Meaning Of Overtrading In Accounting
Overtrading occurs when a firm is engaged in buying too much and selling too little. This means that the organization accumulates more volume of trade than its financial capacity, which results to piling up in debts in the long run. In this case, the working capital becomes inadequate as the current assets of the firm will not be sufficient enough to pay the current liabilities to a ratio of at least 2:1.
SIGNALS OF OVETRADING
The signals of overtrading are:
- Increasing amount of creditors
- More capital locked up in stock
- Excessive use of bank overdraft
- Constant use of trade discounts to customers
- Cash discounts to debtors to encourage prompt payment
- Mortgaging the firms properties; in other to obtain loan capital
- High ratio of debtor to equity capital and to sales
DISADVANTAGES OF OVERTRADING
The disadvantages of overtrading includes;
- Shortage of cash for future operation
- Too many creditors to be settled
- Aggrieved creditors may sue the firm to court in order to recover their money.
- Reduced assets as some of them are fully mortgaged
- Difficulty in obtaining loan as a result of shortage of assets.
REMEDIES FOR OVER TRADING
- The business organization should reduce its over-spending or it should arrange for more funds.
- Preventing over-trading by taking precautionary measures
COMPONENTS OF TRADING ACCOUNT
- Opening stock
- Purchases
- Purchases returns or returns outward
- Carriage inwards
- Cost of goods available for sale
- Closing stock
- Trading expenses e.g warehouse, wages etc.
- Cost of sales
- Sales
- Sales returns or return inward
- Gross profit or Gross loss.
