Problems arising from Growth - Over-trading 3.2.1
Growth - A common corporate objective which means expanding the sales revenue of a business, probably in the hope that profits will increase too.
Overtrading - occurs when a business expands top quickly without having the financial resources to support such as quick expansion.
Overtrading is where a business suffers financial difficulties from growing too quickly. This particularly relates to a business' s cash flow as if a business expands too quickly it may not have enough money to be able to purchase raw materials to meet the demands of higher sales.
Overtrading is, therefore, essentially a problem of growth. It is particularly associated with retail businesses who attempt to grow too fast.
When is Overtrading Most Likely to Happen?
Overtrading is most likely to occur if:
Overtrading - occurs when a business expands top quickly without having the financial resources to support such as quick expansion.
Overtrading is where a business suffers financial difficulties from growing too quickly. This particularly relates to a business' s cash flow as if a business expands too quickly it may not have enough money to be able to purchase raw materials to meet the demands of higher sales.
Overtrading is, therefore, essentially a problem of growth. It is particularly associated with retail businesses who attempt to grow too fast.
When is Overtrading Most Likely to Happen?
Overtrading is most likely to occur if:
- Growth is achieved by making significant capital investment in production or operations capacity before revenues are generated
- Sales are made on credit and customers take too long to settle amounts owed
- Significant growth inventories is required in order to trade from the expanding capacity
- A long-term contract requires a business to incur substantial costs before payments are made by customers under the contract
- High revenue growth but very low gross and operating profit margins (compared with key competitors)
- Persistent use of a bank overdraft facility
- Significant increases in the payables days and receivables days ratios
- Significant increase in the current ratio
- Very low inventory turnover ratio
- Low levels of capacity utilisation (alongside high levels of investment in capacity)
- Reducing inventory levels
- Scaling back the pace of revenue growth until profit margings and cash reserves have improved
- Leasing rather than buying capital equipment
- Obtaining better payment terms from suppliers
- Enforcing better payment terms with customers (e.g. through prompt-payment discounts)
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