The King of Cashflow: How overtrading kills businesses, and how to avoid it

Hello Smarta readers, great to be with you. January, eh - it polarises the business world. You're probably having one of the best months of the year (that's you, retailers, fitness companies and electronic cigarette manufacturers) or the worst (pretty much everyone else). Either way, I'll bet you'd like to sell a load more right now, wouldn't you? Tonnes and tonnes more? More sales can only ever be a fantastic thing, right?

WRONG. Big fat wrong.

Because there's this mean old devil known as overtrading that creeps up on you just when sales are going fantastically. Overtrading means selling more than you can handle as a business. It means you might have a pipeline of orders longer than the Great Wall of China, but then discovering you don't actually have the cash or resource available to fulfil those orders.

Typically, overtrading sneaks up on you when your invoices are being paid too late, and/or when sales take off unprecedentedly. You think you're doing amazingly well, then you suddenly find you don't have cash in the bank to pay your own suppliers, or enough working capital to pay wages and bills and rent, even though you've sold more than enough to cover your costs.

Let's take a real-life example to see how easy it is to overtrade unwittingly.

  • You sell "King of Cashflow" T-shirts for £30 a pop (hey, I'm kind of a big deal, it's worth it). You buy the T-shirts from your supplier for £20, making £10 profit.
  • You start January 2013 with £800 in your account.
  • On January 8, you get an order for 20 T-shirts, giving you £200 profit on total sales of £600. Hurrah!
  • On January 10, you get another order for 30 T-shirts, making you £300 profit on the £900 payment. Winning!
  • Except - uh oh - you need to pay your supplier £1,000 to fulfil the two orders of total 50 T-shirts. You only have £800 in your account - and your payment terms are 30 days, which means you won't have the cash in place to get the T-shirts made, despite having sold £1,500 of goods.
  • #overtrade
  • #bizfail

 So how can you avoid overtrading?

  1. Don't just make one sales forecast - make three: best, worst and medium-case scenarios. Draw up cashflow forecasts regularly (at least monthly) to go hand in hand with each of these, but assume worst case scenarios for payment periods. So forecast what would happen if you sold best-case figures, but were paid late by a majority of your debtors. Then make sure you've reserved enough cash to see you through potentially sticky months.
  2. Make sure you are clear (and, if necessary, firm) with customers about payment terms. Invoice immediately and have a process in place for gentle reminders to chase payments - CRM software can help you manage this.
  3. Try to negotiate deals with suppliers whereby you pay them after you've received payment from your own customers.
  4. Try offering discounts to customers who pay their invoices early (without eating into your profit too much).
  5. Crucially, you need to watch out for the key overtrading warning signs...

Warning signs that you're overtrading

  1. Payment terms are slipping - customers are paying after 40 or 50 days, although you set 30-day terms. Consider invoice finance to help you manage late payments.
  2. The quality of your goods or services has dropped (a rise in complaints will indicate this).
  3. You're dipping into your overdraft every month to make it through.
  4. You keep paying your own suppliers late because you don't have the cash in place to meet their payment terms.

Keep an eye on all that lot, and you've got every chance of keeping that demon overtrading at bay, and selling to your heart's content. Happy cashflow management!


The King

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