Overtrading on CreditBy:Harshala ThakurRajesh MudaliyarSagar SawantAkhay MenonPrathamesh GaikwadSMBA No.7
INTRODUCTION Imbalance between the orders. Not enough current assets, or working capital. Fatal to business.
How does OvertradingHappens?† The length of the working capital cycle gets longer:‐ E.g.: Trade debtors start taking longer to pay their debts.‐ E.g.: Stocks are ordered earlier and need to be paid for beforethey are sold.‐ E.g.: Suppliers insist on being paid earlier.† Business turnover/ output increases:‐ E.g.: More stock is required(Raw materials, greater value ofwork in progress)‐ E.g.: The value of trade debtors grows in line with highersales.
INDICATORS OF OVERTRADINGInvesting too much in fixed assetsStock pillingAllowing too much creditTaking too much creditOver borrowing
CONSEQUENCES OF OVERTRADING† Capital loss† Poor money management† No trading plan† Behavioral changes
EXAMPLE ON OVERTRADING• Emilys business is three years old. Her annualturnover is £200,000 and her annual profit is£18,000. She operates with a bank overdraftof up to £25,000. Her working capital issufficient to steadily expand the business.• Emily succeeds in winning a contract to supplyBusiness A. The order is for £40,000 a monthfor two years. She will be paid 75 days afterdelivery.
EXAMPLE ON OVERTRADING• The first monthThings go very well. All the suppliers start delivering as promised. The only problem isthat she is short of space.• The second monthThings still look good. She has made the first delivery to Business A. She increases heroverdraft.• The third monthEmily has problems. She has made more deliveries to Business A but her overdraft is atthe limit. She is getting calls from unpaid suppliers.• The fourth monthEmily has a crisis. She cannot pay all her suppliers. Some have stopped delivering andare threatening legal action. She thinks that she will be fine because she is stillsupplying Business A.• The fifth monthHer overdraft is £4,000 over the limit. Three suppliers start legal action. The bankrefuses to pay any more cheques. But her first payment from Business A arrives ontime.• The sixth monthThe next Business A payment does not arrive on the due day. She cannot fulfill anymore orders. The bank demands that the overdraft be repaid within seven days.
INVESTIGATION OF OVERTRADING† Stock (inventory) days† Debtor (trade receivable) days† Creditor (trade payable) days† Current ratio† Quick ratio† Gross profit margin† Net profit margin† Return on capital employed
AVOIDING OVERTRADING (DEBTS)• Set new payment terms• Offer discounts for prompt payment• Encourage automated payments• Use factoring or invoice discounting• Negotiate payment terms with your suppliers• Improve stock control
AVOIDING OVERTRADING(ASSETS)• Lease assets or buy them on hire purchase• Inject new capital• Reduce the money taken out• Cut costs and be more efficient
EXAMPLE OF AVOIDINGOVERTRADING• Karens business is three years old. Her annualturnover is £200,000 and her annual profit is£18,000. She operates with a bank overdraftof up to £25,000. Her working capital issufficient for her to steadily expand thebusiness.• Karen wins a contract to supply Business B.The order is for £40,000 a month for twoyears. She will be paid 75 days after delivery.
EXAMPLE OF AVOIDINGOVERTRADINGKarens plan• Karen asks Business B to pay her in 45 days in return for a smallreduction in the contract price. Business B agrees.• Karen rings her suppliers to place the orders. She orders carefullyand schedules the delivery dates so that her payments are delayedfor as long as possible.• She asks her biggest supplier to wait an extra 15 days for payment.In view of the bigger orders they agree.• She decides to devote more time to persuading all her othercustomers to pay on time.• She decides not to take any money out of the business for threemonths. She has savings and can manage to do this.• She draws up an impressive written plan and presents it to thebank. The bank agrees to increase the overdraft limit to £50,000.