Cash Flow Problems – Overtrading 3/8

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In the third of a series of eight blogs, our banking experts will look at common cash flow problems that businesses encounter. In this blog, Colin Burns discusses a very common type of cash flow problem – over-trading – which can lead to business failure if a business grows too quickly without the right financial resources in place.

What causes over-trading?

Over-trading happens when a company takes on more business than its resources can support. Many business owners spend time worrying about not being able to attract enough work as opposed to taking on too much. When a large order comes in or sales start taking off, there is usually cause for celebration. However, fulfilling increased order levels without the right level of resources may become impossible. Failing to plan for this uptick can catch many businesses off guard.

One of the dangers of over-trading is that productivity, morale and the quality of goods or services delivered can suffer. Employees may be overstretched by working longer hours to fulfil orders. When absence strikes – whether through illness or holidays – corners may be cut to rush orders through. This may result in a reduction in the quality of goods and impede repeat business or extend customer waiting times.

Businesses with a small number of high-value orders need to consider the impact of a customer failing to pay on time. The consequences of being forced to take on additional staff or acquire additional resources to meet demand also need careful consideration. This could leave large overheads when demand slows down. So it is vital that you plan for all eventualities.

What are the key indicators?

The following financial indicators can help you identify if you are over-trading, enabling you to spot warning signs and prevent any long-term damage to your business:

  • Significant growth in sales/receivables.
  • Increase in debtor days.
  • Growth in your cost base.
  • Creditor days.
  • Number and sum of short-term credit lines.
  • Frequent cash shortages.
  • Late supplier payments and debtor receipts.

When faced with a business that is over-trading, these are the steps that key stakeholders within your business should take:

Role of the MD/CEO

The MD needs to take control of the emerging situation by:

  • Establishing the root cause for over-trading.
  • Ensuring resources and capital levels are adequate to support additional incoming business.
  • Making sure the sales pipeline is accurate and visible across the organisation.
  • Deciding whether the profit margin on extra business is sufficiently attractive to justify the risks of taking it on.

Role of the FD

The FD needs to take responsibility for identifying internal and external solutions to protect cash flow by:

  • Establishing the impact of additional business on projected cash flow, stock balances, payables and receivables.
  • Identifying if prompt invoicing, modified contract terms or discounting could help manage faster cash receipts.
  • Negotiating existing supplier arrangements such as higher volume discounts or better payment terms.
  • Identifying if an external capital solution is required, for example reverse factoring, term loan, leasing or equity.

Role of Ops/Sales

The Sales and Operations teams need to support the MD and FD by:

  • Identifying opportunities for customer down payments to cover risks or fixed costs.
  • Ensuring customer payment schedules have clearly defined milestones for billing and sufficient granularity of payments to reflect value delivery.
  • Improving the overall efficiency of the existing process design and resource planning through transformation projects.
  • Speeding up billing milestones on existing jobs.

Key points

Always check if the capital within your business is sufficient and aligned to growth needs. If organic capital and cash flow efficiencies are already maximised, explore external working capital solutions. These may include expediting revenue cash receipts, reverse factoring to elongate supplier payments and stock loans to reduce cash drain. Always seek out the most cost-effective or flexible capital solutions to support your growth requirements. But always check what covenants, security or compliance requirements these involve.

I hope this blog has provided some useful tips on what may trigger over-trading and how your teams should work together to mitigate any long-term damage. To see how we recently helped Dunton Environmental overcome its over-trading problem, please read our case study here.

If your business is facing a similar cash flow situation, please do feel free to contact me, I’d be delighted to help.

Colin Burns – Director, Shaw & Co

Colin is a Funding Advisor at Bristol-based Shaw & Co. He is part of one of the largest corporate finance advisory teams in the South West. He is a fully qualified Chartered Banker and Green Finance Certificate holder. Over the last 15 years he has arranged facilities in excess of £250m in over 20 MBO transactions including small owner managed businesses and listed corporates.