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Overtrading

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After nearly 18 months of lockdowns and the constant interruptions to trade, having too much business seems like a problem every director would take in a heartbeat, but overtrading is a real issue that needs to be identified early and carefully  managed.

What is overtrading?

As The Specials put it ‘You’ve done too much, much too young’, although I’m not sure they were concerned about cashflow and balance sheet insolvency, staffing issues, delivery of goods and services, and breach of contract claims! Overtrading is essentially taking on more than you can handle or doing too much: a new large contract, a sudden increase in business, or other additional activities that consume resources and divert your attention from traditional sustainable sources of income.

Why is having too much work a problem?

Well, there are several knock on effects from overtrading which include:

  • Lack of cash – stock, staff, equipment, and services consume cash. A sudden increase in workload will require more resource which the business needs to acquire.
  • Increased borrowing – Funding a significant investment in stock, machinery, premises, or equipment in order to service an increase in demand is expensive. While such purchases may be funded by borrowing, unless the investment delivers sustainable profitable income, sufficient to discharge the interest and capital repayments, as well as the additional costs associated with the expansion such as higher rent, maintenance costs, and employee costs, the business may find itself in an unsustainable position should demand recede.
  • Reduced profit – it can be tempting to bid for a big contract or look to acquire market share on the basis of reduced margins, but servicing the delivery of the work may actually cost more than ‘normal’ business. Staff overtime, finance costs, and funding the working capital cycle can all eat away at margins and reduce headline profitability.
  • Supply chain issues – Existing suppliers may not be able to meet the demands you make. They may require additional upfront payments, stricter credit limits or increased prices; and there is a significant risk of a breakdown in ongoing supply chains if, through overtrading, you are unable to maintain payments to your suppliers while waiting for the increased trade to turn into cash in your bank account.
  • Customer dissatisfaction – whether failing to deliver on promises to customers, poor quality products or services because of increased pressure and insufficient resources, or ultimately breach of contract claims, customer dissatisfaction will see them migrate to competitors, leaving your business with a cost base which is unserviceable on the basis of the remaining demand. If in the rush for growth some traditional customers have been overlooked, they may have sourced new suppliers, leaving the business with weak foundations.
  • Employee exhaustion – you can’t do anything without people. Pushing employees to breaking point, especially after the stress and worry of Coronavirus, will increase mental health issues, cause illness, and ultimately see staff seek alternative employment. Staff leaving during a period during which the business is growing will cause additional pressure on those left behind, and the problem can quickly snowball. Look after your employees and your employees will look after your business.

If identified early, any of the effects of overtrading can be managed and it doesn’t need to cause the business irrecoverable damage. However, if left unchecked any of the above symptoms can spread and become a downward spiral which is difficult to arrest.

As lockdowns end and we learn to live with Coronavirus, demand will increase. Consumers have cash to spend, businesses will want products and services to sell, while various market trends will have changed, meaning there is the opportunity for growth. Being alive to the risks of overtrading, having a sustainable plan to benefit from growth opportunities, and being able to spot symptoms of overtrading early, will give directors the confidence to come back from the pandemic stronger.

Should you identify one or more of the effects of overtrading and have concerns about its impact on your business, Mercer & Hole’s Corporate Restructuring team are experienced in working with businesses to overcome such threats and plan for a successful future.

Henry Page Corporate Restructuring Partner

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