One of the main objectives for any company is profit maximization, regardless of its size (large, medium or small) the optimum goal is to increase sales revenue and reduce costs at the same time. Although there is nothing wrong with this and that is exactly why many smalls businesses are being established on a daily basis, the problems rises when the business grows too much in just a short period of time and without having sufficient money or credit available to keep on supporting the extra trade that the business is facing; while it doesn’t sound as bad as no having enough customers, overtrading is one of the reasons why some small companies go bust – they are victim of their own success.
Business Financial Problems: Liquidity and Overtrading
Liquidity or Marketability is a simple but sometimes misunderstood term; in simple words is how easy you are able to convert your assets to cash; why is liquidity important for any company and the relationship with overtrading? When a company grows too fast during a short period of time, additional funds are needed to supply the demand for products or services; although the money will be recovered later, it is important that the business meets its financial deadlines and pay its creditors; otherwise will start incurring in penalties for breaching an agreement placed between the two or more parties.
Financial Problems when Overtrading
One of the main signs that your company is overtrading is when the turnover increases dramatically over a short period of time. Although extra revenue is always a boots for any firm, it is important to identify if this growth is sustainable in the long term; proper budgeting systems must be in placed and variance analysis should be performed on a monthly or quarterly basis; however, all significant variance must be justified and dealt with accordingly; for example: a increase in sales for product B was the result of an intensive campaign of Internet Marketing.
A simple variance analysis will give you the signs you are looking for to determine if your business is overtrading, normally a company that is growing too fast and without any control presents a big increase in current assets (inventory and debtors) and decrease in the cash available at bank; additional loans and credit is requested to the bank and since the company is profitable this is normally approved without considering the possible consequences of this action; having cash available to pay taxes, debts and ‘not budgeted’ problems is fundamental for the long term survival.
When a credit sales is made, this normally rises an informal contract between the two parties; one provides the goods needed and the other party agrees to pay at a specific period that depending on the terms, could be 30, 45, 60 days or longer; a company that is overtrading regularly uses its overdraft facility (occurring in interest charges) or delays to pay its debt for long period of times; looking for this sign on time could reduce the interest paid, penalty fees and being blacklisted from our favorite provider.
There are many ways in which your business will be able to increase profit, probably one of the best ones is by an effective online marketing strategy; however the signs of overtrading must be constantly evaluated if your firm is growing too fast.