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Overtrading: why a profitable business can have no money in the bank

In this Beach Talk, Ciaran O'Donnell tells the story of a client that was doing well by every profit measure and still had a problem it could not see. His name for it is profitably overtrading: two words, he says, you do not want to hear.

An example of overtrading

When Ciaran starts working with a chief executive, he pushes them to understand the profit and loss first: where the business makes money, where it does not, and what needs to change. But he warns that you cannot leave the balance sheet behind.

The client in the video had a profit and loss that looked good: profitable every month and heading for its best year yet. The owners were not looking at the balance sheet. Scroll down it, even in a quick conversation, and there was £400,000 of accrued income: work done that had not even been invoiced.

In a normal world you do the work, raise the invoice, the customer pays and the money lands in your bank. With deliverables and long-term contracts, you may not yet have reached the point where you can invoice. That is how a business can post a strong profit with no money in the bank. Ciaran found the explanation by reviewing the accrued income on the balance sheet.

How to stop overtrading

Ciaran's steps are practical, in order:

• Review the balance sheet every month. If you do not, you never get under the skin of what is going on or who is accounting for it.
• Get the invoice out. The first job is to raise it as quickly as you can.
• Get the invoice paid. The second job is to turn it into cash in your bank.
• Manage your deliverables and your customers. How work is delivered and accepted decides when you can invoice, so manage both.
• Keep the books squeaky clean, all the time. A customer can pull a contract or not renew, or you can lose a key member of the team, and you want to react from a position of strength.

The alternative, in his words, is suddenly realising you have less than one month of cash left and need money quickly. Worse still, he says, and inexcusable, is overtrading while you are making profits simply because the invoices have not gone out.

Where the weekly check fits

Overtrading hides in the gap between profit and cash, which is why a monthly profit figure will not warn you. Own Your Numbers connects to your Xero read-only and every Monday puts your bank balance, net cash and cash cushion side by side, with the debtors to chase. Its net cash counts accrued income as money owed to you, just as the balance sheet does, so it will not flag uninvoiced work on its own. Ciaran's warning is to inspect that balance yourself and get the work invoiced and paid.

Overtrading questions, answered briefly