Overtrading

Overtrading is often caused by unforeseen events such as manufacture or delivery taking longer than anticipated, resulting in cashflow being impaired. More specifically in the construction industry, the delayed final sale of a project may also be the unforeseen event that leads to cashflow restrictions.

·         Just in time stock

·         Trade debtors

·         Trade creditors

·         The bank balance

·         Cashflow forecasts

Current assets, made up of stock which can be sold to inject cash into the business, and trade debtors, money owed to you usually within the next 30 days.

Current liabilities consist mainly of, trade creditors, money owed which will become due in the near future, usually the next 30 days. In addition bank loans and over draft repayments which will be due in the next year and any payments due to HMRC for VAT/PAYE or corporation tax will also be current liabilities.

By offsetting your current liabilities against current assets you can establish your working capital, which is a measure of how much cash is flowing either into or out of your business.

A positive figure indicates that cash is flowing into the business, a negative figure is a sign that you owe more money than is coming in, in which case you should take some time to review your position with a member of our staff.

Upon determining the working capital, you should review the mix of stock to trade debtors held in your current assets. The reasons behind this being, trade debtors are legally bound to pay and stock can diminish in value over time.

Just in time stock, buying stock based on seasonal trends is essential to ensure that working capital is not tied up too soon, use an average of two years sales results to determine peaks and troughs over the year. Now place your orders with suppliers based on what you have left in stock and what you predict to use in the near future, allow for a standard growth in sales year upon year as your business grows. Remember to take into account delivery times and stock used up to the delivery date when calculating your order.

A potential disadvantage of just in time stock can be anomalies in the sales trends, which lead to stock running out. In which case you have a choice, you could order emergency stock, depending on your supplier’s additional charges and response time. Or you could accept the lost sales as a sacrifice for improved cashflow and stability in your business.

Trade debtors, although a large trade debtors figure will provide an impressive working capital figure, the quality of this debt will ultimately determine how healthy your business is.

As a rough guide to how quickly you receive payment, you can divide your trade debtors by your sales turnover and times that figure by the number of trading days so far that year. The resulting figure is the average number of days it takes to receive payment.

Ways to reduce this figure can be:

• Reset your standard terms for payment to a shorter period.

• Offer early payment discount, when determining the discount take into consideration the bank interest (net of tax) lost by the debtor if they were to take  advantage of your discount.

• Factoring, where a third party will lend you the invoiced amount and chase the outstanding payments on your behalf, in return for a percentage of the invoiced amount. If the debt becomes bad, they have the right to collect in their loan to you and return the responsibility of collecting the debt.

• Encourage automated payments, direct debits and BACS payments can be life savers. Although care must be taken that you don’t become a loan facility, effectively offering 0% interest, by invoicing more than you collect in on a monthly basis.

Bad debts, at some point you will incur a bad debt, unfortunately there is no way to avoid it. The question is when and how best to mitigate the loss. There are two key ways, either by requesting personal guarantees buy customers or by restricting the hold that one customer has over your turnover. By restricting each customer’s trade you are splitting the probability of a bad debt leaving you unable to meet your fixed annual costs, costs which if unpaid could seal the fate of your business. To determine by how much to restrict a customer’s trade, talk to our staff.

Trade creditors, treat others as you would like to be treated is a motto which has seen many a business through tough times. By establishing a relationship with your suppliers and a reputation as a good payer, when times are hard the rewards of having a friend rather than foe can really pay off.

Don’t forget to include your anticipated monthly drawings in your trade creditors figure.

The bank balance, should act as the buffer zone, absorbing any deviations in your working capital. A percentage of trade debtors should therefore be kept in reserve incase of bad debts, for those who like to sail close to the wind, an over draft facility can be arranged to cover the possibility of bad debts, however this doesn’t come without it’s costs and therefore the gain on re-investing all avaliable bank funds should be compared to the costs of servicing the over draft when you incur a bad debt. In addition, using an over draft provides no secondary provision for further deviations once the limit has been reached, therefore you run the risk of problems should there be a fluctuation in sales following a bad debt.

Cashflow forecasts, the easiest way to prevent over trading is to produce a cashflow forecast, which will map out the future of the business through cash ins and outs as opposed to profit and loss. By using this forecast you can maximise the re-investment in the business without jeopardising the stability. Banks are also more influenced by a cashflow forecast when reviewing loans and over drafts, as it shows a business with a strategy. Talk to us about arranging your forecast, you may be surprised by the results.