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CA Intermediate · Financial Management and Strategic Management · Introduction to Working Capital Management

Which of the following situations most clearly indicates overtrading by a firm?

Overtrading is shown by rapid sales growth financed by rising trade creditors and bank overdraft, with a falling current ratio. The business is expanding beyond its capital base. Idle cash with falling sales or a very high current ratio points to overcapitalisation, not overtrading.

  1. ASales are rising rapidly, financed mainly by growing trade creditors and bank overdraft, while the current ratio keeps fallingCorrect
  2. BSales are falling while inventory piles up and large cash balances remain idle
  3. CLong-term funds finance a large part of current assets, leaving a very high current ratio
  4. DSales are stable and the operating cycle is shortening steadily

Explanation

Overtrading means the business expands sales beyond what its long-term capital and working capital base can support. It shows as fast sales growth, heavy dependence on short-term credit and overdraft, and weakening liquidity ratios. The other options describe overcapitalisation, excess liquidity, or healthy working capital management.

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