We all go into business with valid expectations that the start up will grow and maybe someday be a big company. What may not be obvious at that point is that growth, if not managed well, could kill your business.
As the cliché goes, if you live fast, you die young! You can think of many businesses that seemed to flourish then went bust without warning.
A common phenomenon in such enterprises is what business analysts call over-trading. Simply put, over-trading happens when a business tries to do too much too quickly with too little long term capital. In other words, over trading is a form of under-capitalization.
Possible causes include starting off with inadequate capital, drawing cash from the business without replenishing and high inflation.
There are many ways one can draw cash from their business. The obvious one is taking cash for personal use. Many of us start businesses as a way of earning a livelihood. It is therefore silly to ask a business man not to draw money from their venture. What is advisable is to keep proper records so that your personal needs are supported by profits and not capital!
Other subtle ways of drawing cash exist that may miss the entrepreneur’s eye. For example, if you have a bank overdraft and pay it off, the business may experience a cash crunch because that money is no longer available. Similarly, when you pay off creditors before receiving from your debtors, the business is starved of cash.
Inflation usually reduces what the money we have can buy. It therefore means that businesses have either to raise extra cash or brutally manage costs to stay afloat.
How do you tell a business that is over trading?
Rapid increase in sales revenue can be a danger signal. Realistically, if you are selling more, you need to hold more stocks and meet increased overhead costs like salaries, rent etc. You will be worse off if you sell on credit because the debtors will owe more while you owe your creditors more! It may therefore be important to inject more capital into your business to sustain growth.
Business inventory growing quickly means there is more money held in assets that are not bound to convert into cash. For example, when you buy a car for business purposes, it may make movement of goods easier but has denied you the money with which to buy stock.
Small or no increase in capital levels as the business grows means that while your customers demand more goods and services from you, the business does not have the resources to meet this demand. You may then get more credit from suppliers or request for a longer grace period to pay back for supplies. If the suppliers refuse, you have no goods to sell!
You may also keep calling your bank to honor cheques you have issued with promises to pay up when you make the next sale. Thus your account gets overdrawn. When the bank refuses to honor your cheques anymore, the business could just collapse as suppliers have held back, you have no stock to sell and no money is forthcoming.
While injecting additional capital will cure the problem of over trading, is is best avoided by raising adequate capital for envisaged growth and sticking to a gradual growth process.