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Overtrading can happen to any business and in the worst cases can lead to insolvency. After all, if a business can’t fulfil its orders, it doesn’t get paid.
Overtrading can lead to a business’s finances spiralling out of control. If money is leaving a company before it comes in, the likelihood is that it won’t be able to keep up with outgoings. To try and earn more money, a business may continue to accept orders that it can’t fulfil. This kind of overtrading can lead to unbalanced finances, affecting payment of staff or bills.
Depending on the sector your business operates in, the signs that you’re overtrading will be different. However, here are some of the most common experienced by all types of business:
- Poor cash flow - if you haven’t planned for all costs, or don’t have the reserves to pay for unexpected ones, your ability to provide key products and services could be severely affected
- Reduced profit margins - dipping profits could reflect a drop in demand or increase in competition. If profits drop, your cash flow could be affected
- Borrowing money regularly - if you need to borrow cash to pay your staff and bills each month, this could be a sign that your business isn’t sustainable
- Supplier issues - if the size or frequency of your orders drops because finances are tight, suppliers could get nervous and look to move away from working with you
A business takes on a range of new contracts but runs out of money to pay its suppliers. As a result, the suppliers stop delivering and the business can’t fulfil its orders. This leads to the business not getting paid by its clients, as well as reputational damage. Over a period of time, the business will come under severe financial stress as it has debts to pay and no money coming in.
Other examples of overtrading include:
- Not having the space to keep stock that’s been ordered by clients
- Long periods between payments mean you can’t keep up with expenses
- Not having enough staff to service rising demand, slowing down your service
As your business grows, the chances of overtrading increase. There are also external factors, such as the economy and demand in the sector you operate in, that you can’t control. The main thing you can do to minimize the chances of overtrading is to manage your finances effectively. This means having a solid grasp of your cash flow, using a budget to manage income and expenses, and making sure your business’s assets equal its liabilities and equity with a balance sheet.
Here are some ways to avoid overtrading:
- Issue late payment letters - late payments can significantly disrupt your cash flow, meaning you may not be able to service other clients
- Carry out a PESTLE analysis - taking stock of the political, economic, social, technology, legal, and environmental factors affecting your business can help you to plan for the future
- Manage supply chains effectively - controlling the flow of products and materials you need to run your business can be challenging
If your business is showing some of the overtrading signs outlined above, there are steps you can take to reduce the chances of things getting worse. Here are some of the most effective ways to overcome overtrading:
- Try invoice finance – this can be used to access cash if you’re waiting for payments from clients
- Use hire purchase – spreading the cost of important equipment or assets like a business van can help to keep your spending down
- Scale back growth – if you’re growing too quickly, keeping up with demand could be tricky. Improving processes and infrastructure first could help to secure your long-term future
- Hire more staff – if you can’t keep up with demand or finish projects on time, growing your workforce could make a big difference
- Change suppliers – supply chain issues could have a negative impact on your cash flow. If you’ve been having issues for a while, changing suppliers could help to get things moving again
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Overtrading can happen to any business and in the worst cases can lead to insolvency. After all, if a business can’t fulfil its orders, it doesn’t get paid.
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