Overtrading on Credit

By:Harshala ThakurRajesh MudaliyarSagar SawantAkhay MenonPrathamesh Gaikwad

SMBA No.7

INTRODUCTION

Imbalance between the orders.

Not enough current assets, or working capital.

Fatal to business.

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.

INDICATORS OF OVERTRADING

Investing too much in fixed assetsStock pillingAllowing too much creditTaking too much creditOver borrowing

CONSEQUENCES OF OVERTRADING

† Capital loss

† Poor money management

† No trading plan

† Behavioral changes

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.

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.

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

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

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

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.

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.

OVERTRADING ON CREDIT

CONCLUSION??