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Overcapitalisation and Overtrading – ACCA Financial Management (FM)

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    • 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)

  4. 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.”

  5. 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?

  7. 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.

  9. 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.

      • 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.

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