Although Cash Flow Projections Appear To Be Complex They Managing Business Growth – The Problems With Overtrading

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Managing Business Growth – The Problems With Overtrading

Understanding overtrading and the problems it creates is very difficult. Of course, if a business is selling many of their products and their customer base and profits are growing rapidly, how can this be a problem? Indeed, this is not only a problem, but in some extreme cases, it can cause a business to cease trading.

The fundamental reason why overtrading is a problem is that it can put a huge strain on a business’s resources, especially cash flow. If the turnover is growing too fast, you may need to acquire more machinery or equipment to increase the number of customers. There may also be a situation where you need to move to a larger premises or a larger office with more storage space. Hence, the growth in sales is likely to match the increase in capital investment and other working capital requirements. If the business does not retain profits for this rapid expansion, it tries to borrow. These loan facilities can be very expensive. However, many new businesses that experience overtrading are unable to obtain additional funding due to a lack of trading history and are forced to downsize their operations or possibly ‘throw in the towel’ entirely.

Other costs that can cause a large increase in working capital when growth is too rapid are personnel costs. With any expansion comes an increase in the number of employees. This can be extremely expensive for a business to fund, especially when combined with any increase in added payroll taxes. Additionally, if your sales are growing rapidly, this may mean that you need to carry more stock and thus tie up more of your capital in that inventory. Again, stocks are like many other assets, if you own too much, it can starve other areas of the business that urgently need funding.

Several precautions can be taken to avoid the potentially harmful effects of overtrading. First, growth should be managed properly and with a good understanding of how it will affect the working capital of the business. By creating sound monthly budgets, cash flow forecasts and monthly management accounts, you will be in a better position to control the potentially detrimental effects of rapid growth. Secondly, before you grow too quickly, try to secure growth funding. In other words, it would be a prudent idea to approach your bank and get the ‘green light’ for future financing if you need it. Having this contingency finance in place will mean that working capital can be maintained and growth can be properly managed.

Finally, to avoid the consequences of overtrading, it might be a good idea to take an ‘only what I need’ approach. For example, instead of keeping larger and larger amounts of stock as you grow, consider ordering your stock ‘just in time’ (JIT). This can significantly reduce your stock holding costs and free up all the working capital held in stock. Alternatively, buy the equipment you really need or see if you can buy any second-hand equipment that is cheaper but still works. Again, with everything you buy for your business, ask yourself: Do I really need or want this?

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