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Causes of Over-trading :-
•Depletion Of working capital – Results in depletion of
cash resources. Cash resources may get depleted by premature
repayment of long –term loans, excessive drawings,
dividend payments, purchase of fixed assets & excessive net
trading losses etc.
•Faulty Financial Policy :- Such policy can result in
shortage of cash & over-trading in several ways like—
Using working capital for purchase of fixed assets.
Attempting to expand the volume of business without
raising necessary resources.
•Over-Expansion :- In national emergencies like war,
natural calamities etc. a firm may require to produce goods
on a larger scale. The government may pressurise the
manufacturers to increase the volume of production
without providing for adequate finances.
•Inflation & Rising Prices:- inflationary trend in the economy
puts pressure on the prices of the resources. The
manufacturer needs more cash resources even to
maintain the existing level of activity.
• Excessive Taxation:- Heavy taxes result in depletion of
cash resources at a scale higher than what is justified. The
cash position is further strained on account of efforts to the
company to maintain reasonable dividend rates for their
shareholders.
CONSEQUENCES OF OVER-TRADING
•Difficulty in Paying Wages & Taxes – Leads to insecurity &
dissatisfaction among the labour & affects the reputation of
the company in the business.
•Costly Purchases-
•Reduction in Sales- Company may suffer in terms of
sales because cash needs may compel it to offer liberal
cash discounts to debtors & also resort to distress sale.
•Difficulties in making payments- Will force the company
to persuade creditors to extend credit facilities.
•Obsolete Plant & Machinery-
UNDERTRADING
•It is reverse of Overtrading. It means improper & under-utilisation of
funds lying at the disposal of a firm. In such a situation the level of
trading is low as compared to the capital employed in the business.
It results in increase in the size of inventories, book debts and cash
balances. Basic cause of undertrading is under-utilisation of the
firm’s resources. This may be due to following causes.
•Conservative policies followed by the management.
•Non-availability or shortage of basic facilities necessary for
production such as, raw materials, labour, power etc.
•General depression in the market resulting in fall in the demand.
SYMPTOMS
•High current ratio.
•Low Turnover ratios
•Increase in working capital turnover(working capital/sales)
•CONSEQUENCES
•Profits showing declining trend resulting a lower ROI.
•Decline in market value of shares.
•Loss of reputation
•REMEDIES
•Dynamic & result oriented approach
•Diversification and attempt to improve utilisation factor of
the firm’s resources