When starting a business, every owner wants to see a healthy amount of growth, but, taking on too much at once, or overtrading, could actually do more harm than good.
What is overtrading?
Usually, overtrading occurs when businesses try to expand too quickly.
Whilst it might sound like a better problem to have than under trading, it is not safe to assume that the risk is any less. In fact, overtrading is very common and is probably a bigger cause of SME failure than not having enough business coming in, particularly if the economy or an industry is experiencing growth after a period of recession. In a way, it is more dangerous because the threat is less obvious – after all, having too many orders is better than not having enough, right?
But, if a business requires any significant upfront costs in order to fulfil an order, then it can be in danger of running out of working capital.
How can overtrading arise?
Most overtrading situations arise from chasing turnover when resources are thin, so is particularly prevalent in new businesses. That big new contract may be tempting, but how will it be funded? What will the payment terms be with the customer and will it really be that profitable? There may be additional costs which will arise such as wages of extra staff, rent and the purchase of raw materials which must be paid for before any payments are received from the customer. This can leave a business walking a tightrope with nowhere to go if any problems arise on the contract, for example a delay in the delivery of supplies which in turn will delay completion of the contract and payment by the customer.
How to avoid overtrading
Awareness is key to anticipate and plan for any potential risks. Cash is king in these situations and accurate projections are essential, with different scenarios built in to allow for any unexpected problems. Can the business support the cash requirement or will external finance be required before taking on a project, such as debt factoring, single invoice financing or other short term facilities?
A good accountant will be able to help with all these issues, fully assess the cash needs of a business and help maintain up to date records and financial forecasting so that it is as reliable as possible. They will also be able to help identify the warning signs to avoid overtrading.
If you would like any further advice relating to overtrading, contact Wilkins Kennedy LLP’s insolvency team to see how we can help.