Alarm bells for overtrading
Overtrading occurs when companies expand their business too quickly or aggressively. It results when the rapid increase in revenue requires more resources (e.g. people, working capital or net assets) than are available. It’s often caused by unforeseen events such as project delays, delivery problems, quality issues, cost blow outs, and debtor collection problems.
The warning signs of overtrading include:
- Rapid growth in business development and sales.
- Less net profit.
- The business running with limited knowledge.
- Cash flow problem or short of working capital.
- Inaccurate or unrealistic cash budget.
- Having many unpaid vendors.
- High level of interest/debt servicing costs.
- High gearing ratio.
- Keen market competition.
- Overstocking or slow movement of inventory.
- Current and quick ratios fall.
The problems of overtrading can be avoided by:
- Effective debt management and credit control.
- Financing capital assets – The leasing or hire purchase of fixed assets reduces upfront capital costs.
- Injecting new capital into the business.
- Reducing the money taken out by the business owners.
- Cutting costs and becoming more efficient.
- Better inventory management. Such as just in time (JIT) techniques.
- Shortening the manufacturing cycle.
- Increasing stock turnover.
- Up-to-date and reliable financial records.
Overtraded companies eventually face liquidity problems and/or run out of working capital and go bust. Overtrading is like driving a car too fast. It can be done, but results in a lot of crashes and wipe-outs.