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Sir i have watched your lecture relating to over capitalisation and over trading
For over trading you have illustrated an example where the company expands massively double in its size and therefore the inventory, recievables and payables doubles .
I wanted to ask a question about this
In this question when everything in current assets is increasing this means that our working capital is high for example if a statement says that our sales increased which means our recieveable increases and therefore our working capital is higher now but now higher working capital means over capitalisation not over trading
Higher rec higher inv higher cash less payables [over capitalisation]
Higher rec higher inv low cash high payables higher overdraft [ over trading]
Am i right.?
You cannot really look at it that simply. It depends how the working capital is being financed.
If a company is expanding and they need higher working capital and should therefore raise more long-term finance to cover the increase. Overtrading is where it has happened quickly and they haven’t raised more long-term finance and so are forced to use short-term finance (i.e. overdraft).
Over capitalisation is where the level of working capital is too high for the size and type of the business and where they have therefore raised more long-term capital than they should be needing.