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. A shortage of the resources may mean you are unable to deliver on contracts. If you cannot deliver on contracts you will not get paid and may even be liable for a counterclaim for any losses arising from your failure to deliver. This can respectively lead to an inability to pay for company liabilities, thus resulting in tax arrears and a possible breakdown in creditor negotiations.
A lack of a solid business forecast is a cause for concern. If there aren’t any defined objectives for entering a trade, too many opportunities may result in more ‘cash’ in the short term, but a lack of stability in the long term.
Often, seasonal trends can prove costly for businesses and proper forecasts must be put in place to account for this. Company resources at specific periods in the year, or a sudden increase in a particular stock, may need to be dealt with. If your company doesn’t collect the money efficiently, your liabilities may increase. For instance, even a late payment of one day to your corporation tax can incur penalties, and significantly reduce your working capital.
Overtrading is responsible for a large number of company insolvencies in the UK, most notably Carillion. The collapse of Carillion, Britain’s second-largest builder, has been attributed to, amongst other reasons, taking on too many projects. Overreach at Carillion was detected in 2013, when they began to build contracts which were deemed a ‘risk’. To add to the problems, borrowing spiralled out of control to an average of 925 million in 2017. More information can be found on the dissolution of the construction company here.
Carillion is just one example of a company failing to provide a realistic business forecast. The latest insolvency figures for Q1 in 2018 tell a similar tale. The total number of insolvencies in Q1 are at their highest since Q1 in 2014, driven by an increase in creditor voluntary liquidations and, in the case of Carillion, compulsory liquidations.
As a director, you should be aware of the particular signs of overtrading to ensure your business doesn’t follow suit of the likes of Carillion.
A company that repeatedly has to dip into an overdraft and borrow cash regularly is a warning sign. Often, unexpected expenses - such as licensing and software - may be required one month and, without the cash reserves, you could compromise your company’s financial health. It’s also important to note that SMEs may struggle to obtain business credit, so you need alternative methods of finance in place.
Often, we see companies that cut costs and, subsequently, profit margins in an attempt to improve sales. As you reduce your profit margins, you are making it ever difficult to sustain a business - especially in a rapidly changing marketplace. In the long term, you may even hinder your company as you will have to work harder to initially gain sales.
As mentioned above, excessive borrowing will alert your lenders to financial difficulties. Borrowing money to pay invoices and suppliers each month is certainly not sustainable. In some cases, the banks may even ask for a personal guarantee from the directors, thus putting you at risk of any liabilities.
Initially, most suppliers will be happy to provide additional resources to meet demand. However, if you begin to fall behind on payments, they may reduce your stock - further complicating your situation if you are without resources, and suppliers to help. Essentially, your company will lack working capital and the supplies to carry on. If you believe your business is facing this issue, you must seek immediate debt management advice.
Be aware that insolvency occurs when there are insufficient resources to pay debts as they fall due, and the number of liabilities exceeds the assets. Therefore, keeping an eye on cash flow is critical to maintaining a healthy business. You must also ensure that you prepare regular and realistic business forecasts, taking into account historical and competitor records.
Leasing the required company assets may free up some available cash flow, particularly as you are not buying them outright. However you should always consider whether buying second hand equipment at a reduced price would also cover the issue.
Try to find ways to reduce costs that will not affect your ability to deliver your services / contracts.
You could attempt to negotiate new payment terms with your suppliers and creditors, in an attempt to provide your company with breathing space. However, if you habitually offer late payments - you must be aware that your creditors could issue a winding up petition to recoup their losses.
If you already fear you are at the stage of overtrading, it’s worth noting the alternative methods of business finance. Similarly, we suggest seeking immediate advice to ensure you avoid insolvency and, possibly, the closure of your company. Our business rescue experts can discuss your concerns and provide ideas and advice to find a solution for your cash flow issues. Alternatively, we can advise if you are already facing the early signs of insolvency.