Comparison with Sector Averages
Any conclusion relating to the signs of overtrading needs to be put in the context of the normal values of accounting ratios indicated by the sector averages. But it should be recognised that averages exist because no two companies are identical even when in the same business sector and the following discussion should be read with this in mind.
The escalating trend of receivables days away from the sector average of 100 days is clearly a cause for concern. If our stage of receivables was brought into line with the sector average our financing need would fall by $477000 ($2·75m × 21/121) which is equivalent to 17% of our forecast overdraft. The reduce in inventory days is encouraging although forecast inventory days remain 13% higher than the sector average indicating the possibility of further improvement.
There is obvious evidence of an increased reliance on short-term finance. The trend of payables days is escalating away from the sector average of 120 days and the forecast of 190 days is a very worrying 58% more than the average. This represents $940000 ($2·55m × 70/190) supplementary in trade finance that our company is carrying compared to a similar company in our business sector. On this evidence it is probable that our suppliers will begin to press for earlier settlement in the near future and this will add to the pressure already being exerted by our bank.
The quick ratio is expected to raise but will still be 15% below the sector average while the current ratio is expected to be 25% lower than the average. The low current as well as quick ratios reflect the increased reliance of our company in comparative terms on short-term sources of finance.