Overtrading and a lack of working capital in the time between investing in business growth and realising the profits can cause serious problems for some growing businesses.
What does overtrading mean in business?
Overtrading happens when a business expands too quickly without having the money to support such fast growth. Lack of resources may mean you are unable to deliver on contracts or pay for your company liabilities.
Overtrading can occur if, for example:
- your customers are buying on credit or paying late
- you are overspending (on equipment, materials, etc) before you are able to generate revenue
See what is overtrading.
Typical signs of overtrading include:
- lack of cashflow
- small profit margins
- excessive borrowing
- loss of supplier support
See an example of overtrading.
As an issue of working capital and cash flow, overtrading can occur even in profitable businesses.
How do you fix overtrading?
Sensible cashflow and good working capital management are the most effective ways to deal with the problem of overtrading. If you’re at risk of overtrading, you may want to, for example:
- improve stock control and reduce inventory
- match sales and production cycles
- scale back the rate of growth
- renegotiate payment terms with suppliers
- set new (or better) payment terms for your customers
- use factoring or invoice discounting
- lease assets or buy them on hire purchase, rather than outright
- cut costs or inject new capital to increase your cashflow
See how to avoid the problems of overtrading.
Working capital management
Proper management of working capital is key to your business' financial health during growth.
Lack of working capital is not the same as unprofitability, but the effects can be just as catastrophic. If you don’t have enough working capital to cover your obligations, insolvency can result. You may find your business facing legal problems, liquidation of assets and potential bankruptcy.
If you're experiencing periods of negative cashflow, you may try to relieve them by extending payment terms to suppliers, either by taking additional time to pay or negotiating longer terms. Reducing the capital that you take out of the business, freezing salaries and increasing prices may all help to produce some respite.
If problems arise from lack of cashflow, stopping expansion for a short period should enable revenue levels to catch up. Read more about business growth: cashflow management.