overtrading

• What is overtrading?


  it happens when a business expands too quickly without having the financial resources to support such a quick expansion.
• When is Overtrading Most Likely to Happen?

  • Growth is achieved by making significant capital investment in production or operations capacity before revenues are generated

  • Sales are made on credit and customers take too long to settle amounts owed

  • Significant growth in inventories is required in order to trade from the expanding capacity

  • A long-term contract requires a business to incur substantial costs before payments are made by customers under the contract
• Classic Symptoms that a Business Might Be Overtrading

  • High revenue growth but very low gross and operating profit margins (compared with key competitors

  • Persistent use of a bank overdraft facility

  • Significant increases in the payables days and receivables days ratios

  • Significant increase in the current ratio

  • Very low inventory turnover ratio

  • Low levels of capacity utilisation (alongside high levels of investment in capacity
• How Can Businesses Manage the Risk of Overtrading?

  • Reducing inventory levels

  • Scaling back the pace of revenue growth until profit margins and cash reserves have improved

  • Leasing rather than buying capital equipment

  • Obtaining better payment terms from suppliers

  • Enforcing better payment terms with customers (e.g. through prompt-payment discounts