Overtrading (2)

ACCA F9 考試：Overtrading (2)

Summary

This session has examined the items which make up working capital and considered how organisations can improve their management of working capital. Although an ideal level of working capital is difficult to calculate and will vary from one organisation to another, depending on the industry in which they operate, it is essential that a business avoids having too little or too much working capital.

Too little working capital ("overtrading") is common when a business is starting up or is experiencing a period of rapid growth. The level of sales might grow very quickly, but inadequate working capital is available to support this growth. The situation will then arise whereby a business may be profitable on paper but has insufficient funds available to pay debts as they become due. In the short term this situation can be solved through a combination of measures including:

·obtaining an increased overdraft facility;

·negotiating a longer credit period with suppliers; and

·encouraging receivables to pay faster.

However, in the long term a business is unlikely to survive without a combination of:

·new capital from shareholders/proprietor;

·better control of working capital; and

·the building up of an adequate capital base through retained profits.

Almost as bad is too much working capital or overcapitalisation. Poor management of working capital will result in excessive amounts being tied up in current assets. Such a scenario will lead to a business earning a lower than expected return.

It must be remembered that the shorter an organisation's working capital cycle, the faster cash, and hence profits, from credit sales will be realised. To achieve this an organisation must regularly review its working capital, taking action where necessary.