What is Overtrading and why you need to know if you’re reopening
For the thousands of retail and hospitality businesses along with many other sectors that can finally begin the process of reopening and welcoming customers into their premises once again – it might have felt even longer.
Business owners and directors will have a hundred and one things on their minds during this frantic fortnight since certain industries were allowed to reopen with some safety measures and conditions still in place.
Some might have to physically restructure their premises to make them compliant and compatible with current rules, others will have had to hire or rehire staff to operate and all will have had to consider restocking and preparing to go from zero to 100 mph when it comes to physically serving customers again.
So it’s understandable if they’re paying little attention to important business concepts such as overtrading.
If they’re finally taking money in the tills again, they don’t need to worry about things like that, right?
In this blog we’ll remind you what overtrading is and what you can do to avoid it and concentrate on making 2021 a year of real recovery.
What is Overtrading?
The most common cause of overtrading doesn’t sound like a bad thing at all – that’s why it’s so insidious and catches directors by surprise.
Growth. Amazing, huge growth in a short period of time.
Isn’t this what every business thinks is a best case scenario?
Well let’s consider it in action.
Business X reopens after lockdown and immediately becomes a big hit with customers once again. The owners are delighted and looking forward to taking advantage of this wave of custom and money coming in after having to rely on bounce back loans and staff furloughs for the past year.
The demand keeps growing so they realise they need additional resources to keep up. They need to hire more staff, buy more stock, maybe even looking at expanding the premises and/or storage capacity to handle it.
But if this demand outstrips supply, even for a short term, then the business might not be able to fulfill its contractual obligations with its suppliers.
Not being able to deliver on contracts means not getting paid. Not getting paid means no money to fund these essential expansions and worse, can cause a breakdown in trust and relationships, can leave the business open to legal claims for repayment and even in the most serious cases lead to tax arrears building up.
Overtrading doesn’t just affect smaller businesses with limited resources. Carillion, one of the largest public service companies in the UK with thousands of employees, eventually went into compulsory liquidation as a result of taking on too many contracts without the necessary resources to see them through to completion.
A silver lining on the overtrading cloud is that it doesn’t happen overnight.
It’s a gradual process with telltale signs and signifiers that will give the savvy owner some warning and a chance to correct things before they get too far out of hand.
So what do they need to watch out for?
- Cash flow problems
Regularly going into the red is a literal warning sign for any business. Even with an agreed borrowing facility like an overdraft.
True, not every company can store large cash reserves, especially after the unprecedented trading restrictions experienced in the past year, but there are always unexpected expenses.
Software licence runs out, supplier closes and a new one insists on cash payment up front etc. If meeting these inconvenient but essential costs is a struggle then this can be a big warning.
This chain of events could also negatively impact a company’s credit rating and ability to obtain additional funds when needed, so should be avoided at all costs.
Making excessive borrowing requests will put a strain on your relationship with lenders and if they start to ask for more collateral including personal guarantees then this is a sure indication that all is not well.
- Thin profit margins
Sometimes a business will look to cut costs and their profit margins temporarily in order to boost sales.
There might be perfectly logical reasons to adopt this tactic but reducing them makes it more difficult for business to reestablish and regain their liquidity especially in the volatile and fast changing market place we might see in 2021.
Protecting your bottom line might have to be the bottom line if you want your business to have a sustainable future.
- Maintaining suppliers’ support
Under normal circumstances, suppliers will generally be happy to provide additional resources to meet your demand and if you have a good relationship with you then offer favourable credit terms for doing so.
What part of the past 12 months has seemed like normal circumstances to you?
Suppliers are in the same boat as every other business. They need payment, preferably quickly and in full and even if they want to be as flexible as they previously have been, circumstances and their own survival simply might not allow them.
Maintaining supplies is essential for any business, as is a good relationship with their supplier but if there’s a time to avoid asking for credit, preferential terms or paying in arrears then this is it.
How to avoid overtrading
Keeping a positive cash flow and making sure, at all times, that assets exceed liabilities are two of the essential tasks of any business owner or director.
While it’s always easier said or written than done, there are a couple of useful tips that could give you a valuable edge, in the short term, and help you establish a positive growth trajectory for the rest of this year and beyond.
- Fail to prepare, prepare to fail
Don’t think of your business plan and forecasting as rigid, unchanging publications like an A-Z that used to live in a car’s glove box.
Think of them as a SatNav or GPS app that used dynamically, and can help you find the quickest route to profitability and avoid unnecessary hold ups or delays.
Software can automate a lot of accounting functions in a business but even if you’re taking care of this element of your business manually, updating it on at least a quarterly basis, will not only keep it relevant but also keep you rooted to the central plan and mission you formed the business with.
If you’ve been drifting away from this, then a return to focus will reap real benefits and quickly.
- Easy leasing
Purchasing and maintaining assets is a drain on any company so maybe a switch to leasing assets and equipment would create some valuable leeway with your cash flow?
Even purchasing lightly used equipment, software or materials might save money right now rather than committing to a large outlay in a still, uncertain environment.
- Economy drive
When a family is facing tough conditions then they can find ingenious ways to cut their bills and save money – a business is no different.
Conduct a mini-audit with staff to see what efficiencies can be made right now because savings can add up quickly.
Does correspondence have to be posted physically? Can it be sent second class instead of first? Can it be emailed instead of posted? Do you need three floors of an office building when staff only occupy one? Does the business still need company cars with everybody working from home?
Every business is different but one thing they all have in common is the potential to save money and ultimately themselves.
The best thing for any business that fears it might be in danger of overtrading or that it’s been actually wrongful trading is to get professional advice as soon as possible.
Even if they have avoided this outcome, the fact that they are sailing so close to the wind indicates that there’s bigger structural issues that need to be fixed if the business is to have a future of any kind.
Alternatively, this iteration of the business might have reached the end of its natural lifespan and looking to close it down through voluntary liquidation might be the best way forward for the company and its directors.
No matter what they ultimately decide, getting advice and acting on it while they still can is usually the best option.