ACCA Financial Management (F9) Certification Practice Exam

What term describes a situation where a company invests excessively in current assets like inventories and accounts receivable?

1. Overtrading

2. Undertrading

3. Financial distress

4. Equity dilution

The correct answer is: Overtrading

The correct term that describes a situation where a company invests excessively in current assets such as inventories and accounts receivable is overtrading. Overtrading occurs when a company expands its operations without sufficient capital, leading it to excessively acquire current assets. This can create liquidity problems because funds are tied up in these assets instead of being available for operational needs or investment opportunities. When a business overtrades, it often encounters cash flow challenges since it may not have enough cash on hand to meet its short-term obligations. This situation arises from the expectation of higher sales but is hampered by the inability to convert inventories and accounts receivable into cash quickly. The company may experience financial strain as a result, compounded by the lack of sufficient working capital. In contrast, undertrading refers to a scenario where a company operates below its financial capacity, resulting in underinvestment in working capital and current assets. Financial distress involves broader issues related to a company's inability to meet its financial obligations, while equity dilution refers to the decrease in existing shareholders' ownership percentage due to the issuance of additional shares, which is unrelated to the investment in current assets.