Overtrading is a term in financial statement analysis. Overtrading often occurs when companies expand their own operations too quickly (aggressively). Overtraded companies enter a negative cycle, where an increase in
interest
In finance and economics, interest is payment from a borrower or deposit-taking financial institution to a lender or depositor of an amount above repayment of the principal sum (that is, the amount borrowed), at a particular rate. It is distin ...
expenses negatively impacts the
net profit
In business and accounting, net income (also total comprehensive income, net earnings, net profit, bottom line, sales profit, or credit sales) is an entity's income minus cost of goods sold, expenses, depreciation and amortization, interest, ...
, which leads to lesser
working capital
Working capital (WC) is a financial metric which represents operating liquidity available to a business, organisation, or other entity, including governmental entities. Along with fixed assets such as plant and equipment, working capital is consi ...
, and that leads to increased borrowings, which in turn leads to
interest
In finance and economics, interest is payment from a borrower or deposit-taking financial institution to a lender or depositor of an amount above repayment of the principal sum (that is, the amount borrowed), at a particular rate. It is distin ...
expenses and the cycle continues. Overtraded companies eventually face
liquidity
Liquidity is a concept in economics involving the convertibility of assets and obligations. It can include:
* Market liquidity, the ease with which an asset can be sold
* Accounting liquidity, the ability to meet cash obligations when due
* Liq ...
problems and can run out of
working capital
Working capital (WC) is a financial metric which represents operating liquidity available to a business, organisation, or other entity, including governmental entities. Along with fixed assets such as plant and equipment, working capital is consi ...
.
Conditions
* Rapid growth in business development and sales.
* Less
net profit
In business and accounting, net income (also total comprehensive income, net earnings, net profit, bottom line, sales profit, or credit sales) is an entity's income minus cost of goods sold, expenses, depreciation and amortization, interest, ...
.
* The business running with limited knowledge.
*
Cash flow problem or short of
working capital
Working capital (WC) is a financial metric which represents operating liquidity available to a business, organisation, or other entity, including governmental entities. Along with fixed assets such as plant and equipment, working capital is consi ...
.
* Inaccurate or unrealistic cash
budget .
* Having many unpaid vendors.
* High level of
interest
In finance and economics, interest is payment from a borrower or deposit-taking financial institution to a lender or depositor of an amount above repayment of the principal sum (that is, the amount borrowed), at a particular rate. It is distin ...
/ debt servicing costs.
* High
gearing ratio.
* Keen
market competition
In economics, competition is a scenario where different Economic agent, economic firmsThis article follows the general economic convention of referring to all actors as firms; examples in include individuals and brands or divisions within the sa ...
.
* Overstock or slow movement of
inventory.
* Current and quick ratios fall.
Alternative retail definition
In
retail
Retail is the sale of goods and services to consumers, in contrast to wholesaling, which is sale to business or institutional customers. A retailer purchases goods in large quantities from manufacturers, directly or through a wholesaler, and ...
contexts, the term "overtrading" is sometimes used to describe a situation where a retail outlet has more customers than it can handle, to the extent to which it needs to add additional outlets or otherwise increase capacity. This meaning of "overtrading" has been used in relation to
Aldi
Aldi (stylised as ALDI) is the common company brand name of two German multinational family-owned discount supermarket chains operating over 10,000 stores in 20 countries. The chain was founded by brothers Karl and Theo Albrecht in 1946, when ...
and
IKEA,
[https://myplanning.warrington.gov.uk/Planning/StreamDocPage/obj.pdf?DocNo=7444642&PageNo=1&content=obj.pdf {{Bare URL PDF, date=March 2022] especially in the
UK.
References
Valuation (finance)
Business terms
Business failures
Debt