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Sir, I am facing trouble understanding overtrading & overcapitalization. And indicators of both of these look to be too similar which is a problem in my understanding.
I know that working capital is too high in overcapitalization because company has invested too much in their current assets.
But in overtrading the working capital is too low because the company is rapidly expanding too quickly with little long-term capital.
Now the problem is that both of the indicators are too similar and alike. So do you have anything to say to help me whether what ratios can help me differentiate between overtrading & overcapitalization?
I have seen ur lecture on this topic sir BUT I could not find anything on overcapitalization & indicators for overtrading were too limited. I hope you get what I had to say
In the exam it is not a question of having learned specific ratios for this.
The exam is testing that you understand what overtrading and overcapitalisation are and that depending on the information given in the question you can comment on whether either would appear to be the case (we are never in a position to say that either is happening for certain).
There will be several questions on both in your Revision Kit, and best is to see what indicators are mentioned in the answer – again, depending on the information given in the question.
I understand what u said. Can you please comment on this what I wrote is correct or not!
In case of overcapitalization, working capital will be HIGH which has the following indicators such as::
Inventory, Receivable, Cash will rise
Payable & Overdraft will fall[There will be also an increase in working capital from one year to another because company has over-invested]
Current Assets will rise while Current Liabilities will fall
Current ratio will rise along with the Quick ratio because of the increase in current assets overall
Net Sales working capital will fall too
Sales to Non-current asset ratio will rise
Long-term Borrowing will also rise[Because they all will cause the working capital to rise. Therefore, they are symptoms of overcapitalization – correct?]
In case of overtrading, working capital will be LOW which has the following indicators such as:
Inventory, Receivable rise BUT Cash will fall
Payable & Overdraft will rise[There will be also a decrease in working capital from one year to another because company has under-invested]
Current Assets & Current Liabilities will rise
Current ratio & Quick ratio will fall because of the decrease in current assets overall
Net Sales working capital will rise too
Sales to Non-current asset ratio will rise
Short-term Borrowing will also rise[Because they all will cause the working capital to fall. Therefore, they are symptoms of overtrading – correct?]
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