When growth is the goal, businesses often find themselves tempted to win or take on as much work as possible. Scaling up in this way is known as overtrading, and while it may seem like an active growth strategy, acting in this way can lead to detrimental consequences for the business involved.
Understanding what overtrading is and the problems it may cause is key to developing a more informed and sustainable business growth plan. With this in mind, we have created this comprehensive guide to overtrading in business so you can be aware of how exceeding your means could affect you.
What Is Overtrading In Business?
Overtrading occurs when a business takes on more work, projects or orders than its resources can manage effectively. This can manifest in various ways, such as a business rapidly expanding production beyond its means, extending credit to customers beyond reasonable limits, and even pursuing new markets without a proper plan or infrastructure in place.
At first, actions that contribute to overtrading may look like honest attempts to grow the business. However, overtrading can quickly spiral out of control and lead to the business being unable to deliver on promises made which can have significant implications both financially and in terms of business relationships.
What Are The Causes Of Overtrading?
Overtrading is typically driven by a desire to grow a business as quickly as possible. With big dreams and the losses associated with starting a business to recoup, directors can be tempted to make key decisions without proper planning or consideration of the practicalities. This sense of rashness may quickly lead to the business taking on more work than it can reasonably manage or pursuing opportunities that do not align with proper financial planning and the other long-term goals of the business.
A lack of operational efficiency may also exacerbate the issue of overtrading. At first, it may seem like the business is financially sound and can cope with an increase in demand. However, when demand surges at an unprecedented level as is usually the case when a business overtrades, inefficient processes and inadequate infrastructure may be exposed and be simply unable to keep up with the requirements of an expanding business.
What Are The Dangers Of Overtrading?
Despite growth being the objective, the outcome of overtrading is typically the opposite as it can create several problems for the business involved. Company directors must be aware of these issues so that they can act accordingly if any apply to their own business. The key dangers of overtrading are:
Cash Flow Issues
Cash flow problems are one of the major dangers of overtrading. Cash reserves will deplete quickly when resources are stretched and more stock or materials are required to meet the increased demand. This can then cause financial difficulties as the business may not have the cash needed to support its own transactions and expenses. The business may also turn to additional borrowing to make up the difference, further compromising financial health.
Operational Strain
With increased demand for goods and services, business operations will be put to the test. Productivity and efficiency will be pushed to new levels and small slips or unforeseen changes can push the business beyond its means. This may result in product or service quality suffering to meet demand and is likely to reduce job satisfaction in the workplace as staff are pushed to unreasonable levels.
Damaged Relationships
Without the cash needed for the business to meet its financial obligations and with quality slipping, relationships with customers and suppliers can suffer. Both of these groups may decide to end their interest in or relationship with the business if they do not believe that you have appropriate measures in place to return to prior service levels, hampering long-term growth and prospects.
Next Steps For Businesses
Understanding what overtrading is and what drives businesses towards these actions is key to avoiding making these mistakes yourself. If you are concerned that your business may be operating beyond its means, there are a number of measures you can take to stop overtrading and improve efficiency. If you are concerned that your business is overtrading, don’t hesitate to scale back your operations and make sure that you get in touch with an expert for advice. Being proactive is key to navigating the problems that may arise from overtrading.
For honest and transparent advice about your business, get in touch with the experienced team of business rescue experts here at Ballard Business Recovery. Our team has years of experience helping businesses navigate financial distress and come up with appropriate solutions for both recovery and growth.
