Show the signs of overtrading, Financial Management

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Q. Show the Signs of Overtrading?

There are a number of usually recognised signs that a company may be overtrading. These are considered mutually with relevant financial data from Appendix 1 in the following paragraphs.

Rapid increase in turnover

The forecast financial statements for 2003 demonstrate that our turnover is expected to increase by 25% during the year.

Rapid increase in current assets

Current assets are expected to increase by 27% slightly more than the increase in turnover.

Increase in inventory days and receivables days

Receivables days are expected to raise from 110 to 121 days with a 38% increase in total receivables but inventory days aren't expected to increase but to fall from 265 days to 238 days. However a 19% increase in inventory is anticipated.

Increased trust on short term finance

Reserves are expected to rise by $100000 whereas total assets are expected to increase by $1400000. The extension of our business activity is so based primarily on an expansion of short-term finance (trade payables and overdraft). Payables days will raise from 177 to 190 days while in relative terms payables will increase by 42% - more than the expected rise in turnover (25%) and in our overdraft (20%).

Diminish in current ratio and quick ratio

The current ratio is expected to drop very slightly from 1·04 to 1·03, but the quick ratio isn't expected to fall but to increase from 0·44 to 0·47.

Nevertheless any interpretation of these ratios should reflect the fact that different industries have different working capital needs. Sector average data is able to be useful here.


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