes up for the cost of factoring. Factoring has been found more