Problems of Overtrading in Small Business
Problems and solutions of overtrading.
Overtrading is one of the challenges a small business may face when the business begins to grow. What is overtrading? Overtrading is when a business is selling faster than what its resources can support.
In other words, it means taking more jobs than what a business has the capacity to execute. This situation usually happens when a business seems to be profitable and sales begin to increase in a dimension that is beyond the company’s projections. Ordinarily, increase in sales is good for business. But if the sales are growing too fast in such a way that the company does not have enough resources to support, it can harm the business in the long run. Overtrading symptoms are easy to identify. These include the followings:
- When sales are increasing rapidly.
- Debtor figures are increasing rapidly.
- Creditors are increasing rapidly.
- You are buying too much stock on credit.
- You depend largely on overdraft to run the business.
Read Also: Understanding Working Capital Cycle in Small Business
If you are experiencing the above, they are clear manifestation of overtrading symptoms. Initially, it may seem that the business is booming and everything is going smoothly. Overtrading is actually a problem. If not addressed on time, it can cripple the whole business. Is overtrading that serious? Yes, it is! You may want to know why it is that serious. That is why I will like to discuss the problems that overtrading may cause in a business.
Effects of Overtrading
Before discussing the effects of overtrading, it is important to mention that the main causes of overtrading are lack of adequate planning and insufficient funds. Everything revolves around liquidity problem. But the effects go beyond liquidity. As you know that cash is the live wire of every business. Once a company starts experiencing cash problem, almost every part of the business will also be affected. So, let’s consider the immediate effects of overtrading in business.
Borrowing limit
There is a limit to which a company can depend on overdraft in financing its operations. Initially, a company can quickly turn to its bank to meet its liquidity gap. But as the business continues to grow, the liquidity gap will continue to widen too. Also, the more overdrafts a business take, the more it will be paying on interest. It will get to a point that the company will exceed its borrowing limit. This means that the bank will not be willing to extend further credit to the company. This may paralyse the activities of the company. If the company succeeds in impressing on the bank for more loans, then the loan will be at a higher interest rate. Bank will like to charge more to compensate for the extra risk is taking by extending credit that is beyond the previously agreed limit. When interest rate is too high, the business that was once profitable may become unprofitable. This happens in a competitive market where a company may find it difficult to pass extra costs to its customers.
Slow repayment
A business may find it difficult to pay back loans on time. The business will be in dare need of using the available resources to finance its operations rather than paying back loans. When a company is experiencing overtrading, it is difficult getting new loans. Therefore, the company may be tempted to divert the money meant for loan repayment to the procurement of materials. Also, it will be difficult for the company to meet up with the suppliers’ credit terms.
Suppliers failing to supply on credit
By the time a company starts defaulting in paying for the goods bought on credit from its suppliers, the suppliers in reaction to this may stop extending further credits too. The implication of this is that the company may not have sufficient raw materials to produce its products. If the company is into buying and selling, this means that the company will not have enough inventories to sell. It may start cutting down the volume of what it buys or streamlining its products range.
Inability to meet customers’ needs
Since the business is growing, there is likelihood that the customers’ need will be growing too. Besides, new customers will continue to add to the existing ones. If a company is experiencing overtrading, it will be difficult for it to meet the growing needs of its customers. The company may not be able to secure goods on credit from its suppliers any longer. Unfortunately, this can also affect cash customers too.
Negative feedbacks and comments
The problem of overtrading can actually compound into a bigger problem. If the company is unable to satisfy its customers, the customers begin to pass negative comments about the company. With various social media we have around, negative comments can travel as fast as light these days. Before the affected company gets to know about it, the deed must have been done. It may take a lot of investment in media campaigns and soliciting before the company can control the damage and then win the hearts of its customers back.
Read Also: How to turn your customers into marketers
Labour crisis
During overtrading, there will be too much pressure on employees to work very hard so that they can meet the rising customers’ demands. They may need to work overtime. This may not be a problem if the company pays them. But as a result of the pressure on the financial resources of the company, the company may not afford to pay extra for the extra efforts being put in by its employees. If a company is experiencing overtrading, it is possible that wages and salaries will not be paid as at when due. This can lead to labour crisis. The effects of this are better imagined.
Operational inefficiency
A hungry man is an angry man. It takes satisfied employees to work together as a team. In a period of overtrading, it will not be too long before one start noticing inefficiencies in production, operations and accounting. In fact, the accountant will be too much on pressure to even face his core assignments. He may end up chasing debtors throughout the day. Inefficiency in production can lead to wastage and manufacturing of products with defects.
It is actually better to prevent overtrading than to correct it. Prevention is better than cure. Adequate funding and cash flow projections may help you avoid this type of situation. When you are projecting, it is better to overestimate the debtors’ payment period and under-estimate creditors’ repayment period. If you notice any gap, you can quickly plan ahead on how to source for funds before the cash flow problems occur.
Overtrading Solutions
If you are already experiencing overtrading symptoms, you can take the following steps to correct the trend.
Inject fresh capital
You need fresh capital that you can use as permanent working capital instead of depending on overdraft. This may require bringing in new partner. However, you need to exercise caution and ensure that the new partner shares the same values and lifestyles with you. It should be somebody you can trust with resources. Please, look before you leap. You can also consider other options of sourcing funds.
Read Also: Funding Options for Small Businesses
Reduce trading activities
Overtrading is doing beyond what your capacity can carry. It makes sense to scale down to the level that your available resources can support. Rome is not built in a day. Don’t be too aggressive in your growth ambition.
Negotiate new payment terms
You can negotiate new payment terms with your customers and suppliers. Try to negotiate for the extension of credit terms you enjoy from your suppliers to a longer period. Also, reduce the credit term you offer to your customers. You can also have more of cash customers than credit customers. With this, you will be able to bridge your liquidity gap.