Overtrading definition
/What is Overtrading?
Overtrading is the practice of conducting more business than can be supported by a firm’s working capital. When this happens, a company usually runs out of cash, placing it at considerable risk of bankruptcy. As an example of overtrading, a company seeking more sales offers easy credit to its customers on long payment terms. The outcome is that the firm has to pay for the goods it sold to the customers, but will not have any proceeds from the sales for a long time, and so does not have sufficient cash to pay its suppliers. Overtrading can be avoided by regularly updating a cash forecast, as well as by maintaining a line of credit with a lender.
A major cause of overtrading is expanding a business too fast, and especially when there is a disparity between the payment terms for suppliers and customers. For example, if a fast-growing business is paying its suppliers in 30 days but is averaging 45 days payments terms with its customers, then it will require more working capital for every incremental sale. The solutions are to alter the payment terms to bring them into alignment, or to scale back sales until internally-generated profits can cover the extra working capital requirement.
The concept also refers to excessively high levels of trading by a securities broker, usually in order to earn a larger commission. Alternatively, it can refer to excessive trading by an investor, which may run counter to his or her investment strategy.