Introduction
Many businesses have suffered insolvency through being too successful at an early stage, growing too fast at any given time, or simply over stretching the company’s financial capability: hence insolvency by overtrading.
Most business owners start out to build a business to some sort of plan. When you get a larger response to your goods/service than you expected, the natural reaction is to accommodate what is being asked of you.
This is an important decision based on not how much you will earn from the sales, but how much the sales will cost you. How many people have you heard say, “everything was all right until we got that large order” or just after having suffered insolvency, “next time I will keep the business small”.
Overtrading Scenario
The building trade can provide many examples of overtrading, one example is:
You are a small building firm with six labourers, you do not have an overdraft or significant cash reserves. A company you get work from wants you to start another job in a few days (a larger than usual job): to run alongside the job you are currently doing for them. This is the break you have been waiting for and you say ‘yes’ to the opportunity. The new job needs ten extra labourers. You have to hire an excavation machine, a small crane, transport for the labourers etc.
As you have to deal with the needs of the second job you need someone to run the first job: for the first time you have had to leave the running of a job to one of your labourers.
In the past when you wanted an excavator you hired one for the day and made good use of it all day long. You will now need an excavator on site for six days a week (probably only in use for three to four days during the week at different times). The same scenario can be assumed for the crane.
You have managed to get the ten labourers and hope that they all turn up on the first day. You have hired a mini-bus for the workers.
On the first day only seven labourers turn up. To maintain credibility you have to take three of the six labourers off the first job to make up the numbers. Taking labourers of the first job means less work being completed. You are paid ‘day work’ on both jobs (you get £? for each day a labourer works).
The excavator and crane have not been used for the first day due to a hold-up in work being carried out by another company (this happened more often than you bargained for).
You have to provide building supplies for the job. You have to increase your credit account with the supply shop to an uncomfortable figure.
For the rest of the first week you have to split your time between the two jobs, finding labourers, sorting out problems that are stopping your machines from working, organizing supplies, reporting progress to site management (larger jobs mean schedules, constraints, more paper work). At the end of the first week you have lost many days work on the first job due to prioritizing your labour force on the second job. On the second job you have had ten labourers there all week, but due to faults beyond your control, on average only seven labourers have been working during the week. The excavator and the crane have each been in use for three days of the week. You are under pressure on the first job by the site manager due to the short labour. You promise to rectify this by the following week.
You decide to raise your labourers from sixteen to twenty: to ensure a full labour force. There is nothing you can do about the machines standing idle. For the first time since you started your own business you earn your weeks wages without actually working on any job. You decide that you will have to employ someone to administer the business. You still do not know the names of most of your work force. You will have to wait up to six weeks for payments to come through for the work you have completed and billed.
Much of what happened in the first week happened in the second week.
During the third week the site developers called you into a meeting, they told you they were confident with your ability to maintain your labour force and machinery. As such, they want you to start a new job next week!
Conclusion
If you do not take this new work, future work with this company would probably revert to small jobs, if at all. If you take the job, you are unlikely to survive because this increase in business is out of your control, and not based upon a sound financial plan.
If a large customer wanted an increase in sales/service you would have to consider not only whether or not you want to be a bigger company, but whether you want to expose your company to increased borrowing to finance the means of providing the customers needs. You may need bigger/better machines, bulk stock, more staff, bigger premises, increased administration etc. You would also probably loose your close contact with the ‘shop floor’ of your business.
If you had a customer who represented 70% of your sales income, you would be susceptible to price, product, delivery, service and payment demands. If such a customer stated that a similar supplier could provide the same quality etc. for 10% less, could you react without severely impacting on your cash flow requirements?