Overtrading and Other Financial Traps for Startups

Where are all the customers?
Where are all the customers?

There are plenty of traps for startups: a solution without a problem, thinking they’re in a blue ocean when actually the market is already crowded, not building and retaining a customer base, reliance on a technology that itself isn’t going to survive. In this article I’m covering a further set of problems: financial traps.

Out of the money: this happens when goods or services must be paid for before they are liable to be sold. For instance, buying capital items in quantity for a discount, but taking much longer than the invoice period to sell is ‘out of the money’: warehousing and insurance costs will also be incurred. Where foodstuffs have an expiry date, and this is reached, then not only is the ‘eventual profit’ lost, but the cost of disposal further damages the bottom line.

Overtrading: when ‘out of the money’ commitments are not backed by owner’s own capital or long-term borrowing. Overtrading occurs when companies misjudge cash flows and expand their operations too aggressively. In the long term the business could be very profitable, but in the short-term cannot meet immediate commitments, such as employee payroll or government taxes.

Sentiment: in England the airline FlyBe ran into difficulties when there were growing concerns about its viability. It had been trading successfully for many years, flying from the smaller regional British airports, like Southampton (SOU) which is 13 miles from my home. Most income was through online credit-card bookings, but the card handling companies began retaining progressively more of the payments to cover their liabilities should the airline cease trading. FlyBe was reliant on less retention. The downward spiral tightened as concerned travellers booked with other airlines.

Late Payments: this is a major problem for smaller companies in the UK. As a contract worker I once had to “walk off the job” to provide adequate incentive for an overdue interim invoice payment to be made. The money was in the company bank account before my plane landed at Southampton, and more importantly was never late again.

Economies of scale: as a teenager I was interested in hobby electronics, with ‘discrete’ components, like transistors and the then novel integrated circuits manufactured by Texas Instruments, albeit in plants in Indonesia & Singapore. The SN7400 series digital TTL (Transistor-Transistor Logic) chips provided NAND logic gates and flip-flop memory. As they became more popular, more were manufactured and set up costs had been recovered, their price fell. This caused ‘out of the money’ retailers hardship, with my local hobbyist shop closing.

General Deflation: another threat to retailers with capital stock – where prices fall month-on-month because stock must be discounted to entice purchasers. This engenders the expectation that prices will continue to fall, so capital expenditure is delayed, reinforcing the deflationary pressure.

Expanding after Market Saturation: new sales kept on progressing month on month. Suddenly this trend stops: everybody who wanted, and could afford, the item or service has done so. The danger is maintaining an expansion programme after saturation has been reached. Finances are going to be consumed without contributing to profitability.

This isn’t an exhaustive list of financial traps for startups, so if you know of others, please add as comments.

Thanks: to the folks at Oxford Innovation for hosting and sponsoring #SolentFintech events at the Fareham Innovation Centre.


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