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ACCA Applied Skills · Financial Management · The nature, elements and importance of working capital

Which of the following is the most likely symptom of overtrading in a company that has expanded sales rapidly without raising additional long-term finance?

Overtrading is shown by rapidly rising revenue financed by short-term sources, so the overdraft increases and the current ratio falls. The business grows beyond its long-term capital base, leaving liquidity weak, while falling sales and rising cash would indicate the opposite situation.

  1. AFalling revenue with rising cash balances and falling payables
  2. BA rising current ratio with falling inventory days and falling receivables days
  3. CRapidly rising revenue, increasing bank overdraft and a falling current ratioCorrect
  4. DFalling revenue, falling inventory and repayment of long-term debt

Explanation

Overtrading arises when sales grow faster than the long-term capital base, so working capital is funded by short-term sources such as the overdraft and trade payables. This typically shows as rising revenue, a growing overdraft and a deteriorating current and quick ratio. The option with a rising current ratio and shorter cycles indicates improving liquidity, not overtrading.

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