Article reviewed July 2024
Overtrading may seem like a good problem to have in business – after all, landing a big contract means more orders and more sales. However, the risks of overtrading shouldn’t be ignored. A sudden rise in demand can seem great at first, but does your business have the financial resources to handle the influx of work?
Failing to put measures in place for sustainable growth can create cash flow issues, which is why we’re sharing 10 practical tips for preventing overtrading.
What is overtrading?
Overtrading happens when your business doesn’t have the resources – stock, staff, supplies - to fulfil orders before being paid. Even profitable businesses can struggle with overtrading if you don’t manage working capital effectively and you’re not prepared for the level of growth you’re experiencing. Whether you’ve just launched a start up or are an established business looking to expand, overtrading can happen to any business.
What causes overtrading?
At its core, overtrading is all about how much working capital you have to work with. If it’s all tied up in stock, then your business will struggle to buy the materials for the big order you’ve just received. Even though landing a major contract sounds like it can’t have any downsides, if your business doesn’t have the working capital at hand to manage the costs before you get paid, you can quickly run into trouble.
Rising production costs, delays in your manufacturing process, peak trading seasons or low profit margins can also result in overtrading, as they directly impact your cash flow. Late payments are another contributing factor, leading to reduced working capital as you wait for invoices to be paid.
Why is it an issue and what could happen?
Ultimately, overtrading can lead to insolvency and a business failing. A shortage of cash and unsustainable borrowing can also negatively impact on the quality of your service or products.
How can you avoid overtrading?
If you think your business might be in danger of overtrading, don’t panic. With some careful planning, there are several things you can do to help safeguard your business from the pitfalls of overtrading.
- Keep an eye on your cash flow and working capital.
- Look at your stock levels. Do you have too much working capital tied up in stock, supplies or materials? Consider reducing your inventory if you’re experiencing low turnover, or only order when necessary. This will free up cash for other areas of your business.
- Should you scale back? Don’t be afraid to slow your growth to a manageable and sustainable level. It can be hard to turn down sales, but you need to ensure your business can deliver the order to your expected standard and on time, so you don’t damage your reputation.
- Consider leasing or hire purchase. Buying equipment or machinery to complete new contracts can be a costly upfront investment if you haven’t received payment yet, so investigate how you could spread the payments in an affordable way.
- Alternative finance such as invoice finance and invoice discounting can be a safety net to ensure your cash flow runs smoothly and you have the money you need to pay for your outgoings. Not sure if this is the right option for you? FSB Funding Platform can provide impartial advice and help you to find the right business finance for your business.
- Negotiate new payment terms with suppliers. Can you extend your payments to suppliers in exchange for regular orders?
- Tackle late payments. Services like FSB Debt Recovery offer 24/7 advice and support for small business owners facing unpaid invoices.
- Can you reduce your costs? Cutting back where you can and improving the efficiency of your business can free up extra cash and give you a buffer.
- Change your payment methods. If you aren’t already, adding automated payment options from customers or clients, like BACS, can result in faster and reliable payments.
- Encourage customers to pay sooner by offering a discount or ask for a deposit upfront to cover costs.