What is Overtrading and How to Avoid It?
April 7, 2022 (Investorideas.com Newswire) Business expansion does not always translate into long-term success. Growing businesses face a range of daily challenges. Businesses' inability to meet growth requirements can lead to what is known as overtrading.
Overtrading is an issue that can happen to any fast-growing business in the early stages. Expansion requires more resources to keep up with the pace of growth. A lack of necessary resources including cash, production capacity, and human resources can quickly lead to an ability to deliver on orders and disappoint new customers.
Why Overtrading is a Problem
Overtrading is what happens when a business doesn't have enough resources to keep up with its expansion. In simple terms, it's when a growing company over extends itself and does more business than it can support with its available working capital.
There are countless risks associated with overtrading - it greatly decreases your productivity, operational efficiency, and functionality, because you focus all your available resources and efforts on a lost cause. For some businesses, the quality of products can heavily decline, and waiting times increase tremendously, making impatient customers furious.
Identify the Signs and Symptoms
Overtrading can disrupt your cash flow, so it is critical for your business' success to watch out for signs of overtrading, such as:
- You are regularly borrowing money and your working capital is declining sharply. Just about all businesses take on a long-term debt to fund their projects but drowning in debt is an alarming sign.
- Your current assets are less than your current liabilities. Your financial reports reflect the health of your business, so when you see this ratio falling along with your working capital, it's time to take action.
- Low margins also demonstrate that your business is struggling to make ends meet. Even if you have a high turnover, this doesn't mean that your business is doing great. Profit margins are a more accurate representation of success, and if your costs are increasing, you should re-evaluate your business plan.
- Suppliers are skeptical about your business and seem to want to step away from your business. A third party can often recognise signs of trouble in a business before the business owners.
How to Avoid Overtrading
Let the Customers Come to You
One of the primary reasons why business owners are inclined toward overtrading is the fear of losing out on a sale. While this is a rational fear, you have to be careful about where you invest your funds and not over extend your business beyond its capacity.
Watch the market leaders in your industry, see how they operate, and observe their strategies. This will help you to develop your own strategies to grow your business sustainably and avoid overtrading.
Don't be Driven by Emotions
Sometimes when business is flourishing, leaders think that it is the right time to expand, acquire additional capital and launch a new product line. This may be tempting, but that is not always the best approach.
Don't be greedy at this stage, as you'll risk losing everything. Impulse trading triggered by FOMO will most likely yield no significant results and can put you in a difficult position financially.
Look for Alternative Payment Management Systems
Do not restrict yourself to the conventional ways of doing business. With discounting invoices and invoice financing, you can easily ensure that your cash flow runs smoothly. It is also wise to invest in a well-functioning payment management system that can help you manage your invoices and finances.
Try to Lease the essential Assets
Leasing is a way to acquire assets if you don't have enough capital to buy them outright, or if you want to keep more capital available. It's important to understand the two types of leasing: operating and capital.
A capital lease contract entails the transfer of ownership at the end of the payment cycle, while in an operating lease agreement, there is no transfer of ownership of the asset. Either of these arrangements will help you save money and better assess your needs.
Reduce the Outflow
If you want to expand your business, your business needs to be in an excellent position financially. Take a close look at your cash flow management to see where you can reduce your costs and increase your profit margins. If funds aren't readily available you can look for sustainable and secure ways to inject new capital. However, if the numbers don't add up, maybe it's not the right time to expand.
Overtrading has the potential to derail growing businesses, yet it is a concept that is still not fully understood by many businesses. This puts even flourishing businesses at risk of huge losses following expansion.
Simply put, overtrading is selling more than you can produce. To trade successfully with customers, it's important to have a clear understanding of your organisation's financial status and relationship. With the right knowledge and strategic understanding of the market, you can avoid overtrading and take your business from strength to strength instead!
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