Overtrading: when a contractor grows too fast
What overtrading is, why fast-growing contractors are prone to it, and the warning signs to watch for in the balance sheet and aged debtors.
By Achekam · · 4 min read · For Construction businesses in South Africa, Nigeria, Kenya
The order book has never looked better. Two new contracts this quarter, a third awarded last week, and the client on the first one already talking about phase two. The directors are hiring site staff, hiring plant and buying materials ahead of the programme. And yet, at the end of every month, the bank balance is lower than the month before, the overdraft is at its limit, and suppliers have started phoning about overdue accounts.
That combination has a name. It is called overtrading, and it is one of the most common ways for a construction business with a full order book to get into serious trouble. This article explains what overtrading is, why contractors are especially exposed to it, and the signs to watch for in the books before it becomes a crisis.
Too much work, too little working capital
ACCA describes overtrading as having insufficient working capital to support the level of business activity. It contrasts it with over-capitalisation, which is an excessive level of working capital. Overtrading is the more dangerous of the two, because it tends to happen to businesses that look successful.
Construction is particularly exposed because of the way cash moves on a contract. The contractor pays wages weekly or fortnightly, pays for materials on supplier terms, and pays subcontractors on their claims. The client pays on progress once its agent has valued the work, often a month or more after the work was done, and holds back retention on top. Every new contract adds a new layer of cost the contractor must fund before the client's money arrives. The faster the business grows, the more cash it needs just to keep the work going.
Short-term finance rising faster than long-term
ACCA characterises overtrading by a high and rising proportion of short-term to long-term finance. In a contractor, that looks like:
- the overdraft creeping up and staying near its limit;
- suppliers being paid later and later, so trade creditors rise faster than purchases;
- plant and vehicles bought on short-term instalment finance rather than funded from equity or a term loan;
- directors' loans to the business appearing to plug month-end gaps.
None of these is unusual on its own. A balance sheet where all of them are rising at once, while long-term funding stays flat, is the pattern ACCA describes.
Profit on paper, no cash for wages
The confusing part for directors is that the income statement often looks fine. Contracts are profitable; revenue is growing. ACCA warns that many businesses that appear profitable are forced to cease trading because they cannot meet their short-term obligations when they fall due. Investopedia makes the same point plainly: even a profitable business can face bankruptcy if it lacks the cash to pay its bills.
Investopedia also cautions that positive working capital can hide a liquidity problem, for example when current assets are entirely receivables and customers delay payment. A contractor's balance sheet can show healthy current assets, but if most of them are amounts owed by clients and retention not yet released, the contractor cannot pay this Friday's wages with them. Investopedia's explanation of working capital walks through how the figure is calculated and what it can and cannot tell you.
Signs in the balance sheet and the aged debtors
Achekam's management accounts show an income statement for a chosen period beside the period before, and a balance sheet at period end, both added up from the business's own journals and exportable as PDF or CSV. Compare a few balance sheets month by month and look for these warning signs:
| Sign | What to look for |
|---|---|
| Receivables growing faster than revenue | Clients taking longer to pay, or claims not being approved |
| Trade creditors growing faster than purchases | The business paying suppliers later to cover the gap |
| Overdraft at or near its limit most of the month | No headroom for a late payment |
| Short-term borrowing rising while long-term funding is flat | The pattern ACCA associates with overtrading |
| Retention receivable building up | Cash locked in completed work |
Receivables are aged in Achekam into 0-30, 31-60, 61-90, 91-120 and over 120 days, with overdue totals. Watch how the total moves between the columns. A growing balance in the 61-90 column, while revenue rises, often means the business is doing more work than its clients are paying for on time, which is exactly how overtrading starts.
A business can also set a budget per account and period and compare it with actual figures from its ledger. Budgeting the overhead that comes with growth, such as additional site staff, plant hire and insurance, shows whether new contracts are adding cost faster than planned.
Slowing down or funding the growth
Once the signs are there, the business has two broad options, and often needs some of both.
Fund the growth properly. Long-term funding for a long-term need: a term loan or new equity rather than a stretched overdraft. A lender will want to see the order book, the cash forecast and the management accounts, so have them ready before the conversation.
Slow down. Decline or defer a contract the business cannot fund. Negotiate better payment terms or advance payments on new work. Chase overdue payment certificates and retention releases hard. Hire plant rather than buying it on short-term finance.
The worst option is to keep taking work and hope the cash catches up. In construction it rarely does, because each new job adds a new funding gap before the old ones have closed.
For what the bank will ask to see, read the figures a bank wants for a contractor's facility; for collecting the money already earned, see reconciling the final account.
A full order book is good news only if the business can afford to deliver it. Checking the balance sheet each month is how a contractor finds out in time.
General guidance only, not advice on your own circumstances. Tax and payroll rules change: check the current position with the authority or your adviser.
