NE of the most noteworthy efforts

of recent years to bring about an intelligent consideration of the problems of valuation through coöperative effort was the valuation of the Pittsburgh Railways by a joint board of engineers, made up of representatives of the city of Pittsburgh, and of the Pittsburgh Railways Company, with the chief engineer of the Pennsylvania Public Service Commission presiding. It is thought in Pennsylvania that most of the discreditable differences of opinion between opposing interests in street railway valuation work can be eliminated by this process of conference, coöperation and joint agreement. The conditions upon which a particular set of valuation data is to be compiled are laid down in advance; the assumptions are defined and it is presumed that identical results can be obtained by the application of the same rules under the same conditions to the same property. Metaphorically speaking, the Public Service Commission gets the opposing engineers into the same room, knocks their heads together and compels them to agree upon all those facts and inferences from facts with respect to which honest men, striving to reach an agreement, have no real excuse for ultimate difference.

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The Pittsburgh Engineers Valuation Board was composed of eminent engineers who found themselves able to agree upon many things, although by no means upon all things, entering into a determination of the fair value of the Pittsburgh Railways property for rate purposes. Among the things upon which they reached a unanimous agree

ment was working capital. The engineers for the city thought that the total rate base should be about $48,000,000, while the engineers for the company stood out for $65,000,000 to $70,000,000, but in both figures were included an allowance of $1,075,000 for "cash working capital" and an allowance of $1,134,000 for "stores and supplies," making a total of $2,209,000, or something more than 4 per cent of the total valuation admitted by the city's representatives and something more than 3 per cent of the total valuation claimed by the company's representatives.

In this case the board defines working capital as "the total mobile capital required in addition to the fixed capital," and goes on to say:

"Working capital may appear as cash or equivalent, materials and supplies. It is that reservoir of funds which is necessary for the efficient and economical transactions of daily operation."

The board then states that it has separated working capital into two elements in order better to apply the actual experience of the Pittsburgh company. It says:

"The first element covers general stores and supplies. The second element in working capital covers funds necessary to meet minor irregular payments incident to the ordinary conduct of the business, for the prompt payment of bills in order to secure trade discounts, for prepayments which may be desirable and necessary, and for the purchase of materials in an advantageous market in advance of pressing necessities."

With respect to the first element the board says:

"The inventory of stock in storehouses and storage yards, carried in the general accounts of

the company, and not including the miscellaneous distributed small stocks of supplies and tools in barns and shops, showed $906,571. The smaller scattered amounts in the shops and barns, the stores of track and roadway supplies at various locations and the scrap materials, salvaged from completed jobs but not yet disposed of, were all inventoried and found to amount to $227,429, which amount added to the foregoing figure for materials makes a total of $1,134,000."

The engineers found no difficulty The engineers found no difficulty in allowing the figure just given as representing the first element of the "mobile capital" which, according to their definition, is the working capital, but with respect to the second element, which takes the form of cash or funds, the engineers were much less clear, and were finally compelled to resort to an act of judgment. They

say:

"This board knows of no generally accepted rule for determining the amount of working capital necessary in this case. There are, however, various ways in which the problem can be approached, and figures have been deduced to show the range of estimates."

THE BALANCE SHEET METHOD

Their first way of approach is by an examination of the balance sheets of the company and an analysis to determine what construction is in progress and to what extent the construction accounts and the operating accounts have been merged. They say that the cash account should be studied to ascertain for what purposes the cash on hand has been assembled, and add:

"To obtain the figure of the working capital from the balance sheets, cash, prepaid accounts, accounts receivable, and bills receivable should be added and accounts payable and bills payable

should be deducted from the total so obtained."

The board says that the balance sheets of the earlier years do not afford a conclusive figure, for the reason that in the past the Pittsburgh Railways Company has depended more or less upon the resources of the holding

concern, the Philadelphia Company. Moreover, it calls attention to the fact that on account of higher prices the money requirement of the present and future will be greater than in the past. It also points out that a higher standard of credit should be maintained than the company has previously enjoyed and that while this per

haps may be effected principally by the establishment of proper reserves, it is promoted also by adequate working capital. The average figure deduced from the balance sheets for the year 1918 was $1,031,468.

CASH IN BANK-WHO FURNISHED IT?

Before we leave this first method suggested by the board as a way of estimating cash working capital, attention should be briefly directed to the specific balance sheet items used in arriving at the result. First, on the positive side, is the item of "cash." It is a common fallacy in dealing with the problem of working capital in valuation proceedings, to assume that cash "lying idle in the bank" is working capital in the sense that it is money advanced by the investors, or money borrowed on bills payable, or money accumulated from the rates, which the investors had the right to put into their pockets and use for their own purposes. It is clear that under any one of these conditions, cash on hand, if necessarily held for use in the conduct of the business, is true working capital, upon which the public is bound to pay a return, the same as on fixed capital. The fallacy lies in the failure to see that in the ordinary status of a going street railway business, the cash on hand is chiefly cash accumulated from fares and not yet paid out in meeting the expenses pertaining to the service for which the fares were received. It seems to be assumed without thought that the nickel or the seven cents de

posited by the car rider in the fare box thereby and thereupon becomes the property of the stockholders, to do with as they please; whereas the fact is that the fare represents the cost of service advanced by the car rider to the company with which to pay the wages of motorman and conductor, the power bills, the track and car maintenance expenses, salaries of officers and clerks, the taxes, the bond interest and finally the dividends, most of which are deferred expenditures. In a controlling sense, therefore, the cash on hand, so far as it represents service revenues which the company has not yet gotten around to pay out to its creditors, does not belong to the company at all, but is held in trust for the creditors until all of the elements of cost entering into the service which the car rider has consumed and paid for are liquidated. It is clear, therefore, that the balancesheet rule, as laid down by the Pittsburgh Engineers Valuation Board, is defective in its treatment of the "cash" item. Before one can tell what relation, if any, this item has to working capital, one must know where the cash came from and what claims there are against it.

The next balance-sheet item on the positive side is "prepaid accounts." These represent cash which the company has found it expedient or necessary to pay in advance of the utilization of the materials or services represented by them. This item may include such things as insurance, car license fees, certain rentals and certain forms of taxes. Stores and supplies, if paid for in advance, would be included here if they were not treated as a distinct and separate element of working capital. This item of prepaid accounts represents an unquestioned and absolute necessity for working capital, except to the extent that the money required for prepayments was

available from revenues collected in advance of service rendered or from accumulations of current revenues not immediately needed on account of deferred payments.

The next item, namely "accounts receivable," represents deferred revenues for service, the cost of which the company may have already been compelled to pay, at least in part. Το the extent that the company has, in fact, had to pay the cost of service. rendered, while deferring the collection of revenues from the beneficiaries of the service until later on, the accounts receivable represent a legitimate claim for working capital.

The final item on the positive side of the calculation is "bills receivable." Clearly this item, like the "cash" item, needs to be looked into. If the bills receivable are interest-bearing notes, there can be no reason why they should be included as working capital upon which the car riders are required to pay the company a rate of return in addition to the return paid in the form of interest by the company's debtors. If the interest received on bills receivable is included in the company's income statement used in the determination of the amount of revenue necessary to be derived from the rates, this duplication does not exist and the bills receivable may be regarded in the same light as the accounts receivable.

On the other side, the board suggests the deduction of two balance-sheet items, namely, "accounts payable" and "bills payable," in arriving at the amount of working capital required. It is evidently proper, in this connection, to put accounts payable on the side opposite to accounts receivable, and bills payable on the side opposite to bills receivable. However, if the term "accounts payable" be expanded to include all of the company's de

ferred payments, such as accrued wages and salaries, accrued taxes, accrued rentals, accrued interest and accrued dividends, the deduction is likely to assume unexpected proportions. If the item "accounts payable" is used in the usual narrow sense of that term, then the balance-sheet method of determining working capital described by the Pittsburgh board is in a very important respect incomplete and defective. In any case, it does not include among the offsets or deductions the item of advance payments or "unearned revenue," which normally results in the street railway business from the sale of tickets in strips or in books. Where the difference between the cash fare and the ticket fare is considerable, especially during a period of rising rates, it is quite usual for the great majority of the regular car riders to purchase tickets. Even where tickets are sold in strips of four, five or six, the company has on the average a large amount of advance revenue, and this condition is accentuated where tickets are sold in larger quantities, as for example, eleven for 50 cents, sixteen, twenty or twenty-five for a dollar, or one hundred for four dollars.

ONE MONTH'S OPERATING EXPENSES

The second method of estimating cash working capital described by the Pittsburgh board is to take one month's operating expenses, which, in the case of the Pittsburgh Railways Company during the first three months of 1919, averaged $1,182,780. The engineers do not explain or defend this method, and upon close examination it appears to be, so far as the street railway business is concerned, wholly indefensible. If street railway revenues were not collected day by day as the service is rendered, but, like the revenues of most other utilities, were collected once a month for service rendered

during the preceding month, there would be some logic in claiming that one month's expenses are, in a rough way, a measure of the "cash working capital" required. But where the business is done upon a strictly cash basis and the service is sold and paid for the moment that it is performed, the company receives from its patrons the entire amount of the revenue covering the cost of the service before it is compelled to make the disbursements normally included in operating

expenses.

A PERCENTAGE OF SOMETHING

The third method of estimating the cash working capital allowance, suggested by the Pittsburgh engineers, is to assume a certain percentage either of the property account or of the outstanding securities. In this connection, they say that 2 per cent on the property account is sometimes applied. With respect to this method, also, explanation or defense is omitted, and in the absence of any affirmative reason for adopting it or any proof that the results obtained are pertinent to the inquiry, it is perhaps unnecessary to criticize it. The only apparent reason for taking a percentage basis is the desire to provide an amount of working capital roughly proportionate to the size of the enterprise.

AN ARBITRARY ESTIMATE

The fourth so-called "method" suggested by the engineers for estimating cash working capital requirements is even more baffling-it is "to apply business judgment." In support of this method the opinion of the receivers for the company is cited to the effect that in the case of the Pittsburgh Railways a cash balance of not less than $750,000 should always be maintained. The engineers state that this minimum figure, increased by the ex

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cess of accounts receivable over accounts payable, would amount to $975,402. Again, we have an entire absence of explanation or defense, but obviously the method is based upon the now familiar fallacy that the cash balance carried by a street railway company is made up from funds furnished by the investors.

It was from a consideration of these four methods that the board of engineers unanimously agreed upon the figure $1,075,000 for cash working capital, upon the assumption, apparently, that a composite of four equally bad theories would produce a just result. Forsooth, by careful and coöperative scrambling, four bad eggs may be made into one good omelet. THE INTEREST FUND IN CLEVELAND THE INTEREST FUND IN CLEVELAND

In connection with the development of the service-at-cost idea, originating with the Cleveland Railway settlement of 1910, devised by the late Judge Robert W. Tayler, it is customary to establish a "barometer" or "stabilizing" fund as an automatic or semiautomatic regulator of the fares. In Cleveland, under the Tayler plan, this is called the "interest fund." It was originally established in 1910 by the setting aside of $500,000 in cash, represented by floating indebtedness and included in the permanent capital value of the property. This $500,000 must be considered as cash working capital. It is entirely apart from and in addition to the inventory of stores or materials and supplies. These were included in the valuation of the Cleveland Railway property represented by outstanding bonds and recognized capital stock.

WORKING CAPITAL UNDER MONTREAL

TRAMWAYS CONTRACT

Another service-at-cost franchise that has deservedly attracted a great

deal of attention is the Montreal Tramways contract negotiated in 1918. As a basis for the financial section of this contract and for the semi-automatic regulation of rates, a valuation of the physical property was made and an agreed upon "capital value" was written into the contract. A permanent Tramways Commission was established with the function of exercising public control over the operation of the Montreal street railways and of interpreting and applying the terms of the contract. The initial capital value was fixed at $36,286,295. However, a clause was inserted to the effect that this sum 'does not include any working capital," and, therefore, “it is agreed that any working capital required shall, as and when ordered by the Commission, be furnished by the company." The contract does not specifically provide that the "working capital" shall be added to and become a part of the "capital value," but it does provide that "upon such working capital so furnished the company shall receive a return at the rate of 6 per cent (6%) per annum." As 6 per cent is the basic rate of return to be paid on the "capital value," the treatment of working capital is nearly equivalent to its inclusion in that item, .

In its original orders for the inauguration of the financial plan contemplated by this contract, the Montreal Tramways Commission did not fix an amount for working capital, but appeals were taken to the Quebec Utilities Commission, which in its decision of September 20, 1918, found that a working capital allowance should be made. Under this caption the Commission included the book value of the material in stores, the material in process of manufacturing and the cash on hand at the date when the contract went into effect. These three items totaled the sum of $914,348, of which