Genesis Ltd was incorporated in 2005 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:

Statement of financial position (balance sheet) as at 31 October 2008

£000 £000 Non-current assets Property, plant and equipment Land and buildings at cost 530 Accumulated depreciation (88) 442 Fixtures and fittings at cost 168 Accumulated depreciation (52) 116 Motor vans at cost 118 Accumulated depreciation (54) 64 622 Current assets Inventories 128 Trade receivables 104 232 Total assets 854 Equity Ordinary £0.50 shares 60 General reserve 50 Retained earnings 74 184 Non-current liabilities Borrowings – 10% loan notes (secured) 120 Current liabilities Trade payables 184 Tax due 8 Short-term borrowings (all bank overdraft) 358 550 Total equity and liabilities 854 Income statement for the year ended 31 October 2008 £000 £000 Revenue 1,640 Cost of sales Opening inventories 116 Purchases 1,260 1,376 Closing inventories (128) (1,248)
Gross profit 392 Selling and distribution expenses (204)
Administration expenses (92)
Operating profit 96 Interest payable (44)
Profit before taxation 52 Tax (16)
Profit for the year 36 All purchases and sales were on credit.
A dividend was paid during the year on ordinary shares of £4,000.
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 the business is overtrading.

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