The Growth Trap - avoiding overtrading
If you're a business owner or an entrepreneur, you might have experienced the thrill of landing a huge deal or seeing your sales skyrocket almost overnight.
The sense of accomplishment and the rush of excitement can be intoxicating.
But what if I told you this rapid growth could actually put your business at serious risk?
In this week's Numbers Knowhow podcast episode titled "The Growth Trap: Avoiding Overtrading," I’ll guide you through the treacherous waters of rapid growth and help you avoid the pitfalls that could lead to financial disaster.
We'll explore a hidden danger—overtrading—which can creep up on even the most profitable businesses and leave them in tatters.
In this episode, you'll learn about what overtrading really means and how it can manifest in your business operations.
Transcript
Foreign.
Speaker:Most business owners, including myself, aspire to growth.
Speaker:But did you know that growth, specifically rapid growth, can be
Speaker:a very, very dangerous thing? In this week's podcast, I'm going to
Speaker:be diving into this crucial topic of growth, specifically how
Speaker:rapid growth can lead to a hidden danger called
Speaker:over trading. Is it trapped that even businesses that are
Speaker:profitable can fall into, with the disastrous
Speaker:consequences that follow?
Speaker:Let's set the scene. Imagine you're building your business, your emotion,
Speaker:your drive, your passion. You're pouring your heart and soul into it. And
Speaker:growth is that ultimate goal, that ultimate aspiration,
Speaker:right? After all, if your business isn't growing, it's probably going
Speaker:backwards, it's falling behind. But there's a twist in the tell.
Speaker:Uncontrolled and rapid growth can wreck even the
Speaker:most promising ventures. Now, this brings us neatly to this topic of
Speaker:over trading. What actually is it? Well, in simple terms,
Speaker:it's when your business takes on more than it can handle, both in
Speaker:financial and operational terms, or a combination of the two.
Speaker:Imagine revving your car engine so hard that it blows up.
Speaker:That's similar to over trading. Now, to explain this,
Speaker:let me share a story. I'm going to introduce Serena. Now,
Speaker:Serena say four years ago she started a boutique
Speaker:business making high quality bags. Things were steady,
Speaker:turning over £250,000 a year with a
Speaker:£30,000 profit margin. She has an overdraft facility of
Speaker:20,000, just in case those unexpected bills come in.
Speaker:Just in case demand is low. But those bills have still got to be paid.
Speaker:Those overhead and running costs have still got to be met. And then one day,
Speaker:that dream deal comes along. A big major retailer
Speaker:puts in an order for £50,000 worth of her bags every
Speaker:month for the next two years. That's got to be exciting, right?
Speaker:It's the kind of moment that many business owners and entrepreneurs dream
Speaker:about. Let's see what happened next. Now, to meet the demand,
Speaker:Serena orders more materials, takes on more staff
Speaker:and ramps up the production line. By month two, the first
Speaker:batch has been delivered. But there's a catch. Her payment terms
Speaker:will the retailer are an eye watering 70 days. And
Speaker:that's over two months before Serena will see any of that money
Speaker:in her bank account. Meanwhile, her suppliers want to
Speaker:be paid sooner. They've got their own bills to pay. They don't want
Speaker:to extend their credit terms. So Serena goes to the bank and asks
Speaker:to increase her overdraft limit. They agree initially, but by
Speaker:month three, their cracks are forming. Suppliers
Speaker:aren't being paid on time, that cash isn't coming in, they're
Speaker:stopping deliveries now of the materials required to make those
Speaker:bags. Legal threats are piling up and a bank, getting a
Speaker:bit jittery, a bit nervous, refused to extend the
Speaker:overdraft. Serena's business is now in serious
Speaker:trouble. This everybody is overtrading in
Speaker:action. It's what happens when growth outpaces cash
Speaker:flow. Now, there are trigger signs, there are warning signs. These
Speaker:include cash flow struggles. Materials are being
Speaker:purchased, staff are being paid. You want to keep the lights on, but the
Speaker:revenue, the cash flow isn't coming in fast enough to
Speaker:meet that cash outflow. Secondly, you're over
Speaker:investing in resources. You need to buy more equipment, you need
Speaker:to stock up with more inventory, you need additional staff,
Speaker:otherwise you're not going to be able to operate and those reserves are going
Speaker:to quickly diminish. There are going to be tensions with your
Speaker:suppliers. Those suppliers you haven't been paid will
Speaker:understandably want to be paid and they will, if needed, stop
Speaker:working with you. A worst case, they will take legal action against you and
Speaker:you're going to have that legal scimitar hanging over. Other
Speaker:signs, there are going to be banking roadblocks. Lenders understandably
Speaker:will be hesitant to extend credit when they see some instability.
Speaker:And if they do advance credit facilities, they're likely to be more
Speaker:expensive because they perceive the risk is much greater. And also
Speaker:your profit margins will take a squeeze in order to fulfill those
Speaker:orders. Those retailers, by the way, are going to be negotiating strong
Speaker:and hard discounts. Increased costs to fulfill those large orders
Speaker:will gobble away at your profits. Now, over trading isn't
Speaker:just a theoretical issue. It's a very common pitfall, especially
Speaker:for startups and those businesses that suddenly experience rapid
Speaker:growth. Growth demands investment, not just in cash
Speaker:investment, but also staffing resources to meet it as well. Too much too
Speaker:for us and you create a cash crunch. Now, having
Speaker:said that, how can we actually avoid it? Now, there are a few strategies
Speaker:that Serena could have adopted. Firstly, negotiating her payment
Speaker:terms, if she'd secured shorter terms, say 30 days instead of
Speaker:the 70 days, the cash flow would have been more manageable. She might be
Speaker:thinking, I can't go down that route of negotiating 70 days,
Speaker:otherwise I won't get the business. Well, you need to be strong and
Speaker:firm and make the case. Secondly, exploring the different
Speaker:options for financing. Tools like invoice financing, financing or
Speaker:factoring can convert those unpaid debts into
Speaker:immediate cash. Instead of buying equipment outright, perhaps the
Speaker:equipment could have been hired or leased. That working capital, that
Speaker:central ATM of the business, would have been kept intact.
Speaker:Thirdly, managing those supplier relationships carefully
Speaker:by communicating with our suppliers, perhaps even asking them if
Speaker:it were possible to extend the credit terms, making those payments on
Speaker:time would have kept them on side during those busy periods. There were
Speaker:two more bits Shisha could have factored in. Investing in a back office, support
Speaker:the infrastructure, making sure she's got enough resources, for example, in the
Speaker:accounts team. Having good, strong credit control, chasing payments
Speaker:and keeping track of cash flow will be a lifesaver. A more critical
Speaker:thing would have been to actually have done a cash flow forecast,
Speaker:a cash plan. Having that idea of what the future looks like
Speaker:in cash flow terms makes the anxiety much less,
Speaker:and it makes it easier to take account of what lies ahead.
Speaker:Now there's a key takeaway here. Growth isn't just about winning new
Speaker:contracts. Adrenaline rush though it may be. It's about sustaining that
Speaker:growth. And you need to track two critical numbers. Number one,
Speaker:cash flow. The money coming in and out of your bank account on a daily
Speaker:basis. There's a truism in business that you can sustain and
Speaker:survive without making profits. But once you run out of cash or access to
Speaker:it, close the lights as you leave the building. You will not survive.
Speaker:The second thing to track is the working capital, and that's the flow of
Speaker:inventory, supplier payments and cash. And these are the resources
Speaker:available to cover the short term obligations like paying your staff,
Speaker:paying suppliers, paying your bills, and paying yourself. If any of these
Speaker:run dry, even most profitable business will collapse.
Speaker:As we draw things to a conclusion, remember this growth is a
Speaker:positive thing. It's the goal for most of us. And even if your ambition to
Speaker:grow is not significant, remember, standing still means you're
Speaker:going backwards. But growth has to be managed carefully. Take the time
Speaker:to plan your cash flow, do those forecasts, access and secure
Speaker:flexible funding options, and negotiate terms that keep the
Speaker:balance in your favor. This is not a one directional conversation,
Speaker:and if you're considering taking a major leap, ask yourself, do I have the
Speaker:resources and the systems in place to handle it? If the answer is
Speaker:no, it might be wiser to hold off, scale up more gradually, or make
Speaker:that investment. If this episode resonates with you, well, check out the show notes for
Speaker:links to more resources and until next time, stay savvy.
