3. How does Overtrading
Happens?
† 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 before
they are sold.
‐ E.g.: Suppliers insist on being paid earlier.
† Business turnover/ output increases:
‐ E.g.: More stock is required(Raw materials, greater value of
work in progress)
‐ E.g.: The value of trade debtors grows in line with higher
sales.
6. EXAMPLE ON OVERTRADING
• Emily's business is three years old. Her annual
turnover is £200,000 and her annual profit is
£18,000. She operates with a bank overdraft
of up to £25,000. Her working capital is
sufficient to steadily expand the business.
• Emily succeeds in winning a contract to supply
Business A. The order is for £40,000 a month
for two years. She will be paid 75 days after
delivery.
7. EXAMPLE ON OVERTRADING
• The first month
Things go very well. All the suppliers start delivering as promised. The only problem is
that she is short of space.
• The second month
Things still look good. She has made the first delivery to Business A. She increases her
overdraft.
• The third month
Emily has problems. She has made more deliveries to Business A but her overdraft is at
the limit. She is getting calls from unpaid suppliers.
• The fourth month
Emily has a crisis. She cannot pay all her suppliers. Some have stopped delivering and
are threatening legal action. She thinks that she will be fine because she is still
supplying Business A.
• The fifth month
Her overdraft is £4,000 over the limit. Three suppliers start legal action. The bank
refuses to pay any more cheques. But her first payment from Business A arrives on
time.
• The sixth month
The next Business A payment does not arrive on the due day. She cannot fulfill any
more orders. The bank demands that the overdraft be repaid within seven days.
8. 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
9. 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
10. 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
11. EXAMPLE OF AVOIDING
OVERTRADING
• Karen's business is three years old. Her annual
turnover is £200,000 and her annual profit is
£18,000. She operates with a bank overdraft
of up to £25,000. Her working capital is
sufficient for her to steadily expand the
business.
• Karen wins a contract to supply Business B.
The order is for £40,000 a month for two
years. She will be paid 75 days after delivery.
12. EXAMPLE OF AVOIDING
OVERTRADING
Karen's plan
• Karen asks Business B to pay her in 45 days in return for a small
reduction in the contract price. Business B agrees.
• Karen rings her suppliers to place the orders. She orders carefully
and schedules the delivery dates so that her payments are delayed
for 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 other
customers to pay on time.
• She decides not to take any money out of the business for three
months. She has savings and can manage to do this.
• She draws up an impressive written plan and presents it to the
bank. The bank agrees to increase the overdraft limit to £50,000.