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Overtrading happens when a business can’t meet the demand for its products or services. It can lead to starting a project that you can’t finish, or delivering a service below your usual standards.
Overtrading can have an impact on the reputation of your business and in the worst cases lead to financial problems. Read our guide for tips on how to spot the signs of overtrading, plus how to avoid or overcome it.
The overtrading business definition is when a business can’t fulfil its orders so it doesn’t get paid. It could be down to a range of factors including manufacturing issues, lack of staff, or shortage of stock.
Overtrading can happen to any business and in the worst cases could lead to insolvency. Businesses can reduce the chances of overtrading by managing their cash flow effectively and making sure they have the structure in place to fulfil rising demand as they grow.
Overtrading can lead to a business’s finances spiralling out of control. If money is leaving a company before it comes in, the likelihood is that it won’t be able to keep up with its outgoings.
To try and earn more money, a business may continue to accept orders that it can’t fulfil. This kind of overtrading can lead to unbalanced finances, affecting payment of staff or utility bills.
As well as a difficult working environment for staff, not having the resources to meet demand will also impact customers.
In the worst cases, overtrading businesses could face legal action, whether that's from suppliers they’ve failed to pay or clients they’ve not serviced.
It can be very difficult for businesses to recover from this position, often leading to insolvency or closure.
Undertrading is the opposite of overtrading. Instead of not having the finances to meet demand (overtrading), an undertrading business has healthy cash reserves but isn’t using them effectively.
Undertrading is usually caused by poor management and a lack of accountability. Companies with a solid structure and well-developed organisation chart are less likely to suffer from undertrading.
Companies that undertrade could also experience repetitional damage, or have a reduced chance of external investment such as venture capital or crowdfunding due to a perceived lack of ambition or innovation.
Depending on the sector your business operates in, the signs that you’re overtrading will be different. However, here are some of the most common experienced by all types of business:
A business takes on a range of new contracts but runs out of money to pay its suppliers. As a result, the suppliers stop delivering and the business can’t fulfil its orders. This leads to the business not getting paid by its clients, as well as reputational damage.
Over a period of time, the business will come under severe financial stress as it has debts to pay off and no money coming in.
Other examples of overtrading include:
As your business grows, the chances of overtrading increase. There are also external factors, such as the economy and demand in the sector you operate in, that you can’t control.
The main thing you can do to minimise the chances of overtrading affecting your business is to manage your finances effectively.
Here are some other things you can do to avoid overtrading:
If your business is showing some of the overtrading signs outlined above, there are steps you can take to reduce the chances of things getting worse.
Here are some of the most effective ways to overcome overtrading:
Business finance is a complex topic, so remember to speak to a professional financial advisor or accountant if you're not sure of anything.
Do you have any unanswered questions about overtrading? Let us know in the comments below.
Conor Shilling is a Copywriter at Simply Business with over two years’ experience in the insurance industry. A trained journalist, Conor has worked as a professional writer for 10 years. His previous experience includes writing for several leading online property trade publications. Conor specialises in the buy-to-let market, landlords, and small business finance.
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