How to avoid undercapitalization and what it is, is the topic of this video and blog. It’s when the company hits a financial brick wall. But, let’s take a more step-by-step approach and explain everything so it’s easy to understand.
In this blog (and vlog), you will find out the following:
- What is undercapitalization?
- Why is it a problem?
- How to avoid it?
Undercapitalization
To put it simply, it’s when a company runs out of money.
The term describes a state in which a company does not have enough capital to perform its day-to-day business operations. In other words, it is a shortage of funds for the business which, in turn, cannot afford to cover what it spends. What’s more, it may also lead to the company being unable to pay its creditors.
If you’re keen on watching videos, then click on it to learn something useful which could save your company from making some common mistakes and risk undercapitalization. If not, then scroll down and continue reading the blog.
Why does undercapitalization happen?
The reason why so many small businesses fail due to this issue is because they have a false sense of security in their own abilities. They think that because they are a good worker or a good salesperson that they can also be a good business owner who does not need any outside funding from investors or banks.
Undercapitalization is the main reason why many businesses, from startup to established, become financial basket cases, become financial failures, do not go past go, do not collect 200 pounds…
It really happens because many businesses underestimate several things, among which:
- How long something takes to accomplish,
- How much it costs to run the business,
- What resources the business has at its disposal, etc.
Why is it a problem?
Well, we all know that not having money is not the best of situations. In addition, it may lead you to a vortex of undesirable situations.
You wonder why… Here are some examples of what undercapitalization brings to the table.
- If you run out of money, you are more likely to try to take loans that you wouldn’t necessarily take. Just because your back’s against the wall, so to speak. So, what you’d consider unfavourable conditions as per usual, might not stop you from borrowing the funds because you feel hopeless at the given point in time.
- Another situation in which you will find yourself is not being able to pay your staff. As a consequence, you will either have to let staff members go, or deal with unmotivated and unhappy employees.
- Even if you somehow managed to pay your staff, you wouldn’t be able to pay yourself. Or pay your bills! And eventually, things will come to a halt.
How can you avoid undercapitalization?
Creating a good cash flow plan is the way to go. It will ensure that you have realistic expectations for your business.
Remember what we mentioned at the beginning? That many business owners underestimate how time-consuming something is, or how much something will cost. Well, as much as they underestimate these things, they overestimate the money that’s going to come into the business.
Such things lead to undercapitalization i.e. being broke. Hence, the need for proper financial planning and realistic goals and expectations.
Conclusion
Hopefully, we have managed to inform you about undercapitalization, and also inspire and educate you to get closer to your numbers. Above all, you can improve your financial understanding and well-being, you make more profit, save tax and time, and your money mindset. How wonderful is that?
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