Overtrading

Posted in Marketing and Strategy Terms, Total Reads: 524
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Definition: Overtrading

There are two definitions to this term.

• Generally, overtrading refers to the state when a business is carrying out transactions at a high speed which cannot be supported by its working capital. This means that the increased number of transactions are putting pressure on the cash-flow of the business, thus giving rise to risks of insolvency.

• As per Securities-Trading, overtrading refers to the state when a broker attempts to gain higher compensation from the customers by excessive buying and selling activities.

 

Here, we would expand on the general definition of overtrading.

 

The problem of overtrading is very common to businesses, but it severely affects the following:

• Start-ups

• Small and medium-sized enterprises

• Rapidly expanding businesses

 

Some signs of overtrading which should be avoided by all businesses are:

• Cash being borrowed regularly, almost every month.

• The low profit margins due to decrease in selling prices (to increase sales) negatively affects the working capital.

• The suppliers are getting difficult to deal with, due to the considerable placing of orders.

• The customers are not paying on time, thus disrupting the cash-flow.

 

Some of the ways through which the risks of overtrading can be reduced are:

• Debt Management

• Credit control

• Leasing assets or buying them on hire-purchase

• Introducing new capital

• Shortening the manufacturing cycle

• Reducing the period of inventory stocking

• Cutting costs and improving efficiency

• Using financial tests (like working capital or gearing or quick ratio tests) to check the cash needs of business

 

Not only does overtrading place a great strain on company’s finances and cause stresses to business, but also, the reputation of business drops owing to the drop in the output quality and due to the inability of business to fulfil an agreement.

 

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