Overtrading occurs when a business isn’t able to meet the demand for its products or services. This can have many knock-on effects, including issues with finishing promised projects, delays in customers receiving your product or your service level dropping below your normal standards.
This can lead to a bad customer experience, a decline in your reputation and, if you leave it too long, possibly a detriment to your finances.
If this is sounding a little familiar, don’t worry. Keep reading to find out more about how to recognise the early stages of overtrading and what you can do to prevent it.
What Does Overtrading Mean?
Overtrading is when a business can’t fulfil its orders or contracts, meaning you don’t get paid for them. It can come about due to several factors, such as issues with your manufacturer, staff shortages, and even supply problems.
In an absolute worst-case scenario, a business that finds itself overtrading could see its doors closing for good. However, there are a number of ways businesses can reduce the chances of overtrading if they keep a close eye on their cash flow and ensure they have a clear growth structure in place to make sure they can fulfil a rise in demand.
Why is Overtrading Bad?
Overtrading often triggers a business’s finances to spiral out of control. If your business is spending money quicker than it’s bringing it in, it’s likely that at some point you’re not going to be able to keep up with your outgoings.
To combat this, a business might try to keep accepting orders that they know they won’t be able to fulfil. This can only lead to unbalanced finances, and with no money in the bank, it suddenly becomes tricky to cover things like staff wages and utilities.
As you can imagine, a customer receiving a sub-par service or product (or none at all!) isn’t going to be a happy one. In some cases, a business could even face legal action if they’re not able to refund clients they’ve been unable to service.
Once your business gets here, it can be difficult to come back around. That’s why it’s important to have measures in place to avoid overtrading altogether, and keep a close eye out for any potential warning signs.
Overtrading vs Undertrading
As you’d expect, undertrading is the opposite of overtrading. Instead of being unable to meet the demand for their products or services, an undertrading business has healthy cash reserves but isn’t using them effectively.
This can be equally as detrimental for business. A company that isn’t reinvesting its profits to retain their staff members or develop could see a decline in demand over time.
Undertrading is usually the result poor management. A company with a thought out structure and well-developed organisation chart are less likely to fall victim to undertrading.
Common Signs of Overtrading?
The warning signs of overtrading will vary depending on your business sector and type. Here are a few of the most common, however, to keep an eye out for:
1. Poor Cash Flow
If you haven’t planned for all costs, or don’t have the reserves to pay for unexpected ones, your ability to provide key products and services could be severely affected.
2. Lower Profit Margins
A dip in your profits could indicate a drop in demand or an increase in competition. If profits drop, your cash flow could be affected.
3. Regularly Borrowing Money
If you find you’re needing to borrow cash to pay your team and bills each month, this could be a sign your business is no longer sustainable.
How to Avoid Overtrading
As your business grows, unfortunately, the chances of overtrading increase.
There are some things you’ll never be able to control, such as the economy and customer demand, but there are still plenty of steps you can take to try and protect your business.
The most important thing you can do is manage your finances effectively. That means having a solid grasp of your business’s cash flow, budgeting, and checking that your business’s assets equal its liabilities and equity with a balance sheet.
Here are some other things you can do to avoid overtrading:
1. Issue Late Payment Letters
If a client consistently pays late, it can significantly disrupt your cash flow. Sending reminders to your clients who haven’t paid on time will encourage them to send over the funds and keep your finances ticking over.
2. Carry Out a PESTLE Analysis
Taking stock of the political, economic, social, technology, legal, and environmental factors affecting your business can help you to plan for the future.
3. Manage Your Supply Chain
Controlling the flow of products and materials you need to run your business can be challenging. That’s why getting to grips with supply chain management can increase your chances of being able to service demand.
How to Overcome Overtrading
If you’ve been reading so far, and you’re concerned that your business has shown some signs of overtrading, there are some steps you can take to get your business back on track.
Here are some of the most effective ways to do so:
1. Try Invoice Finance
This can be used to access cash if you’re waiting for payments from clients.
2. Use Hire Purchase
Spreading the cost of expensive equipment or assets can help to keep your spending down.
3. Scale Back Growth
If you’re growing too quickly, keeping up with demand could be tricky. Improving processes and infrastructure first could help to secure your long-term future.
4. Grow Your Workforce
If you can’t keep up with demand or finish projects on time, adding more members to your team could make a big difference.
5. Change Suppliers
Supply chain issues could hurt your cash flow. If you’ve been having ongoing issues, swapping to a new supplier could help to get things moving again.
And there you have it, our full guide to what overtrading is and how you can avoid it.
Hopefully, it's given you all of the information you need to keep your business on the right track and avoid running into any potential issues.
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