Over-trading is a common problem among novice traders and investors. This phenomenon occurs when someone places too many trades in a short period of time, often in an attempt to capitalize on short-term market movements.
While this strategy may seem like a good way to earn quick returns, it often leads to disastrous results. Not only does over-trading expose traders to excessive risks, but it can also cause them to miss out on other more profitable opportunities.
Ultimately, the best approach for anyone looking to successfully trade in the markets is to adopt a steady and consistent strategy that allows them to achieve their goals without taking undue risks or overloading their portfolios with unnecessary trades.
This is a prime example of how over-trading can cause cash flow problems. As a director, you should be aware of the particular signs of overtrading to ensure your business doesn’t follow suit of a number of high profile businesses.
What Is Overtrading?
Overtrading is a very serious threat to any company. If left unchecked, several dangers could even result in the closure of your company. Overtrading typically occurs when a business grows at a staggering rate.
Suddenly, the business requires new resources, such as increased staff, stock and, perhaps, even more office and warehousing space, having a clear idea of what is cash flow and how to utilise working capital to ensure you do not overtrade.
What else can cause overtrading?
This is a curious and often overlooked problem for small businesses. When you’re setting out and thinking about the risks to your enterprise, you might be thinking about what happens if demand dries up, the economy changes or if a big client can’t pay in time. You may not have thought about what happens if business is simply too good.
The problem is this: doing business costs money. This is a bigger problem for some companies than others. For example, the construction industry is notoriously front-loaded.
To do a job, the company will have to invest heavily in workers and equipment, but they only receive payment at the end. To survive they must ensure they have enough money in the bank to meet all their obligations until their invoices are paid.
This is where the difference between cash flow and profit comes into play, and business owners need to check the companies financial statements to understand what the differences are.
Why over-trading is a problem
Difficulties can then arise if the orders come in too quickly. As a business operating in a competitive environment, you may feel obliged to take the business. After all, if you don’t one of your competitors will. Equally all that business coming in can light up the eyes of even the most cautious business leader.
They see a big contract coming in and sub-consciously they count that money as part of their overall cash situation and that’s the big mistake because that money isn’t in the account and won’t be until the project is completed.
This, then, is something of an Icarus effect. The company is flying too high too soon. It is taking too big an investment onto its shoulders without getting the money in the bank. As such, it may have put itself in a precarious financial position without realising it. To survive, they need all that money to come in quickly before they have to meet their own payment terms.
Unfortunately, there is no guarantee that this will happen. Clients may pay late, projects can be more expensive than you expect or may run past their deadline. Your customers might not be happy with the end result and request a refund. There are all sorts of problems which could occur between the time you make a sale, and the time that money hits your account.
How to avoid overtrading
- Being aware of the possibility and significance of overtrading is the first step in avoiding it.
- Insolvency occurs when there is insufficient cash with which to pay the bills as they fall due or if the company’s liabilities are greater than the total of its assets.
- Preparing cash flow and monthly management forecasts helps to highlight when a cash shortfall is likely. This also allows directors the opportunity to secure finance if necessary.
- Making sure that stock is turned as quickly as possible. Ordering materials just before it’s needed, rather than too months in advance.
- Effective credit control supports healthy cash flow. This provides the working capital needed on a day-to-day basis. Offering credit limits to new and existing customers.
- Chasing payments rigorously using an effective credit control system is key to avoiding overtrading.
Managing business finances
The problem can be compounded by the fact that many businesses do not have a clear view of their financial situation. Accounts systems can be inefficient and financial statements might be out of date. It is also all too easy to over-estimate income and under-estimate expenses. If a big bill becomes due and the money isn’t in your account to settle it, you’ll be in trouble before you know it.
There are ways around the problem. The first is to become more effective at managing your finances. Advances in accounts system enable you to get a clear real-time view of your true financial position. You can see what’s in your account, what you have to pay and what is coming in. It can reduce accounting errors and help you make more informed decisions. If you are about to hit trouble it can give you advance warning and help you to make plans ahead of time.
Overcoming cash flow problems
So, how can you solve this problem? The simplest option could be to avoid the problem of over-trading in the first place and avoid running out of money. Only take on as much work as you can manage. This will reduce your risks, but it will also risk losing clients – many of which may become loyal customers in the future.
To ensure you can take on this business, while also avoiding a cashflow crisis, you may also look at a number of financing options. This might include:
- Business loan: If you have a lot of work on your books, but not much money in your account, your bank may be willing to advance you a loan. This will obviously depend on your own credit rating and may be expensive, depending on the interest rate they charge.
- Merchant cash advance: involves a cash advance based on projected credit and debit card sales. You will then pay a percentage of future sales until the sum has been paid back. This is ideal for those companies which manage a lot of business via credit and debit cards and also offers a flexible repayment option in that repayments will rise or fall depending on how much money you’re bringing in.
- Invoice finance: A provider will give you a portion of your unpaid invoices. They will then chase your clients for payment and, once that is received, return the remaining sum to you, minus their fees.
The idea that over-trading can be a problem for your business is counter intuitive, but it’s one you need to think about. While you won’t necessarily need to avoid taking on clients, it is a good idea to ensure you have a clear view of your finances and have a plan in place to avoid any cash flow problems if they arise.
Over trading cash flow solution
Invoice Funding are one of the UK’s leading Invoice Factoring and Invoice Discounting Brokers. Having funded 1000’s of companies since we started trading in 2000 with over trading cash flow solutions.
Invoice Funding have a solution to businesses that over trade by releasing tied up cash in un paid invoices. Invoice Finance is the perfect fit for this to enable you to carry on trading while ensuring suppliers, contractors and staff are paid. if you would like more information on an over trading solution please complete the online enquiry.
Seasoned professional with a strong passion for the world of business finance. With over twenty years of dedicated experience in the field, my journey into the world of business finance began with a relentless curiosity for understanding the intricate workings of financial systems.