Overtrading occurs in a period of very rapid growth. That’s very common in the early days of a new business. What happens is that the costs necessary to support the business running at the level you think it’s going to be are too great to support it at the level that is actually is right now. You’ve planned for the larger turnover and you’ve had to invest to achieve that.
If you’re investing using future receipts – perhaps customers are paying you in advance before you do the work – then if they decide they don’t want the work done there want their money back and you are instantly unable to trade. As it is, if you make a loss you may well become insolvent and the law forbids you to trade. That’s easy enough in the early days if you are investing for future growth. You can continue if you have firm plans that will not allow that loss to increase and over time reduce as the business grows.
To achieve that you may have to cut down the rate of growth so that instead of having a fast steep growth line, you slow it down so that curve flattens out for a bit and the sales match the costs and you can recoup some of your losses. Then you can go again. Remember growth usually involves bleeding cash for the growing element until it catches up (you may have to pay suppliers or new employees before sales happen and customers pay). That cash bleed is a loss that can only be funded by existing work or by cash put into the business. Too fast growth can exhaust the cash and you crash and burn from too much success.
You also have to be sure that your cost base and your business model works at different levels of activity. Entrepreneurs are naturally optimistic. That’s a good thing, but over optimism causes as many problems as it solves. Your plans have to be based on reasonable assumptions and not just hope. Your business model has to be capable of being scaled so you mustn’t assume that the same model will work at different levels of activity. Usually it won’t. You have to go back and check regularly. If you are trading whilst insolvent, you have to document you’ve done this otherwise it is likeley that the directors of the business will be personally liable for any debts if the business goes down. If they’ve made reasonable assumptions, and have acted on them, mixed with a good base of reality in that they have management accounts to check whether that is working or not, then they should be okay. It’s very helpful to discuss this with us too, as that also gives you some protection from being pursued by your creditors. Taking professional advice is some defence – as long as you take it.
What you take out of the business must also be commensurate with what it earns. Business owners should get the largest slice of the pie. They put in all the risk, and most of the effort, so this should be rewarded accordingly. Whilst it might be the largest slice, for sure it’s the last one. It’s after everybody else has been paid. And if they have expectations and lifestyle that means that their slice of the pie doesn’t fit the size of business that they got at the moment, they need to scale that down. Creditors will not be sympathetic if they have lost money because the directors have taken too much out to fund the lifestyle that they think they deserve.
So what’s to be done? Regular, accurate, on time management information is a must for any fast-growing business. Check your plans against that and test to see what happens if turnover goes up by a lot or drops significantly. What can you do to cut your cost base or to increase capacity with sufficient headroom to earn a profit and pay back any likely losses? As long as you can demonstrate this you should be okay from your creditors, and it is more likely that you will be able to trade successfully. It’s not just about covering your back, the same principles work in actually making the business successful.
We have all the tools and ability to help you to get what you want from your business; helping you design and test the models to show how the business works, helping you with regular reporting, to helping you manage the growth and keep your sanity (and your house). It just takes a call.