Overtrading is common in young, rapidly expanding businesses. It can be very serious or even fatal to an organisation. Overtrading happens when a business accepts work but finds that completing the work (fulfillment) requires more resources (such as people, working capital or net assets) than are available. It's often caused by unforeseen events such as delays or delivery problems.
Effective debt management and credit control can help you avoid overtrading, by ensuring that you get paid more efficiently and have the cash to pay suppliers and staff.
One way you can help prevent overtrading is by keeping a tight control of the money you have going out of your business to pay for assets. You could consider:
- leasing your assets or buying them on hire purchase (HP)
- injecting new capital
- reducing the money taken out
- cutting costs and improving efficiency
You could employ just-in-time (JIT) techniques, where goods and materials are delivered just in time for you to use them. JIT systems can help you with:
- shortening the manufacturing cycle
- reducing the period that you hold stock
- reducing the need for working capital
Assessing your cash needs
You can avoid overtrading by checking your cash needs using financial tests such as gearing, working capital or the quick ratio tests.
Consider comparing the assets and liabilities of your business. This can be useful for forecasting what your assets and liabilities will be. You can do this by using cashflow forecasting and ratio analysis. However, for either to be effective, you need up-to-date and reliable financial records.
In order to assess your cash needs accurately you need to use accurate, up-to-date figures or, when these are not available, use forecast figures.