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The warning signs of overtrading

Our Business Advisory Expertise

Updated: 8th January 2020

The dangers of overtrading and how you can protect your business

When first starting up in business, your main worry will probably be about not attracting enough work rather than taking on too much. So when your orders begin to increase, or you secure a major contract, this is undoubtedly a cause for celebration. Increased orders mean your business is thriving and going from strength to strength.

More often than not having more work is a good thing; however, amidst the excitement you should be sure that you are able to fulfil these orders to a good standard and in a timely manner. Fail to have the resources and infrastructure available to do this, and you run the risk of overtrading. Having too much work in the pipeline may seem like a nice problem to have but the dangers of overtrading should not be underestimated.

Unfortunately when it comes to business, there is something as too much of a good thing. So what exactly is overtrading and how does this differ from simply experiencing a period of growth?

What is overtrading?

Overtrading is when the level of orders you have taken on is impossible to fulfil, or when you take on an excessive amount of work in order to cover up existing cash flow problems. Essentially, it can be defined as selling more than you can reasonably deliver. The temptation to overtrade is understandable, nobody likes to turn away business, but you should be aware of the perils inherent in this type of behaviour.

Potential dangers of overtrading:

  • Productivity is pushed to the max. This can lead to corners being cut as you rush to fulfil the order, leading to a dip in the quality of the goods you produce or the services you provide.
  • Decreased quality coupled with increased waiting times. Delivering sub-standard goods, or failing to deliver in a timely manner, could severely hamper your chances of repeat custom, spelling bad news for your company in the long-term. You should consider the facilities you have and how much you can realistically produce to the standards you have set before accepting orders.
  • The threat of late or non-payment. This is a danger particularly if you have a small number of high-value orders. Unless your cash flow is extremely healthy you can quickly come unstuck if a major customer fails to pay on time. This can escalate into insolvency should the debt turn bad.
  • Suppliers grow impatient. While suppliers will be pleased when your orders of raw materials increase, they will be less impressed if you fail to pay for this on time. With working capital tied up in materials, you could find it increasingly difficult to pay your suppliers. This can sour relations extremely quickly, threatening your entire business supply chain.
  • You are left with staff and equipment you can’t afford. In times of business growth you may find you have to take on additional staff or improve your resources in order to satisfy the orders you have accepted. Should business slow down again, you may be left with huge overheads you simply cannot manage.
  • Increased stress levels as you rush to fulfil your orders on time.

One of the main threats of overtrading is what it can do to your cash flow. Once this runs dry you can quickly find yourself in serious trouble. Needing to borrow cash regularly to get through the month is a classic sign of overtrading. Once you begin struggling to pay your key suppliers, your business could be in serious jeopardy. This is why ensuring you have a healthy working capital is absolutely vital when it comes to growing a business.

Before taking on a large order you should consider whether you can realistically fulfil this in the way you would hope and that your customers would expect. Don’t be afraid to say no if taking the order has the potential to push you and your company’s resources to breaking point. You also need to consider the possibility of your customer failing to pay on time. Is your company in the position of being able to ride this out until payment is made? If a late payment, particularly from a significant order, has the potential to cause you serious cash flow problems going forward, you should weigh up whether the risk is worth it before accepting the job.

Sustainable growth is key

The main thing to keep in mind is that the key to company growth is sustainability. Remember that while improved short-term profits are certainly welcome, if they threaten to have damaging long-term consequences then they may be best avoided.

What should I do if my business is suffering due to overtrading?

If you know you have expanded too quickly, or taken on more than your business can handle, you need to take a step back and look at the state of your cash flow. Can you afford to keep up with your current liabilities? Are creditors and staff being paid on time? If not, you should seek the guidance of a professional as soon as you can in order to stop your company becoming insolvent. Your accountant is ideally placed to help with this as is a licensed insolvency practitioner.

Cash flow is king

If your cash flow has been halted due to delayed payments from customers, you may wish to consider a form of invoice finance to inject some much needed capital into the business. Invoice finance, including both factoring and discounting arrangements, allow you to receive a cash advance which is secured against unpaid invoices your company has issued. This can help operations to keep moving even when customers are slow paying what they owe. You should also take this time to consider your current debt collection strategies and ensure you have procedures in place to deal with late payers.

If you are worried your business is overtrading, or have any other concerns about the financial health of your company you should seek expert advice as soon as possible. Real Business Rescue can advise you on a range of business rescue and recovery methods to get your company back on a solid financial footing. Contact us today on 0800 644 6080 to arrange a free no-obligation consultation at any of our 70+ offices.

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