We have been talking so far about the kind of loans made for ordinary purposes of living-the kind technically called consumer credit. But out of the millions of men in the Army, a good many thousands are going to want to start out in business for themselves when they get out of the service. Most of them will have to borrow money to do it.

Money borrowed to start or run a business is called producer credit. The big difference between it and consumer credit is that the borrower o f producer credit hopes to make a profit out of it.

The money that is invested in any business falls into two categories—“working capital” and “fixed capital.” Working capital is the money that is tied up in such things as raw materials, goods being manufactured or awaiting sale, accounts receivable from customers, and so on. This money is only temporarily tied up, for it can be recovered comparatively quickly by the sale of the finished goods or the collection of the accounts receivable. These items are said to be “current” or “live” assets, and working capital is sometimes called “liquid” because it can be converted into cash in a short time.

Fixed capital consists of the money that is invested in the site, the buildings, the machinery, and other equipment of a business. It is called fixed because it could be converted back into cash only with considerable difficulty and possibly with a serious loss.

If the businessman or the industrialist has sufficient cash to pay for all his current needs of materials, labor, and other costs, he can do so and get a cash discount. But few businesses have enough cash to provide all the working capital they need. Most of them have current liabilities, consisting either of debts they owe the firms which supply them with goods and services, or debts they owe banks for money borrowed to pay for these goods or services.

These current liabilities normally run for a short term—usually 30, 60, 90, or 120 days. When a banker or a seller of goods extends short-term credit to a businessman or manufacturer, he takes into consideration only the debtor’s ability to pay out of his current assets. He ignores the debtor’s fixed assets, because the debtor can pay from this source only by selling the fixed assets-which means going out of business.

Because it is not always possible to liquidate current assets for the full value at which they are carried on the books of the borrowing concern, it is a rule in granting credit that the current assets must provide a liberal margin over the current liabilities. The ratio may stand at 3 to 2, or 2 to 1, depending upon the nature of the current assets-how stable their values are, and how easily marketable they are.

Current liabilities offer the businessman two great advantages. They enable him to get the materials and labor he needs for production in greater volume than he could if he had to depend entirely on his own working capital. They are also a source of profit, for if he can make the means of production pay a gross profit of 8 per cent, and the interest rate is only 6 per cent, he makes a net profit of 2 per cent.

Current liabilities consist of short-term accounts payable to the sellers of goods, and short-term notes or acceptances payable to a commercial bank. How does a businessman or an industrialist get credit from these sources? Obviously, only by convincing his creditors that he knows his business; that he is honest; that his record of debt paying is good; that his financial position is sound; and that his sales will yield enough to enable him to pay them.

Does it pay a businessman or an industrialist to incur short-term debt? That depends upon his ability to get credit upon reasonable terms and, even more, upon the soundness of his production and marketing plans. As all of us know, the risks that a businessman has to face are so many and so varied that meeting them puts a heavy strain on his foresight, ingenuity, and resourcefulness.

Experience shows, however, that most of our successful businessmen do not hesitate to incur short-term debts when they see a reasonable opportunity for profit.

Long-term borrowing for the purpose of obtaining fixed capital is accomplished either through mortgaging the plant or through the sale of bonds. It is hardly worth while to discuss this here, however, for very few, even of the vast numbers of men in the Army, are likely to attempt so ambitious a project immediately on leaving the service. Anyone who may do so is advised to consult the Smaller War Plants Corporation.

From EM 36: Does It Pay to Borrow? (1945)