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Medium2 marksMultiple Choice
Working Capital ManagementSection BFinancial ManagementSyllabus COvertrading

ACCA · Question 16.4 · Working Capital Management

CASE 1: AQUAHARVEST LTD

AquaHarvest Ltd is a commercial aquaculture firm farming premium salmon. The company currently allows its wholesale customers 60 days to pay their invoices. However, due to cash flow constraints, the Finance Director is considering offering an early settlement discount of 2% if customers pay within 15 days. AquaHarvest currently finances its working capital using a bank overdraft that charges an interest rate of 8% per annum. Assume a 365-day year.

AquaHarvest has grown its revenue by 40% over the last year without raising new long-term capital. Which TWO of the following are classic symptoms of 'overtrading' that AquaHarvest might exhibit?

Answer options:

A.

A rapidly increasing reliance on the bank overdraft.

B.

A significant decrease in the volume of inventory held.

C.

A declining current ratio and quick ratio.

D.

Suppliers offering more generous credit terms.

How to approach this question

Identify the financial symptoms of a company expanding too fast without adequate long-term capital (liquidity crisis, high short-term debt).

Full Answer

Overtrading occurs when a business expands its operations rapidly without sufficient long-term capital to support the expansion. Symptoms include a rapid increase in sales, a sharp increase in current assets (inventory and receivables), but an even sharper increase in current liabilities (payables and overdrafts) to fund them. This leads to a heavy reliance on overdrafts (Option A) and deteriorating liquidity ratios like the current and quick ratios (Option C).

Common mistakes

Thinking overtrading means trading too successfully and having excess cash.
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