The Disastrous Practice Of Governments “Overtrading.”

Governments can overtrade just as businesses can – both with disastrous consequences. In the case of business, they collapse and pass into history, but for governments, their deficits grow and with it their austerity programmes. The quality-of-life for the majority plummet. They pay the price for the government’s stupidity in chasing GDP growth and following an inappropriate economic policy.


The mantra chanted by most politicians and governments today is that as long as GDP (Gross Domestic Product) growth is good, things are good because there’s increased revenue to meet expenditure. If there’s no growth or a decline, that’s bad – very bad. This belief is entirely wrong, and therefore, a reckless policy to follow. Chasing GDP without due financial consideration is pure insanity. If the underlying financials do not support growth, then growth hurts the average citizen – it doesn’t benefit them. So growth under all circumstances is crazy nonsense. Only managed growth is beneficial.

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There are strong similarities between a business overtrading and governments chasing GDP growth without due consideration for critical, underlying financial considerations, which if ignored, leaves the majority of citizens considerably worse off. Just as it’s bad for business to chase sales, ignoring the same financial considerations, so too is it financially reckless for governments to chase GDP growth.

So, if it's “insanity” to chase GDP growth without due consideration of the underlying financials, why do we do it? Because it's another lie fed us by vested interests to serve their needs, not ours. One of the most effective ways of influencing public opinion is to influence and shape politician's thoughts as they are influential in determining policy. They, like the general public,  are bombarded by vested interest to modify their perceptions. To see things from their perspective and to influence policy accordingly. It's not about the truth and reality, but about perceptions created to support their one-sided interests. It’s in the wealthy one per cent’s interest to have the economy keep on growing as it supports their short-term sales and profit.  So, naturally, they tell us that GDP growth is essential for our economy and our well-being. Like all their other lies, they promote them vigorously, until they enter our conscious mind, and we quote them as if they are some law of nature - “we need GDP growth.” However, would vested interests invest in any business who is knowingly over-trading? Of course not, because it spells financial disaster and business failure. They won't knowingly over-trade, but they encourage governments to chase GDP growth, in the full knowledge that it will create financial misery if the underlying financials cannot support growth. They do it out of self-interest, with no regard to the hardships the citizens of the country will face as a consequence. We have to get politicians to see the light and stop singing vested interests tune, which inflicts harm on their constituents.

Businesses prove that by cutting back sales and improving their financial situation is a far more prudent strategy to follow. The same applies to governments. Cutting back on GDP growth can benefit rather than harm, as I will explain. Governments need to grow at a sustainable financial rate, as do businesses, otherwise, they overtrade and fail.

When a business overtrades, it invariably goes under because they didn’t plan their financial growth correctly, and as a result, they run out of cash. Governments can get into a similar “overtrading” situation, but rather than go under, they increase their borrowings, thereby increasing their costs, which worsens their financial position. Increased borrowing over an extended period eventually forces the government into “austerity programmes” involving severe cost-cutting. Unfortunately, governments don’t address the underlying causes, so their austerity programmes have to become even more austere and last longer - indefinitely until the fundamentals are addressed. Such austerity programmes hurt society and drastically lower the quality-of-life for most citizens.

The UK is a case in point, it has been “overtrading”, and continues to do so, thereby perpetuating their austerity programme; this is because the fundamentals of the problem have been ignored. Citizens quality-of-life has dropped over the decades and will continue to fall rapidly. This is a major problem and a screw-up which needs to be fixed as it directly affects the quality-of-life for the majority.

What's overtrading?

So what is over-trading and how does a government overtrade, as it cannot be classified as a trading entity? First, let's understand how business overtrades and then draw similarities with government. Business overtrades when it chases sales but does not have the cash resources, or access to further borrowings, or equity to fund the increased sales. As a result, the business’s cash dries up, and it is forced out of business.

Increased sales come at a cost. Business has to find additional resources to fund growth. Take the example of an imaginary business shown below, to demonstrate where cash is tied up in business.

Raw Material stock holding + 15 days
Production cycle + 5 days
Finished stock holding + 25 days
Debtor days + 50 days
Creditor days - 35 days
Conversion Cycle = 60 days

If the business wishes to increase sales, it has to find cash to fund this 60-day cycle, called the “Cash Conversion Cycle”. So, on average, this business only gets their cash back in 60 days. They have to find cash to fund new sales for up to 2 months.

Every business has a “Cash Conversion Cycle” (CCC), which is a measure of its short-term cash-flow requirements. There are many things a business can do to reduce its CCC, which means it will require less cash to fund growth and can, therefore, grow faster. The longer the cycle, the more working capital the business requires, the slower its growth.

Funding Working Capital.

Because every new sale has to be funded through increased Working Capital (except for those businesses with a negative CCC. Certain businesses, such as cash retailers, who buy on credit and have a high stock-turn, may experience a negative CCC where increasing sales reduces their Working Capital requirements.) Ideally, growth should be funded out of profits. The extent to which a business can fund its growth through profit is called it’s "sustainable growth rate.” If it exceeds this, cash-flow starts drying up. Cash dries up in proportion to the extent that sustainable growth is exceeded. If a business exceeds this rate, then it has to borrow or raise equity to fund the increase in working capital to prevent a cash flow crisis.

Sales expansion often goes hand-in-hand with increased infrastructure expansion, such as increased expenditure on R & D, production facilities (machinery/buildings,) storage, distribution, sales, marketing and promotions. These involve additional expenditure, which adds to costs and reduces profitability, thereby reducing its sustainable growth rate and the business’s ability to fund working capital.

Where a business’s margins are low, and they require infrastructure expansion to meet additional sales, they are particularly vulnerable to market downturns. In downturns, margins come under competitive attack and are often reduced. Costs could also rise unexpectedly. Under such circumstances, their margins may be inadequate to produce a profit to service their increased infrastructure costs. They will obviously cutback costs where they can, but some infrastructure costs may be medium or long-term, meaning they can’t reduce costs enough. If the downturn lasts, they will face a cash flow crisis and will, in all likelihood, fail.

Key issues in preventing over-trading.

For a business to ensure it does not over-trade it needs to:-

  • Optimise it’s CCC (i.e. reduce its working capital through greater efficiencies,) and
  • Improve margins and therefore, profits (although this is not easy.)
  • Not exceed their sustainable growth rate, and
  • Ensure infrastructure expansion can be supported through a serious and sustained downturn, preferably funded through retained income, borrowings or increased equity. However, it's unlikely any business will be able to borrow or raise equity if they have ignored the three preceding financial considerations.

Businesses who chase sales, irrespective of these key issues, will fall victim to overtrading and fail.

Governments who chase GDP growth without due consideration for the same key issues will have to borrow to survive, thereby worsening their financial position and will eventually introduce austerity programmes to cut costs. Most will not address the underlying financial causes, so austerity deepens and continues until the fundamentals are addressed. Downgrading or cutting services, the result of austerity programmes, lowers the quality-of-life for the average citizen. Every year these austerity programmes continue, there is a progressive decline in quality-of-life. The responsibility of government is to build quality-of-life, not destroy it by chasing GDP growth.

Government equivalents.

Governments don’t use the same language to refer to the same things in business, so let’s look at the government equivalents for these key financial considerations, which if not managed effectively will ultimately lead to cuts and extended austerity programmes.

CCC equates to Departmental efficiencies.

Businesses must use their working capital more efficiently (i.e. optimise their CCC) to improve profit, and therefore, their ability to fund growth. Governments are no different. They to must manage their departmental resources more efficiently, which leads to an improved surplus, or helps reduce their deficit. Just as a business’s profit dictates its growth, so too does a governments surplus dictate government growth. If a government grows off a deficit their borrowings increase, so to their costs, with a reduction in their sustainable growth rate. Continued expansion off a deficit, compounds the problem. Therefore, it starts by ensuring government uses their resources efficiently, otherwise, they will deplete their surplus (should they have one) and increase their borrowings.

Profit margin equates to tax margins.

If business makes too little profit from a sale, because of small margins, its sustainable growth rate will be low. It can only grow slowly. Furthermore, if growth requires infrastructure expansion, involving medium to long-term debt, the business is at high risk of failing.

Governments are in the same position. If they have a low tax margin, i.e. where their revenue barely covers their cost, they can only expand slowly. If they expand beyond the rate of their surplus, their borrowings will increase and so to their costs. At this point, their costs may exceed revenue, putting them into a deficit. Future growth can now only be funded through borrowings, as there is no surplus. The situation gets progressively worse, year-on-year because of their reliance on borrowing to fund growth. Their debt keeps mounting. Continuous expansion requires increased infrastructure support. This places the finances under even more pressure, increasing government debt even more. To stop the hole getting even bigger, governments go on drastic cost-cutting programmes. This negatively impacts on the average citizens quality-of-life. Business, under these circumstances, would immediately cut back sales (growth), cut costs where they can and not undertake any infrastructure programmes, as well as limited maintenance of infrastructure. They would then consider ways of improving their margins. Governments, on the other hand, trundle along, making very few critical adjustments, apart from cutting costs. The critical thing to do is to increase taxes (margin.)

Address poor tax margins.

The increasing divide between rich and poor is an indication of government’s inadequate tax policy, particularly concerning corporate and personal tax of the rich. During the Reagan presidency in America (1981 - 1989) he was responsible for supporting and introducing neoliberal economic policies, such as privatisation, deregulation, free trade and reducing the size of government. Reagan lowered taxes on the wealthy from 70% to only 28% and broke the air traffic union strikes, which saw the weakening of collective bargaining. He had a major influence on Margaret Thatcher (UK Prime Minister from 1979 to 1990) who followed his neoliberal economic policies. She reduced the tax rate from 83% on the wealthy to 60%, which has subsequently been lowered to 45%. She also broke the strength of the trade unions. This is the era when the rot set in. These legacies live on in today's politicians as they follow neoliberal economic policies based on the misinformation fed them of how it serves our needs when the proof that it does not is evident all around us. The point I want to make here is that we do not tax the wealthy adequately. Top tax rate should return to the pre-Reagan era and be set at over 70% as suggested by leading economist Emmanuel Saez, Thomas Piketty and Stefanie Stantchev. This, and increasing corporation tax will go a long way in lifting tax margins. However, corporate welfare and the welfare of the rich is deeply embedded in our tax codes. Because of this, and a low top tax rate, we have a regressive tax system where the rich pay less tax pro-rata than the average person. We have the wealth and resources to eliminate poverty and improve everybody’s quality-of-life but can do little about it until we change our economic policy.

Copyright © 2019 Adrian Mark Dore

adrian.dore@growingvalue.net



About the Author

Adrian Dore
Adrian Dore has over forty years experience as a business owner, corporate executive and adviser. He has worked for, and with diverse businesses in equally diverse roles. This has given him a wealth of experience and knowledge. However, he has always been interested in understanding how businesses go about creating value; the underlying processes and their interrelationships, which he has spent the past twenty years researching and understanding.