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FM
Overcapitalisation and Overtrading - ACCA Financial Management (FM)
28 Comments
A
Aditya·
Wonderful lecture. I always love the examples the tutors give, which makes things much more interesting and explains the topic better!
J
John MoffatTutor·
Thank you for your comment :-)
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Aditya·
Thank YOU for the amazing lectures Mr. John Moffat :)
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Alex·
How did we arrive of $ 100 bank over draft?
J
John MoffatTutor·
We assume that the current level of cash is that needed for the current level of activity. If the level of activity doubles then we are going to need twice as much cash.
The overdraft is the missing figure because the SOFP must balance.
(You will not be asked to do this in the exam but you can be asked to explain what over trading is and why it can cause problems which is why I work through this illustration in my lecture)
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Alex·
Why do we have cash doubled also
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Ahmed·
Excuse me, but I feel a bit confused. From the beginning of the video, the explanation seems to be labeled as overtrading, but the example appears to match the concept of overcapitalization instead. Could you please check and clarify if this is correct? I appreciate your guidance."
U
Umar·
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?
J
John MoffatTutor·
But where would the 50 come from given that the SOFP must balance? :-)
U
Umar·
Ah yes. I see the issue. Thanks John
J
JojoBeat·
Hi Sir, does an aggressive working capital investment policy mean we are overtrading?
J
John MoffatTutor·
No - it is a choice of policy.
J
JojoBeat·
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?
J
John MoffatTutor·
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.
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Abigail·
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?
J
John MoffatTutor·
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!
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Abigail·
Thank you sir, this was very help3
J
John MoffatTutor·
Great :-)
S
Sam·
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.
S
Shobinya·
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???
F
farah·
Thank you for explaining so well, Sir. :)
A
Asher·
Thanks John for this presentation on over/under capitalization. I really do appreciate the distinction more so with the illustration.
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Ansu Koroma·
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?
A
Ansu Koroma·
*should the instead of be.
J
John MoffatTutor·
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.
A
Ansu Koroma·
Noted with thanks sir
I
irham·
Dear Sir,
How did we arrive of $ 100 bank over draft?
J
John MoffatTutor·
It is the missing figure to make the SOFP balance :-)
The overdraft is the missing figure because the SOFP must balance.
(You will not be asked to do this in the exam but you can be asked to explain what over trading is and why it can cause problems which is why I work through this illustration in my lecture)
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?
Look again at my illustration as to how this might happen.
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?
Thank you so much.
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.
How did we arrive of $ 100 bank over draft?