OVERTRADING & UNDERTRADING

The concepts of over-trading and under-trading are

intimately connected with the net working capital position
of the business. To be more precise, they are connected
with the cash position of the business.

OVER-TRADING: Over-trading means an attempt to

maintain or expand scale of operations of the business
without sufficient cash resources. The firms involved in
over-trading have a high turnover ratio & a low current
ratio. In such situation, it is not in a position to maintain
proper stocks of materials, finished goods, etc., & has to
depend entirely on the suppliers to supply them at the
right time.

Causes of Over-trading :-
•Depletion Of working capital – Results in depletion of
cash resources. Cash resources may get depleted by premature
repayment of long –term loans, excessive drawings,
dividend payments, purchase of fixed assets & excessive net
trading losses etc.
•Faulty Financial Policy :- Such policy can result in
shortage of cash & over-trading in several ways like—
Using working capital for purchase of fixed assets.
Attempting to expand the volume of business without
raising necessary resources.
•Over-Expansion :- In national emergencies like war,
natural calamities etc. a firm may require to produce goods
on a larger scale. The government may pressurise the
 manufacturers to increase the volume of production
without providing for adequate finances.
•Inflation & Rising Prices:- inflationary trend in the economy
puts pressure on the prices of the resources. The
manufacturer needs more cash resources even to
maintain the existing level of activity.
• Excessive Taxation:- Heavy taxes result in depletion of
cash resources at a scale higher than what is justified. The
cash position is further strained on account of efforts to the
company to maintain reasonable dividend rates for their
shareholders.

CONSEQUENCES OF OVER-TRADING
•Difficulty in Paying Wages & Taxes – Leads to insecurity &
dissatisfaction among the labour & affects the reputation of
the company in the business.
•Costly Purchases-
•Reduction in Sales- Company may suffer in terms of
sales because cash needs may compel it to offer liberal
cash discounts to debtors & also resort to distress sale.
•Difficulties in making payments- Will force the company
to persuade creditors to extend credit facilities.
•Obsolete Plant & Machinery-

SYMPTOMS & REMEDIES FOR OVERTRADING

Symptoms
•Considerable rise in amount of creditors as compared to debtors
•Increased bank borrowings & corresponding inventories
•Purchase of fixed assets from short term funds.
•Low current ratio & high turnover ratio.
 •Fall in working capital turnover
Remedies
- Reduce the business or increase finance
- Sell or merge with healthy business entity, preferably under the same
Management

UNDERTRADING
•It is reverse of Overtrading. It means improper & under-utilisation of
funds lying at the disposal of a firm. In such a situation the level of
trading is low as compared to the capital employed in the business.
It results in increase in the size of inventories, book debts and cash
balances. Basic cause of undertrading is under-utilisation of the
firm’s resources. This may be due to following causes.
•Conservative policies followed by the management.
•Non-availability or shortage of basic facilities necessary for
production such as, raw materials, labour, power etc.
•General depression in the market resulting in fall in the demand.

SYMPTOMS
•High current ratio.
•Low Turnover ratios
•Increase in working capital turnover(working capital/sales)

•CONSEQUENCES
•Profits showing declining trend resulting a lower ROI.
•Decline in market value of shares.
•Loss of reputation

•REMEDIES
•Dynamic & result oriented approach
•Diversification and attempt to improve utilisation factor of
the firm’s resources