Over-trading is when a company is growing its sales faster than it can finance or fulfil them, in other words, taking on additional orders when it can’t afford to service or fulfil them.
The impact on cash flow is often concealed by the growing profits from growing sales.
The assumption that you cannot turn down business and must accept all orders is normally based on a rational fear of either leaner times in the future or that your customers will go elsewhere.
However, the American author and trader psychologist Rande Howell has an interesting perspective on the causes of and motivation for over-trading.
He outlines this in his book, Mindful Trading: Mastering your emotions and the inner game, and on his website mystateofmind.com.
While acknowledging that there is a fear element, the decision-maker’s fear of missing out, he attributes this to their mindset as a hunter.
The business leader, or trader as he refers to them, has a bias to act and therefore to chase after sales.
This can lead to taking action out of boredom because the mindset is about making things happen. Inaction, and the suspicion that opportunities are passing by, is therefore uncomfortable but it can also lead to acting on impulse rather than reason.
Howell also points out that there is a biological imperative in this behaviour in that the brain rewards success by releasing dopamine, the “feel good” chemical. Add to this Testosterone, which is associated with risk-taking and you have the elements of a behavioural pattern that can lead to over-confidence and unconsidered behaviour.
The danger of acting on impulse rather sticking to the business plan
As I have said before a well-organised business ought to schedule work and know when an order can be easily fulfilled.
When planning for growth, the business should look carefully at its finances and have a clear idea of its capacity.
I have also advocated in the past my view that those businesses with more demand than capacity should, instead of building more factories or taking on more staff, consider selling their existing capacity instead of selling more services or products.
This can be done in two ways, either by pricing to manage demand or fixing prices but managing expectations. No one minds waiting if the quality justifies the wait, at least until a competitor offers a similar quality at a similar price but quicker. This sale of capacity allows you to focus on quality of both product and service and avoids taking on more fixed costs in a febrile market.
Honesty and self-awareness, what Howell calls mindful trading, can help to combat the psychological components that lead to risk-taking and can strengthen the confidence in sticking patiently to the growth plan.