CAPITAL AND CAPITALIZATION 341
reason, it is essential that it be obtained from long-term investment sources
rather than from short-term borrowings.
As a general rule, optimistic promoters are inclined to give too much
attention, proportionately, to fixed capital needs and too little to the
demands of circulating capital. Consequently, the enterprise is shortly
embarrassed for lack of funds before it has had a fair opportunity to
demonstrate its reasonable earning capacity. Optimism feeds upon dreams
of immediate profits instead of facing the nightmare of probable losses for
a time after the business is launched.
In addition to the amount of capital that is invested in going-concern
value, every corporation must have an initial investment in circulating
capital that does not fail to circulate. The amount varies with the type of
the enterprise and with the ambition of the promoters. Naturally, a small
business will require a lesser amount of circulating capital than a larger
business in the same industry. The amount needed will grow as the enter-
prise expands until, imperceptibly, the initial investment assumes the
proportions usually desipated as regular or normal circulating capital It
consists of the cash, inventories, receivables, and prepaid expenses necessary
to the regular conduct of the business. Any going concern will always have
some investment in these forms. In addition, it will have larger amounts
varying from time to time for various reasons. Some businesses have sea-
sonal demands for circulating capital that may be several times their
minimum investment in this form.
Cyclical fluctuations in business volume cause wide variations in demand
for circulating capital. Both extremes of the cycle are likely to create
unusual demands. When businesses are prosperous, Jtheir optimistic man-
agements do not hesitate to invest large amounts in inventories and
receivables. Cash sells at a discount during optimistic periods, and so this
form may decline in amount. Commitments are made without fear of the
future, and businesses tend to finance each other. During depressions,
inventories and receivables tend to remain large, for the former cannot be
disposed of readily and the latter cannot be easily liquidated. Gradually,
both take the form of cash because our mania for liquidity urges an abandon-
ment of our original purposes as long as the haunting fear of the unknown
future grips us. Prolonged depressions result in large investments to meet
operating losses while overhead is being maintained in the hope of better
times ahead.
In a sense, cyclical changes create emergency demands for circulating
capital. Perhaps it would be more accurate to classify the business cycle
as a succession of emergencies, each bringing its own problems. In addition,
many businesses face other" emergencies that affect their circulating-capital
requirements. These include the cessation of operations due to fires, floods,
strikes, and other unwelcome and unexpected happenings. Likewise, emer-