Overtrading Can Kill A Growing Business
Overtrading, also known as undercapitalization, occurs when a company is trying to undertake a larger volume of trade or activities than it has financial capacity to do. A company is said to be overtrading when it grows rapidly than its cash flow can support. This can have serious financial repercussion for the business.
Though, sales are booming; orders are flying in… It sounds good, but your bank account says otherwise. The business operations may be disrupted if your bank refuses to grant credit facilities or your major supplier insists you pay on cash.
How Overtrading Can Impair Liquidity
- Inventory grows faster than cash
- To satisfy customer demands, you acquire more inventories.
- The inventory swallows up cash, and until sold and cash is received, liquidity suffers.
- Customers delay payments
- Sales increase, but customers don’t pay on time and as a result, liquidity is trapped.
- The book says the company is rich (on paper), but in reality, it is broke in the bank.
- Suppliers want their payments faster
- Cash position will suffer if the number of days credit is taken from suppliers is shorter than the days credit is given to customers.
- The shorter the gap, the more company will be under pressure to settle supplier.
- Borrowing to survive
- Despite increased sales, you may borrow loan to pay salaries, rent, or acquire raw materials.
- Borrowing increases interest costs, and worsening liquidity position.
- Exceeding overdraft facilities limit
- Sales grows. Need cash to purchase inventory. You constantly exceed overdraft facilities limit agreed with the banks.
- The business operations may be curtailed, if the bank facility is withdrawn.
Warning Signs Your Business is Overtrading
- Creditor payment period getting longer i.e. you are delaying payments to suppliers
- Rapid growth in turnover, cash is constantly tight
- Always borrowing to fund daily business activities
- Struggling to satisfy customer demands or orders efficiently
- Low liquidity ratio
- Cash operating cycle is increasing.
How To Prevent Overtrading
- Ensure judicious and efficient management of working capital
- Improve your cash flow projection
- Avoid over-investment in inventory
- Negotiate better credit terms with the suppliers
- Shorten debtors collection period i.e. tighten your credit terms
- Scale consistent with your working capital capacity
- Avoid unnecessary debt
- Seek professional advice.
In Summary
Growth is great and sweet. But uncontrolled growth without working capital will lead to liquidity problem. In addition, failure to meet customer demands can lead to strained relationships with customers, vendors, or even employees, eroding the business reputation and impair its ability to take advantage of market conditions.
Hence, effective and efficient management of the working capital investment is essential to maintaining and ensuring business continuity. Engage financial advisors to develop strategies for managing growth and preventing overtrading.
NEED EXPERT SUPPORT?
At Greena Partners, we help businesses like yours grow sustainably- with clear financial systems, robust cash flow planning, and actionable advisory support. Our team can collaborate with you to develop strategies to managing your working capital judiciously.
Let’s talk.👉 Contact us today to schedule a consultation.
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