OVERTRADING & UNDERTRADING The concepts of over-trading and under-trading areintimately connected with the net working capital positionof the business. To be more precise, they are connectedwith the cash position of the business.

OVER-TRADING: Over-trading means an attempt to maintain or expand scale of operations of the businesswithout sufficient cash resources. The firms involved inover-trading have a high turnover ratio & a low currentratio. In such situation, it is not in a position to maintainproper stocks of materials, finished goods, etc., & has todepend entirely on the suppliers to supply them at theright time.

Causes of Over-trading :- •Depletion Of working capital – Results in depletion of cash resources. Cash resources may get depleted by premature repayment of long –term loans, excessive drawings,

dividend payments, purchase of fixed assets & excessive net trading losses etc. •Faulty Financial Policy :- Such policy can result in

shortage of cash & over-trading in several ways like—Using working capital for purchase of fixed assets.Attempting to expand the volume of business withoutraising necessary resources.

•Over-Expansion :- In national emergencies like war,natural calamities etc. a firm may require to produce goodson a larger scale. The government may pressurise themanufacturers to increase the volume of productionwithout providing for adequate finances.

•Inflation & Rising Prices:- inflationary trend in the economyputs pressure on the prices of the resources. Themanufacturer needs more cash resources even tomaintain the existing level of activity.

• Excessive Taxation:- Heavy taxes result in depletion of

cash resources at a scale higher than what is justified. Thecash position is further strained on account of efforts to thecompany to maintain reasonable dividend rates for theirshareholders.

CONSEQUENCES OF OVER-TRADING •Difficulty in Paying Wages & Taxes – Leads to

insecurity & dissatisfaction among the labour & affects the reputation of the company in the business. •Costly Purchases-

•Reduction in Sales- Company may suffer in terms ofsales because cash needs may compel it to offer liberalcash discounts to debtors & also resort to distress sale.•Difficulties in making payments- Will force the company to persuade creditors to extend credit facilities. •Obsolete Plant & Machinery-

SYMPTOMS & REMEDIES FOR OVERTRADING

Symptoms•Considerable rise in amount of creditors as compared to debtors•Increased bank borrowings & corresponding inventories•Purchase of fixed assets from short term funds.•Low current ratio & high turnover ratio.•Fall in working capital turnoverRemedies- Reduce the business or increase finance - Sell or merge with healthy business entity, preferably under the same Management

UNDERTRADING •It is reverse of Overtrading. It means improper & under-utilisation of

funds lying at the disposal of a firm. In such a situation the level oftrading is low as compared to the capital employed in the business.It results in increase in the size of inventories, book debts and cashbalances. Basic cause of undertrading is under-utilisation of thefirm’s resources. This may be due to following causes.•Conservative policies followed by the management. •Non-availability or shortage of basic facilities necessary for production such as, raw materials, labour, power etc. •General depression in the market resulting in fall in the demand.

SYMPTOMS •High current ratio. •Low Turnover ratios

•Increase in working capital turnover(working capital/sales)

•CONSEQUENCES•Profits showing declining trend resulting a lower ROI.

•Decline in market value of shares.•Loss of reputation

•REMEDIES•Dynamic & result oriented approach•Diversification and attempt to improve utilisation factor ofthe firm’s resources