Genesis Ltd was incorporated in 2001 and has grown rapidly over the past three years. The rapid rate of growth has created problems for the business, which the directors have found difficult to deal with. Recently, a firm of management consultants has been asked to help the directors to overcome these problems.

In a preliminary report to the board of directors, the management consultants state: ‘Most of the difficulties faced by the business are symptoms of an underlying problem of overtrading.’ The most recent financial statements of the business are set out below:

All purchases and sales were on credit.
Required:

(a) Explain the term ‘overtrading’ and state how overtrading might arise for a business.

(b) Discuss the kinds of problem that overtrading can create for a business.

(c) Calculate and discuss five financial ratios that might be used to establish whether or not the business is overtrading.

(d) State the ways in which a business may overcome the problem of overtrading.

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Balance sheet as at 31 October 2004 Non-current assets Property, plant and equipment Freehold land and buildings at cost Less Accumulated depreciation Fixtures and fittings at cost Less Accumulated depreciation Motor vans at cost Less Accumulated depreciation Current assets Stock-in-trade Trade debtors Less Current liabilities Trade creditors Taxation Bank overdraft Less Non-current liabilities 10% debentures (secured) Equity Ordinary 0.50 shares General reserve Retained profit 000 000 000 530 88 442 168 52 116 118 54 64 622 128 104 232 184 8 358 550 (318) 304 (120) 184 60 50 74 184