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Avoiding the Risk of Overtrading

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Following 15th June 2020, many businesses are now able to open their doors for business as the rules for the lockdown continue to be eased. However, what your business looked like before the COVID-19 pandemic may not be what you are looking at as we exit lockdown. For business owners in that position, overtrading will be a key risk, here we look at it in more detail.

What is “overtrading”?

Overtrading occurs when a business expands too quickly without having the resources in place to support that expansion. It is a common cause of failure of start-up businesses and those which are growing, as it usually happens when work is taken on but without the business owners necessarily thinking through how they will be able to deliver that work. In particular, it can happen where you take on a project but purchases and costs are required by the business before the invoice is raised and paid, meaning that there is a cash “ask” for the business before it gets to the point where the cash is paid over. Cash flow is often stretched beyond breaking point at these times, and the company begins a decline before they are paid by their customer.

Managing growth can be quite challenging

At a minimum, a business needs to be able to generate sufficient cash flow to keep trading but it also needs to grow in order to be able to earn an economic return. Many business owners are extremely passionate about their businesses, especially in SMEs, and it can be difficult for them to evaluate accurately whether their rate of growth is sustainable. Ordinarily, this is when there is the highest risk of overtrading.

What are the warning signs?

If you have orders but are struggling for cash, then you may be at risk of overtrading. Usually, this manifests itself by the business becoming increasingly reliant on support from its bank or funder (such as using an overdraft facility more often than previously or, where you have an invoice discounting facility, needing additional drawdowns on an increasingly frequent basis). However, difficulties managing cash flow do not mean that the business is in financial trouble. Often, the business owners are not disciplined enough with managing their cash collection and payments out but as we exit the lockdown, this will likely prove to be a key skill.

Why will it be an issue with the pandemic?

Many business owners will be at risk of overtrading as they start back up again as they look to re-establish their business at similar levels of trading as prior to the pandemic starting. Conscious of the lost revenue, they will be keen to make up for lost time and may look to take on either the same or additional levels of work to make up for the gap. However, working capital is likely to have been reduced significantly if your business has been in survival mode. Having the resources to manage pre-pandemic levels of trading, especially when you have to take into account the social distancing measures that are now in force, may be unachievable.

You may also be at risk of overtrading if you have inventory which you have not being able to convert into work in progress and/or cash. This will be prevalent in many manufacturing and retail businesses at the moment, with the supply chain having been interrupted whilst the business has not been able to convert stock to cash. We have seen a number of high-profile retail businesses enter into formal insolvency processes during the past few months (Debenhams, Oasis, Warehouse, Laura Ashley, etc) and the inability to derive any benefit from the stock in hand due to the pandemic would have likely been a contributory factor to these failures.

Continue to monitor your cash

Cash management will continue to be a vital tool. Maintaining a short term cashflow forecast on a rolling 13-week basis will assist you in monitoring what collections are due in, what invoices can be paid and when and where your focus on managing costs should be. Whilst you may now wish to pay all of the liabilities outstanding from both before the lockdown and during it, you will still need to manage payments whilst your cash reserves are limited. Preparing longer term projections will help you to establish what the position looks like over the medium term and this will help with identifying areas which might need some costs management or reduction.

Keep looking ahead, but don’t forget the past

Your business plan and projections should be focused on the next few months and how you intend to get your business to a point where it is returning to semblance of normality. This may take time but by plotting out how you intend to achieve your aims, it will help to keep you and your business on the right track. However, many businesses will have deferred payment obligations (including VAT and loan repayments) and you will need to ensure that these payments are factored into any forecasts once you have to restart trading. If you have taken advantage of the Government’s loan offerings, you will need to include the payment dates for those loans in your projections too.

In summary

The return to work will raise many challenges for business owners, not least the risk of overtrading, which is a common cause of business failure. Taking measured steps, accepting that it might take a while for your turnover to return to pre-pandemic levels, and managing costs with that in mind will set you on the right path. The exit to the lockdown will be a marathon, not a sprint, and any plan you have will need to be written on this basis otherwise you may find your business becomes another victim to the pandemic. If you are struggling to manage your cashflow, having someone independent to look at it objectively can be a real benefit, especially where working capital is lacking.


For advice on managing your cashflow dueing the pandemic, please call Heather Bamforth on 07900 263 235 or email heather.bamforth@armstrongwatson.co.uk.

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