Too much of a good thing?

When is new business a worry as well as a boon? When there’s a risk of overtrading. In this article Graham Green, Business Development Manager at CBF, explains what it is, how it poses a threat to financial health, and how its negative influence can be mitigated.

As we near Christmas, it’s not just the prospect of a seasonal over-indulgence of turkey and mince pies that might be considered ‘too much of a good thing’.

Many businesses see a seasonal spike in customer activity at this time of year, whether it’s a hotel running office Christmas parties, or a gift retailer experiencing their busiest month. Even companies not offering a product or service in great demand for the festive season might very well see an increase in demand come the New Year, when both consumer and business customers start the year as they mean to go on.

So exactly what about this business-booming situation is ‘too much’? The happy event of an increase in new business can also bring with it some challenges. In order to fulfil a greater number of orders, a company must be able to cover the costs of doing an increased amount of business, but before payment is received. When this is too much of a struggle, and has a negative impact on the company’s ability to operate effectively, it’s known as overtrading.

Overtrading is a common problem in December, especially in retail and hospitality, since the expected seasonal spike is often relied upon to meet expected yearly sales figures. At any time of the year it can also affect any business which is rapidly growing, but particularly start-ups and SMEs. Open credit terms are very common in many sectors, with 86% of trade being conducted in this manner, and companies are understandably loath to turn orders away, since they represent an opportunity to prosper and grow.

The triggers for overtrading are on the whole positive – nobody could complain about an influx of business – but it pays to manage a company’s finances with particular care, to minimise the negative effects of overtrading. Even successful companies can fail if they run out of cash, so having a decent amount of working capital and a healthy cash flow is imperative – especially since there’s a likelihood that late payments will happen (one study found that if the credit terms are net 30 days, the money arrived on average 15 days late), putting pressure on the firm’s finances. When you consider that the ledger can represent up to 70% of a company’s balance sheet, then the danger of overtrading is very real indeed.

Where a company is lacking the working capital to fulfil demand, it follows that the company’s service will falter – and the knock-on effect of the damage to reputation can be significant, as customers may be lost to the competition, and it can be more challenging to secure new business thereafter.

Obviously the circumstances which lead to overtrading – increased demand for your product or service – aren’t to be sniffed at, but there are ways in which the inevitable risk can be mitigated:

  • Credit Insurance cuts invoice exposure, by paying up to 95% of a bad debt if an invoice is unpaid
  • Invoice discounting advances a percentage of the invoice / sales ledger, enabling cash flow
  • Asset finance free’s up further cash, using assets as security
  • By becoming more aware of the company’s debtors, and predicting late payments, it’s possible to effect better financial planning
  • Prompt payment discounts can ease cash flow, as well as be attractive to customers
  • Suppliers should be carefully managed to ensure smooth transactions
  • Purchase Finance can provide extra time to pay suppliers
  • Management accounts will ensure visibility of a company’s financial health, enabling prompt action to be taken if risks increase

No business wants to turn away a customer, but when increased demand could increase financial risk, it pays to have measures in place to minimise the potential negative impact of overtrading. Plan ahead, and the opportunities presented will encourage sustainable business growth, rather than put pressure on the company’s finances.

If you would like to discuss any of the products above, or wish to arrange a risk debtor assessment, please call Graham Green on 07944 092166.


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