Category: Insight | Date: 31/01/2022

Why considerable growth is not such a good thing

There is an expectation and a nostalgic realisation that insolvency levels will increase as we come out of a recession and perhaps at a degree unmatched following the effects of the pandemic. The full impact of Corona Virus on business is starting to emerge and the next chapter of navigation of these new challenges in a constantly evolving economy with ever-increasing complexities will be pose trials like never before. In view of the issues and challenges anticipated, we have commissioned Xenia’s Credit Risk Analyst, Roberto Simone to advise both clients and prospects on areas to consider and be acquainted with.

Growth is perhaps the single most critical goal and objective for most companies. However, not all growth is ideal especially when growth exceeds its capabilities, as it then comes with a whole raft of business risks.

What is overtrading?

Simply put, when growth controls the business, rather than the business controlling growth, there may be trouble ahead.

Overtrading is essentially, where a business enters into commitments beyond its available short term resources. Typically, trying to make a profit with too little working capital underpinning the effort and strategy. Overtrading can be extremely difficult to spot given the striking results that can emerge and that it is caused by time lags within the business model, not easily discernible to outsiders.

Many companies overstretch resources in hot pursuit of ambitious expansion targets even more so now with fierce competition and challenges galore after the pandemic. That can mean something seemingly simple, like taking on a large contract within a known supply chain, or more obviously resource-intensive moves, like R&D or expanding into other markets internationally.

Interestingly, a company might not even be aware they are overtrading!

Almost as often, as companies expand for the right reasons, the endeavour may be an attempt to play their way out of some underlying financial trouble. If you play poker, you will recognise the concept of going ‘on tilt.’ Companies can go on tilt, too.

The Overtrading Cycle: How companies go “on tilt”

The Overtrading Cycle: How companies go “on tilt”
The Overtrading Cycle: How companies go “on tilt”


1. Plan

Planning is paramount in business. If you do not get the first chapter right, there probably will not be an autobiography any time soon. Companies trading sustainably regularly strike a balance: they plan, but not in a hesitant way, that sacrifices velocity. For instance, a mutual client spent two years sending representatives to a new country they were considering moving into – they learned every nuance of that region that they could before fully committing. That is proactive and exigent, but sensible.

Conversely, a business that is overtrading executes its planning fast, reactive, on the hoof, on a whim or a hunch. Aggressively, wearing their cognitive biases on their sleeve and seeking only information that supports what they have subconsciously decided. Sometimes a business does not even realise how short of knowledge or business intelligence it is. It is not uncommon for companies exporting to only find out about certain tariffs and legislation that proves severely detrimental to the bottom line once it is far too late to renege on the deal. Poor planners should expect poorer margins and poorer futures.

2. Expand

Proactive or reactive, expansion needs to happen with a safety first mentality. A sustainable business expands like so: Creeps and peeps, like driving a car out of a busy junction with poor visibility. Making sure, you get a clear picture before committing to a move. Essentially, to their own plan, at their own pace. Proactively seeking new business opportunities, but always working within their means.

Going beyond the simplest, just doing more of the same in existing supply chains, three of the most common expansion methods are:

  • Moving into new regions, either nationally or internationally.
  • Diversifying into new products, services or sectors.
  • R&D trying to innovate and create something ground-breaking, either within the existing sector or with some element of diversification attached.

All of them come with inherent risk, and the more there is going on simultaneously, the more pressure on financial, intellectual capital and management energy levels.

However, a business overtrading expands too much at once and the risk in essence stacks up like Jenga…deemed classic overtrading. Going for too much at once, diving in without proper research or analysis can lead to unforeseen factors eating into profit margins. This can cause knock on effects throughout the supply chain, all for the want of thorough planning.

3. Expend

Put simply, all expansion costs money and time. The source of the funding - and at what the cost of capital - is the difference between doing things right or growing before you are ready.

All forms of expansion costs time and money and a typical sustainable business will expand as cost effectively as possible. This may mean using low cost capital, taking on extra headcount to help manage the influx of work is all well and good but companies growing sustainably take their time hiring, getting the right people whilst working hard to imbed them into the company culture which can be some time before they add maximum value.

Conversely, a business considered to be overtrading will make attempts to grow swiftly taking on more people – companies growing exponentially are often forced to bring in multiple people in key positions thrown into the deep end all at once. Rapid growth often means taking on more debt. Regularly borrowing money, especially short term, is a hint that a company might be in the cycle of overtrading; if they are borrowing money to take on staff that almost confirms it. It is a classic robbing Peter-to-pay-Paul scenario: loaning money to take on staff is buying time with money you don’t have (and paying a premium to the bank for the privilege).

If a company doesn’t have the cash reserves in place to fund any initiative, but they go for it anyway, the underlying fundamentals don’t look quite right and presents a risky trade to potential partners.

4. Credit Control

The financial heartbeat of a business is the approach to credit control.

How sustainable businesses do credit control: A diversified client base on generous, yet sensible credit terms. Structured internal processes with a level of digital automation. A sales ledger secured as an asset through credit insurance - and also not afraid to mix it up with a tenacious, even belligerent, debt collection mode when needs be. It takes a balanced customer base to be successful and ideally, everyone would pay on time, but that’s rarely reality.

However, companies that are trading beyond their means look at credit control a little differently. Control is the operative word here as overtrading companies are losing their grip. Revenues naturally take longer to filter back through certain channels than others. Depending on the nature of the expansion, it can take a long time to see return on the expenditure above and profit margins can often be thinner.

A classic overtrading move is putting the chance to enhance the reputation ahead of the potential effects on profitability. For example, dealing with a big brand company that will look great to have on the books but letting them negotiate down too far on key financial aspects of the deal: price, margin, deposits, payment terms etc. etc.

This can be seriously detrimental to cashflow.

Some clients negotiate really long credit terms and are routinely late paying even then. Some will even enter into disputes around quality or service, to stretch things out, ease their cashflow, possibly to cover their own overtrading. If you’re spending to do work that it takes ages to get paid, that’s overtrading – if you seek to fill the gaps by winning some new business that pays faster – that’s over-over trading.

Therefore, the black hole deepens…

5. Unexpected events, The Good, Bad and Ugly

Unforeseen events, whether good or bad, are huge behavioural drivers for businesses. When you are growing quickly and have the opportunity to expand your business, it makes sense to ride the wave and capture the opportunity – and when you’re afraid of a downturn, you take whatever is going capitalising on opportunity from a crisis such as the infamous black swan event as we have seen since March 2020.

Unforeseen events with gravity all have different effects but they all lead to one place, back to Step 1 of the cycle, right back to the beginning of the loop, the planning stage – only now in a rush, under pressure and potentially in a stressful situation. Being stressed makes decision-making more cavalier, so it is easy to see why businesses can see a series of shocks come their way.

The cycle turns faster in some ways, slower in others, you see quicker spend but slower rewards and thus the financial seams start to come undone.

Frequent Symptoms of Overtrading

  • Slower paying with lengthening Days-Payable-Outstanding (DPO)
  • Rapid growth in turnover that is not scalable…and not relative to assets
  • Increase in the gearing ratio
  • A decline in the liquidity expressed in lower current and quick ratios
  • Reduction in the proportion of assets financed by funds from shareholders
  • High level of debt servicing costs
  • Inaccurate or unrealistic cash budget with poor cashflow
  • Slow movement of stock and therefore cash tied up
  • Having many unpaid Vendors
  • Decline in profitability

Analyst Assertion

Any company can make money in the good times. The great ones make money in the bad times. With the ideal conditions, product offering and business strategy exponential growth and trading over and above means can be positive. It can enhance the brand and provide even further opportunity down the line, and make jobs along the way. Borrowing in order to fund growth is not always a damaging thing but the rate at which you grow, spread risk and forecast are extremely important. A tough period with lost business, delayed payment can trigger a series of events leading to protracted default or at worse insolvency. Even a little shock, or more likely, a series of small shocks, can derail the whole business. If there are ambitions or an opportunity for instant growth (and it does happen), it is important to take a conservative approach. Stability is sometimes the best play.

A relationship with a Credit Insurer can help to mitigate the risks as well as potentially identify those customers who are susceptible to overtrading.

To find out more please contact: Laura Prime / T: 03330 155005