How to reduce the risks of overtrading

Find out how to avoid overtrading and the actions you can take to ensure sustainable business growth.

Overtrading is when a business doesn’t have enough resources to fulfil a customer order.

It’s a common problem for young and fast-growing small businesses.

Although a rise in demand for your product or service might seem like a good thing, sustained overtrading can cause long-term harm to a business, including cash flow issues, legal problems, and even insolvency.

What is overtrading?

If your business receives a new order, but you are unable to provide it to the customer because you lack the working capital, stock, supplies or staff to do so, it means you are overtrading.

Signs of overtrading include:

• relying on an overdraft each month
• low profit margins
• regular late payment of invoices by clients.

Overtrading can lead to issues such as:

• a cash flow imbalance, which means you can’t pay your bills or staff salaries
• delivering a poor-quality product or service, which leads to customers complaining and your business reputation being damaged
• suppliers or customers taking legal action due to supplies not being paid for or an order not being fulfilled
• in the worst case, your business could become insolvent and be forced to shut down.

How to prevent risks from overtrading

To avoid the dangers of overtrading, actions you could take include the following:

Monitor stock levels

Having too much working capital tied up in your stock can impact your cash flow.

Think of ways you can reduce it, such as only placing orders for materials and supplies when absolutely necessary rather than having too big an inventory.

Read our guide to inventory management.

Access purchase order financing

If you receive an order, but you are unable to pay a supplier so that you can fulfil it, purchase order financing can help.

For this type of funding, the lender provides a loan to cover the supplies.

Once the customer pays, the lender deducts fees and gives the remaining amount to the business fulfilling the order.

Read our guide to purchase order financing for start-ups.

Use hire purchase

Buying the equipment, machinery, and vehicles you need to deliver an order can be costly, particularly if the customer hasn’t yet paid you.

Leasing and hire purchase may help reduce the strain on your cash flow by allowing you to access the assets without large, upfront costs.

With leasing, you get the asset in exchange for rental payments over a set period.

At the end of the contract, you may have an option to continue renting or to return the equipment.

Hire purchase is when you agree to buy an asset from the lender over a specified period.

You own the item at the end of the contract.

Benefit from invoice financing

If you are waiting for a client to pay, you can consider using invoice finance by putting the unpaid invoice up as security for funding and getting access to up to 90% of the invoice’s value.

Keep on top of late payments

If your business-to-business clients are late paying their bills, it can impact your cash flow and leave you unable to fulfil new orders.

Actions you can consider taking to tackle late payment include:

• carrying out credit checks on businesses before taking them on as new customers
• ensuring the invoices you send to customers are accurate and contain all the required information
• using accounting software to automate invoice follow-ups and chasing for payment
• tracking down the name of the person in charge of making your payment and building a good relationship with them
• if you struggle to receive payment from a business with more than 50 employees, the Small Business Commissioner may be able to help.

Reduce your costs

Cutting back on your business expenses can be an idea to help improve your cash flow.

Ideas to reduce costs include:

• work with other business owners to share equipment, bulk buy goods and barter for services
• review your subscriptions to check whether they are still necessary and can be cancelled
• use part-time or freelance staff
• downsize your office space or switch to co-working or even working from home
• look for tax reliefs that could apply to your start-up
• reduce travel costs by booking transport and accommodation further in advance or switching to more online meetings.

Re-negotiate with suppliers

By re-negotiating with your suppliers, you could free up some cash.

This could be by getting your supplier to agree to extend their payment terms in return for you making more orders.

Change your supplier

If a supplier falls short of your expectations, it can impact your ability to meet customer orders and harm your start-up’s reputation.

Possible issues include delivery delays, poor-quality supplies, and bad communication.

By changing suppliers, you may be able to overcome these problems.

Read our guide on the ten signs you may need to change supplier.

Monitor your cash flow

You should stay on top of your finances by creating regular cash flow forecasts.

This will allow you to identify any cash shortfalls and access finance to deal with them.

Read our guide to managing and protecting your cash flow during difficult times.

How to reduce customer demand

If you identify that overtrading is becoming too much of a problem, it could be sensible to slow down the growth of your business so you can better manage customer demand.

Ways to reduce customer demand include:

Consider your growth plan

Overtrading is a time to review your plans by considering the objectives, targets, and goals you have set for your business.

You may find you have been too ambitious or not put sufficient resources in place to cope with rising demand.

It can be a good idea to consider what actions you could take to fix it.

Pause sales

Temporarily pausing sales of your product or service can give you time to catch up and fulfil existing orders.

You could encourage interested customers to sign up to your email mailing list to be notified when your product or service becomes available again.

Review your offering

Overtrading may be caused because you have too many products or services.

Review what you provide and decide whether a product or service needs to be dropped.

You can then focus on your core offering.

Increase your prices

By raising the price of your product or service, you can reduce the amount of customers willing to pay for it and better manage the demand.