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Greetings sir.
So I understand why increased levels of current liabilities are a sign of overtrading – because you collect less money and sell more goofs in credit. So in the end, you have less money to clear your payables, because of our overselling.
But what I don’t understand is why increased levels of inventory is also a sign on overtrading. When you sell more goods to customers than the money they send back – your inventory should decrease, because those goods are now with those customers due to your overtrading with them.
Please assist clarify the logics.
Thankyou sir.Your first paragraph does not really make sense. If you sell more then you have higher receivables, but that certainly does not mean that you collect less money!
Higher sales means there is the need to carry more inventory.
I really do not think that you can have watched my lectures because I explain exactly what overtrading involves in my lectures.
In the first paragraph what I meant was that if you are selling but not doing good in the receivables section. For eg: you issue an invoice of $100, but the customer returns back $75 when the time for collection comes and makes another order. And if your sales staff just is focused to show sales for his commission, he will purchase again the goods and make another $100 invoice despite the previous invoice not being cleared. And this difference with time will keep on increasing. Thus, overtrading.
You have to pay to your suppliers ontime – but because of this cycle – you will eventually lack cash to pay off your suppliers because your customers kept on their habit of sending less money each time and your sales staff overtrading with them by issuing new invoices just to show how much sales he has done, and not caring about the receivables being cleared in order to pay the suppliers. Thus, increasing levels of current liabilities becomes a symtom of overtrading.
You said:
“Higher sales means there is the need to carry more inventory”So is that not a sign of overcapitalization instead of overtrading(undercapitalization)? We having more working capital with us than necessary ?
You have clearly not watched my lectures on this because I do explain what happens when there is overtrading.
Higher sales will inevitably mean they will need to carry more inventory (and often they lose control which can mean that the inventory gets higher still).
Whether this leads to under-capitalisation or not depends on whether or not they have raised more finance in order to cover the higher inventory etc requirement. As I show in my example, if they have not raised adequate addition finance (as is often the case with overtrading) then they will be forced into an overdraft position.
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