Avoid the problems of overtrading

It is often helpful to compare the assets and liabilities of your business, as it can be useful for forecasting what your assets and liabilities will be in the future. You can do this by using cashflow forecasting and ratio analysis. However, for either to be effective, you need up-to-date and reliable financial records.

Cashflow forecasting

Since cash is essential to a business, a cashflow forecast is one of the most important management tools you can use. If you are expecting a rapid increase in business, an accurate cashflow forecast is vital. This predicts the money coming into and going out of the business and, to be effective, it needs to be broken down into relevant periods - monthly, weekly, or even daily.

See cashflow management.

Ratio analysis

There are various ratios that need to be monitored in order to avoid overtrading. Along with cashflow forecasting, these ratios will help you understand your own business' cash needs. Forecasting future ratios is an invaluable way of predicting the effect of a rapid increase in workflow.

Working capital and quick ratio

Working capital is the difference between current assets and current liabilities. Clearly, the safest position to be in is to have more assets than liabilities, and the bigger the difference the better.

Quick ratio is a more demanding way of measuring cash needs. Stock is completely left out of the current assets total because it might take some time to turn into cash. Only investments, money in the bank, cash and money owed by customers are counted.

Gearing

This is the percentage of money borrowed from the bank compared with money provided by the owners and other investors. For example, suppose that the bank lends the business £40,000 and the shareholders provide £60,000. The gearing would be 40%, because the bank provided 40% of the total.

Gearing can help a business by boosting cash, but it does involve borrowing potentially large sums of money.