Liquidity, Overtrading, Over-capitalisation

Question 1

What is liquidity?

Answer 1

the concept of liquidity uses to the availability of cash in the business on how easily the assets can be converted into cash. It is crucial that the business ensures that it has enough cash payments to meet, such as payroll, rent when they become due. The lack of cash is referred to as illiquidy and can lead to rapid bankruptcy of a business

Question 2

What is overtrading?

Answer 2

Overtrading occurs when the sales volume of a business grows rapidly but without having long-term funding in place to finance this growth. It can happeneven if the businessis profitable.
The business tries to do too much, too quickly and
liquidity can suffer badly as a result.

Question 3

Overtrading key indicators

Answer 3

1) Rapid in sales volumes and turnover
2) Reducing profit margins
(The business offers discounts to get more sales)
3) Increase in trade receivables (debtors) days
4) Increase in trade payables (creditors)
5) Increase in the level of inventory
6) Increased use of bank overdraft
7) Taking out more loans to cover operating activities

Question 4

The bank usually provides types of references.
What are they?

Answer 4

1) Unqualified, positive assurance
2) Good for your purpose
3) Should be good for your figures
4) A guarded statement

Question 5

What is over-capitalisation ?

Answer 5

It occurs when a business has too much cash tied up in its current assets, its working capital is too high. This might involve very high lents of inventory, excessive outstanding receivables balances or simply a lot of cash sitting in the bank account
The business will be losing out on investment opportunities as it has excessive funds tied up in inventories and receivables thus the profits made by the business will suffer

Question 6

The impact of overtrading on a business

Answer 6

1) Inadequate cash flow means suppliers are paid late and may withdraw credit terms
2) The customers may become annoyed if orders cannot be met on time
3)Quality of service or product could suffer as trying to produce too much too quickly
4) Ultimately the business could fail due to lack of cash flow

Question 7

What is overtrading ?

Answer 7

Overtrading occurs when a business expands too quickly and
was insufficient working capital and cash available to support the increased level of trading

Question 8

The signs of overtrading are .. .. ..

Answer 8

1) A significant increase in turnover ( sales )
2) A reduction in the level of credit control,for example extended credit terms and /or an increase in the trade receivables collection period
3) An increase in irrecoverable debts
4) Reductions in cash balances and/or the introduction or increase in bank overdraft
5) Failure to pay its suppliers on time, which is indicated by an increase in the trade payables payment period, or that payment
period is higher than the industry average
6)Fallingprofit margins
7)A significant increase in the inventory holding period
8) Failure to inject capital, for example equity or long-term loan to facilitate the increase in turnover

Question 9

Impact it can have on a business

Answer 9

1) The dangers of overtrading can lead to a business not
fulfilling orders within the required time or even not at all.
2) The quality of work can be affected adversely as a
business rushes an order to complete it to enable them to
start the next one , reducing the chances of repeat custom
3) Suppliers will grow impatient if the materials or goods bought
From them are not paid for on time which could lead
to relations deteriorating and threatening future supplies
4) Overtrading could lead to the failure of a business , especially
if the business run out of cash to pay suppliers and
other debts they might owe