As businesses emerge from two years of pandemic related stress (financial and otherwise) it would be easy to look at the increasing headwinds of rising inflation, increasing interest rates, and supply chain issues and think “it’s now or never”. In these times, it can be tempting for businesses to throw everything at the target of increasing turnover, back to pre-COVID levels. However, that understandable enthusiasm may in itself cause a problem which could ultimately result in the demise of the business – overtrading.

What is overtrading and why is it a problem?

Surely dramatically increasing turnover is a good thing? Think of the relationship between income at one end and expenditure at the other as being held under tension by an elastic band – when income and expenditure are synchronised with each other, there is little tension between them, but when significant expenditure is incurred in advance of the resulting income, or where income is delayed because of extended (agreed or otherwise!) credit to customers, then that elastic band can be stretched to breaking point or beyond.

Put simply, overtrading is when a business’ working capital is overstressed as a result of rapidly increasing sales or increasing expenditure in anticipation of those sales.

Related article: The current financial landscape for businesses emerging from the pandemic

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How can overtrading affect creditors?

Overtrading is not only an issue for the business, it is also a potential problem for its creditors, who should also be alive to the warning signs:

• Dramatically higher sales, but even higher associated costs
• Increases in average debtor days – a measure of the time taken by customers to pay
• Regular and routine use of the overdraft facility
• A deterioration in the current ratio – the ratio of current assets to current liabilities
• Goods being ordered in increasing quantities, whilst at the same time the business is struggling to pay on time
• A rapid rise in the employee head count – often a positive, but also an indicator of an increase in monthly outgoings

How can overtrading be managed?

• Put measures in place to get quicker. Make sure you have an effective debt collection function, either internal, or outsourced. Try to use the carrot rather than the stick in order to preserve goodwill with customers. Consider invoice finance in order to accelerate cash inflow
• Try to negotiate more generous payment terms with suppliers, at least in the short term if not permanently
• Finance capital expenditure by borrowings, not by buying out of cash flow. To paraphrase something Paul Getty once said “if it goes up in value, buy it; if it goes down in value, lease it!”
• Rein in growth to a sustainable level. Turnover may be vanity; profit may be sanity; but cash is king
• Reduce stock levels if possible. Try to get stock delivered just before it’s needed rather than holding large quantities in anticipation of sales
• Prepare regular cash flow forecasts in order to spot developing problems with time to spare

These measure can help many business with cash flow problems due to overtrading, but, for some, the problem may have already become too serious to handle in-house. This is where seeking professional advice can make the difference. The earlier a business faces this problem the more options they will have available to them.

As a Group, Opus is here to advise and help businesses facing financial and operational challenges. We have extensive experience of identifying and implementing positive solutions in these scenarios. We have offices nationwide and by contacting us on 020 3326 6454, you will be able to get immediate assistance from our Partner-led team.