Overcapitalisation and Overtrading – ACCA Financial Management (FM)
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Hi John,
Thanks for the lecture. Quick question for you, I understand we invested all the money from the long term financing so there isn’t any left for Cash, but why isn’t it just the 50 number and why does it become 0?
But where would the 50 come from given that the SOFP must balance? 馃檪
Ah yes. I see the issue. Thanks John
Hi Sir, does an aggressive working capital investment policy mean we are overtrading?
No – it is a choice of policy.
Hi Sir, overtrading = higher sales = higher receivables = higher current assets = higher working capital. However in the lecture you mentioned we would run into liquidity problems which is associated with low working capital. Can you please clarify this?
Higher sales will lead to higher receivables and higher inventory. This will need cash to finance it and unless they raise more long-term finance, the cash will have to come from their short-term cash which can end up meaning they go into overdraft and therefore have liquidity problems (i.e. might not be able to pay their bills).
Look again at my illustration as to how this might happen.
Hello sir.
Why didnt we double the cash in the beginig when we added the $500 to the $700 and was the non current asset figure doubled or we just added $500?
We can only double the cash if we raise more long term finance to cover the extra working capital. If we do not raise more long-term finance then the cash balance has to reduce. I do stress this in the lecture!
Thank you sir, this was very help3
Great 馃檪
Thank you so much Sir. Your explanantion has made it more clearer for me to understand overcapitalisation and overtrading. It’s helped me to appreciate and be able easily identify the complications that they can cause as well.
Thank you so much.
Sir, I have a 2017 june edition of BPP Financial Management books. Is it fine to refer it for my study purpose for June 2020???
Thank you for explaining so well, Sir. 馃檪
Thanks John for this presentation on over/under capitalization. I really do appreciate the distinction more so with the illustration.
Thanks for the illustrations used. It was very helpful to me. What level of working capital should be business then maintain in order to avoid overtrading or overcapitalization?
*should the instead of be.
There is no ‘best level’ of working capital. It all depends on the type of business.
To avoid over-capitalisation they should make sure that they are managing each part of working capital efficiently (as explained in the following chapters).
To avoid overtrading, they should plan properly when expanding to make sure they raise sufficient finance not just to finance the extra machines etc. but also to finance the extra working capital needed.
Noted with thanks sir
Dear Sir,
How did we arrive of $ 100 bank over draft?
It is the missing figure to make the SOFP balance 馃檪