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ACCA Applied Knowledge · Business and Technology · Accounting and finance functions within business organisations

Which of the following is a recognised cause of overtrading, which cash management should seek to prevent?

Overtrading is caused by expanding sales rapidly without enough long-term finance to fund the extra working capital. The growth in inventory and receivables ends up financed by short-term borrowing and suppliers, creating a liquidity crisis even though the business may be profitable.

  1. AExpanding sales rapidly without sufficient long-term finance to fund the extra working capitalCorrect
  2. BHolding excessive cash balances compared with current liabilities
  3. CReducing inventory levels below the level of sales demand
  4. DFinancing all non-current assets with equity

Explanation

Overtrading occurs when a business grows quickly without enough long-term funding, so the extra inventory and receivables are financed by overdrafts and payables, creating liquidity strain. Excess cash and equity funding of assets are the opposite of this problem, and low inventory is not the defining cause.

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