What is overtrading?
Overtrading is an example of the ways in which a company might find that its success has run away with it  even to its detriment. Learn everything you need to know about overtrading in accounting, from the causes of overtrading to the effects of overtrading, right here. Overtrading can occur in any kind of business, but its most often associated with retailers. Its also much more common in start-ups and small businesses than it is in big, established chains. This is often because larger businesses are more likely to have a cushion in the event of big expenses, while longer-standing establishments are likely to have a better forecast of upcoming income and expenses. Overtrading in accounting  In accounting terms, overtrading essentially refers to when more money leaves the business than comes into it  or, more specifically, money leaves the business before it comes in. Often, youll find that your books are balanced in relation to the money owed, but you may be paying your suppliers before collecting your money from your customers. Similarly, some businesses struggle to cover wages when theyre owed earlier than incoming payments. In other instances, overtrading occurs when youre required to pay cash advances, make sales on credit or to hold stock for extended periods of time. Again, you may know that the money is or will eventually be owed to you, but it can make it difficult to organise your finances in the meantime. This makes it particularly important to keep a record of your finances in relation to both money owed and actual income and expenditure. You should be comparing these figures regularly, so you know whether youll have cash flowing in or out of the business before youre ready. Causes of overtrading  As mentioned, overtrading can come about in a variety of different ways. Sometimes, its caused by the disparity between payment periods. For example, you may have Direct Debits coming into your business on a monthly basis, but you may be required to pay out wages on a weekly basis. In this case, it can be easy to find your books unbalanced. This issue becomes overtrading when you accept work that you wont then be able to fulfil. This could be because you cant cover the labour costs or material costs of delivering an order until you receive the necessary payment. In some cases, businesses will simply ask for payment upfront to cover the costs, but this is not always a feasible option  especially if youre operating as a new business that has yet to establish itself. Effects of overtrading  Overtrading can have a number of effects in relation to both your finances and your businesss wellbeing. One of the key effects of overtrading is that it can lead to immense stress if youre trying to fulfil orders without the necessary resources. This stress can often be passed along to your workforce, creating a difficult working environment. Theres also the risk that the impact will eventually reach your customers. If you take on business that youre unable to fulfil either at all or to the appropriate standard, you risk losing customers. In more extreme cases, you may even face action for a breach of contract or non-fulfilment. This can damage your reputation within the industry and make it difficult for your business to recover from losses. Overtrading ratio analysis  An overtrading ratio analysis is a way of staying on top of your finances and preventing overtrading  or undertrading  before it occurs. Its easy to conduct an overtrading ratio analysis: simply divide your net sales by your tangible net worth. We can help  GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments.