How to avoid overtrading: example
A case study of how to avoid a situation of overtrading and the potential disaster it causes.
Karen's business is three years old. Her annual turnover is 拢200,000 and her annual profit is 拢18,000. She operates with a bank overdraft of up to 拢25,000. Her working capital is sufficient for her to steadily expand the business.
Karen wins a contract to supply Business B. The order is for 拢40,000 a month for two years. She will be paid 75 days after delivery.
Karen's plan
Karen decides to:
- Ask Business B to pay her in 45 days in return for a small reduction in the contract price. Business B agrees.
- Ring her suppliers to place the orders. She orders carefully and schedules the delivery dates so that her payments are delayed for as long as possible.
- Ask her biggest supplier to wait an extra 15 days for payment. In view of the bigger orders they agree.
- Devote more time to persuading all her other customers to pay on time.
- Avoid taking any money out of the business for three months. She has savings and can manage to do this.
- Draw up an impressive written plan and present it to the bank. The bank agrees to increase the overdraft limit to 拢50,000.
The contingency plan
Karen finds out about factoring. She does not intend to do it but she works out how much money she could obtain if she did. See factoring and invoice discounting.
What happened?
Due to the careful management of her cash, the plan worked brilliantly. She did not need to factor her debts because she got the balance just right.
Business B was pleased and after six months increased the size of the order. Karen considered the risks of being too dependent on just one customer and began to look for new business opportunities to complement her existing business.