What is overtrading and are you guilty of it?

A Director starts a business, usually because of enjoying a trade, service or having a passion in some sphere that they wish to share with others. They build the business and hopefully will grow exponentially.

But what happens if trading grows so quickly that the work the business is accepting and trying to complete is greater than the resources, such as cash, people, or stock available? This is known as overtrading.

Why does it matter?
The temptation to overtrade is understandable. The outcome of overtrading can ultimately be the unravelling of your business. If the flow of cash into your business runs dry, then there is a serious threat that it will not survive.

What causes overtrading:

  • Cashflow impairment caused by unforeseen manufacturing or delivery lead times
  • Late payments from customers on credit terms
  • Raw material and stock price hikes resulting in overspending 
  • Long term contracts requiring substantial costs prior to payments being made (under contract)
  • Growth is achieved on the back of significant capital investment before revenue is generated

Symptoms of overtrading:

1.     Rapid revenue growth
The most common symptom of overtrading. Rapid growth is a problem when the company moves so quickly that it can’t keep up with itself and struggles to deliver on the additional responsibilities brought on by the growth.

2.     Small gross profit margin
It’s quite normal for a start-up to be making losses in early times, however gross margins needs to show steady growth and improvement.

3.     Short on cash
A business can be profitable and yet still short of cash. It’s a major symptom of overtrading and should not be ignored. Remember that your P&L shows your sales, expenditure, and profit, but not cash in the bank. If you’ve got late payers and high upfront costs, you’ll soon find yourself in cashflow difficulties.

4.     Over reliance on bank loans and overdraft
We’re not saying that you can’t operate on borrowed funds. An overdraft can be helpful to manage cash flow fluctuations. But to rely heavily on them and for long term is dangerous. Overdrafts can be rescinded at any time with the lender demanding immediate payment.

5.     Unhappy people
Often, we only look at the financial measures when it comes to overtrading, but the people measures also must also be considered:

Unhappy suppliers. Pushing the envelope of supplier credit terms leading to unhappy suppliers and potential withdrawal of credit terms. 30-day standard terms pushed to 45, then 60, then 90? Does this sound like a familiar story? In B2B situations, you’ve probably even been on the receiving end of it. Maybe you are ‘robbing Peter to pay Paul’ or in other words as money comes in, it goes straight out again to appease the most demanding suppliers.

Unhappy customers. Project stalling, delays in delivery of product, service supply shortage are all reasons for customers to become dissatisfied. These are all red flags to potential customers, suppliers and even investors that signal overtrading.

Unhappy employees. The pressure felt by finance teams in companies that are overtrading can be immense. They are the frontline for dealing with both unhappy customers and unhappy suppliers and they have all your financial information at their fingertips. If you can’t hold onto a finance team, it’s symptomatic of overtrading. It doesn’t stop there though; production and service teams also feel the pressure from above to deliver on time in difficult circumstances.

I’m overtrading, what can I do?
Get help, sooner rather than later.

Seek advice and guidance from a professional. This could be from your accountant, or from a licensed Insolvency Practitioner such as Even Keel Solutions.  The sooner there is intervention, the sooner a plan can be drawn up to find a suitable solution and mitigate any further risk of job losses or liquidation.

If you’re experiencing financial distress in your business and need some help, please do get in contact with us for a no-cost initial and confidential conversation. Call us on 01202 237337 or email us info@evenkeelsolutions.co.uk .

We’re an experienced team with strong values. We like to understand your needs and ensure you have the best advice possible. We’re experts in all areas of insolvency; you can read more about us on our website here.

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