7 Micrex Computers Ltd was established in 1989 to sell a range of computer software to small businesses.

Since its incorporation, the business has grown rapidly and demand for its products continues to rise. The most recent financial accounts for the company are set out below:

The company is family-owned and controlled and, since incorporation, has operated without qualified finance staff. However, the managing director recently became concerned with the financial position of the company and therefore decided to appoint a qualified finance director to help manage the financial affairs of the business. Soon after joining the company, the finance director called a meeting of his fellow directors and at this meeting, stated that, in his opinion, the company was overtrading Required

(a) What do you understand by the term ‘overtrading’ and what are the possible consequences of this type of activity?

(b) What are the main causes of overtrading and how might the management of a business overcome the problem of overtrading?

(c) Use financial ratios for Micrex Computers Ltd that you believe would be useful in detecting whether the company was overtrading. Explain the significance of each ratio you calculate.

Transcribed Image Text:

Balance Sheet as at 31 May 199X Fixed assets Freehold land and buildings at cost Less: Accumulated depreciation Equipment and fittings at cost Less: Accumulated depreciation Motor vehicles at cost Less: Accumulated depreciation Current assets 55,000 (4,000) 51,000 20,000 (5,000) 15,000 24,000 (6,000) 18,000 84,000 Stocks 26,000 Trade debtors 59,000 85,000 Less creditors: amounts falling due within one year Trade creditors (88,000) Proposed dividend (1,000) Taxation (6,000) Bank overdraft (10,000) (105,000) (20,000) 64,000 Less creditors: amounts falling due beyond one year 14% bank loan (secured on freehold property) (20,000) 44,000 Capital and reserves Ordinary 1 shares Retained profit 25,000 19,000 44,000