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….