Through its various forms, credit is essential to finance the expansion of operations, not only because it makes growth possible, but also because it allows the exploitation of leverage when the cost of borrowed capital (credit) is lower than the return paid on owners’ capital. Suppose that with $100,000 in capital a profit of $10,000 is obtained, that is, 10%. If resources are increased through credit at an interest rate of 7%, profit can rise to $15,000; after interest, net profit would be reduced from $15,000 to $11,500, but the net return would increase to 11.5%. This example shows the reason for using credit to increase the return on equity. Consequently, when the ratio between total liabilities and equity is relatively low, this may indicate that own investments are excessive, since reducing equity and increasing liabilities would raise the firm’s return, provided the interest rate on debt is lower than the profit rate. Excess capital may therefore mean that credit opportunities are not being fully used.
Naturally, the use of credit cannot expand indefinitely, for the following reasons:
- The volume of credit granted to a firm is limited by the collateral offered to creditors.
- The debt ratio, derived from the relationship between the firm’s obligations and its equity, should not be very high, because it may cause serious financial difficulties.
- Interest and commissions arising from the use of credit may significantly reduce operating results.
In accordance with these principles, when promoting the possible use of third-party credit, the governing bodies of firms must act prudently.
Corporate Bodies and Their Functions
Every firm must be organized on the basis of maximum efficiency. Organizational systems may vary from one firm to another according to the nature of operations and physical size, yet certain principles of general application can be established.
The study of internal organization is approached by taking manufacturing establishments as the typical case. To begin with, it must be borne in mind that every industrial firm must perform the following functions:
a. Productive.
b. Commercial.
c. Financial.
d. Accounting.
e. Administrative.
The productive function is fundamental, as it constitutes the very reason for the existence of the manufacturing firm. It includes all technical aspects of the industrial establishment, among which the most important are:
a. Determination of production processes in order to achieve the highest possible output, with the best quality and the lowest cost.
b. Layout of machinery and facilities so that production processes follow a rational and logical order, without bottlenecks or delays.
c. Procurement of capital goods, raw materials, and auxiliary materials essential for maintaining a high level of production.
d. Use of skilled or adequately trained labor.
e. Production scheduling or planning to anticipate all factory needs regarding raw materials, materials, machinery, tools, facilities, and labor. Failure to do so may prevent timely satisfaction of these needs, reducing output and, consequently, sales and profits.
f. Control of production execution. It is crucial to verify that production proceeds according to established programs and approved technical procedures. This control must be continuous, since deviations would harm output volume and quality, with serious negative effects on sales and results.
g. Quality control. Product quality must be systematically monitored to preserve the firm’s reputation and prevent a decline in sales.
h. Quantitative control of raw materials, supplies, and finished goods.
Warehouses and storage facilities are responsible for safeguarding these assets and handling their issuance—inputs for production and finished goods for sale. Without proper inventory control, losses, breakage, or theft may occur to the detriment of the firm.
Commercial functions arise naturally from productive functions and generally pursue two objectives:
a. Creation of demand. Firms must adopt measures to stimulate interest or desire among consumers and potential clients to purchase their products. This activity is known as sales promotion. Advertising plays a particularly important role, complemented by measures such as price reductions, discounts, credit terms, and facilities.
b. Execution of sales. Selling requires an efficient organization aligned with productive capacity. Branches, wholesalers, representatives, agents, salespeople, brokers, or retailers are commonly used channels. This requires properly trained personnel to achieve a high volume of business.
Financing purchases, production, and sales is a matter of great importance in every firm. Sales are not always made in cash, as extending credit to customers is a widespread tool for promoting business. For these reasons, it is essential to have sufficient equity and ample banking and commercial credit to ensure normal operations without financial strain.
Accounting, by its purposes, also fulfills an important role in industrial and commercial establishments. It enables detailed control of the firm’s assets, operating performance, production costs, and sales revenues. Without this information, it would be impossible to manage an industrial or commercial firm effectively, regardless of its size or purpose.
Finally, the administrative function is fundamental to governance and management. This does not mean that only senior staff perform administrative tasks; middle managers and subordinate personnel also participate in activities related to the direction and control of the firm. The organization of an industrial firm incorporated as a joint-stock company, according to the functions discussed above, can be understood through the organizational chart presented on the following page.