Over Trading &
Its impact on Financial Health of the Business
Working Capital Management
Working capital is the cash needed to pay for the day to day operation of the business
Working capital calculated like below
Current Assets
Current Liabilities
Working Capital
Stocks Debtors Cash Investment
s
Trade Creditors Dividends Taxation Short term
Loans
Working Capital Cycle
When Working Capital mismanaged? Cash Flow Problems
Main Causes of Cash flow problems
Low profits or LossesOver- Investment in CapacityToo Much StockAllowing Customers too much CreditOver Trading Unexpected Changes Seasonal Demand
Overtrading Introduction…
Overtrading represents an imbalance between theOrders. Overtrading happens when a business does not have enough current assets, or working capital, to meet these demandsOvertrading is particularly common in young, rapidlyexpanding businesses. It can be extremely serious,even fatal to the business
Mr. Silva has set up a business 2 years ago. His annual turnover is Rs.200,000 and annual profit is Rs.18,000. He operates with a bank OD of up to Rs.25,000. His working capital is sufficient to steadily expand the business.
Then he get a contract to supply Business A.(with d excitement of increasin sales) The order is for Rs.40,000 a month for two years. He will be paid 75 days after delivery.
The first month Business runs smoothly. Suppliers start delivering as promised. The only problem is that he is short of space.
The second month Things still look good. He has made the first delivery to Business A. He increases her overdraft.
The third month Silva has problems. He has made more deliveries to Business A but His overdraft is at the limit. He is getting calls from unpaid suppliers.
The fourth month Silva in hot seat. Can’t pay all His suppliers. Some stopped delivering and some are threatening legal action. He thinks that he will be fine because he is still supplying Business A.The fifth month His overdraft is Rs.40,000 over the limit. 3 suppliers start legal action. The bank refuses to pay cheques. Then first payment from Business A arrives on time.The sixth month The next Business A payment does not arrive on the due day. He cannot fulfill any more orders. The bank demands that the overdraft be repaid within seven days.
DebtorsIncreasing credit sales volume Extended credit sales period Increasing and excessive reliance on trade
payables Increase in short term borrowings
CashIncreasing sales without corresponding increase
in profit Lack of cash in hand or at bank
Symptoms of Over Trading ……
CreditorsStocks are ordered earlier and need to be paid
for before they are soldExtended trade payable periods
InventoryIncreasing inventory daysMore stock required to meet sales demand
Increasing the length of working capital cycle!!
Internal causes Poor management of operations Production problems Poor marketing decisions
External causes Economic Financial failure:
Other sources of Liquidity Problems ……
Investigation of overtrading….Stock (inventory) daysDebtor (trade receivable) daysCreditor (trade payable) daysCurrent ratio Quick ratio Gross profit margin Net profit margin Return on capital employed
Examples for Over Trading …..
o Seylan Bank PLC
o Next Clothing Retailero Sock Shop
o Borrowing or increasing in capital to increase current assets - casho Sale of non-trading assets o Tightening terms of credit granted to customers o Negotiating longer credit terms from major supplierso Setting new payment terms o Offering discounts for prompt paymentso Automated paymentso Invoice discounting or Factoringo Negotiating terms with supplierso Improve inventory controlo Lease/hire purchase assetso Introduction of new capitalo Reduce distribution of profito Cost cutting
Overtrading may be cured or reduced by:
Anyone can think that overtrading sounds like a good thing, but actually it isn’t – the key to a healthy business is to get a good balance between under trading and overtrading
Borrowing MoneyShrinking profitsLate paymentsOver ExpansionDepletion of Working CapitalAccountant
Impact on financial Health and Business…..
Discipline Cycle !!!Discipline
Consistency
ConfidencePatience
Profits &Success
Overtrading means trying to grow quickly without having the financial strength .
Overtrading can be a very big problem for companies, especially SME.
This is common in start- ups and expanding businesses
Over-trading can be a problem for many firms when the economy moves out of a recession.
If company is growing, It’s vital that you have excellent financial management information in place to keep the business on track and prevent problems arising.
Conclusion….
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