Undercapitalization and Small Businesses
The seriousness of undercapitalization and ways you can avoid it in your business
Undercapitalization is any circumstance where a business owner can not acquire the funds they need. This is generally the case when the business can not afford the current operational expenses because their short term capital is not enough. When capital is low and expenses are still due, this can often times lead to bankruptcy.
When businesses are not financially stable this can result in undercapitalization. Most reasons than others, it is because the fault of the business owner. There are companies such as American Express, the Business Group, and Y.P.O. who have made an industry out of foreseeing the causes of undercapitalization and offer there services too businesses for a fee. However, this service usually only works for people who want to continue having a secure business and want a fall back plan in case something does happen. Companies that already have undercapitalization problems may not benefit from this service.
There are reasons why business does not have complete revenue assurance. The main two reasons behind the problems are because 1) the financing growth is from short term capital rather than permanent capital, and 2) failure to secure an adequate bank loan at a critical time. These two situations can greatly damage your business in the long run. Financial business growth is best financed through permanent capital. Short term capital may be revolving credit, credit cards, and factoring accounts received. Many new small business owners often make the mistake of not using permanent capital, which leads them to undercapitalization.
Though undercapitalization problems generally happen to new businesses in their first year, it can happen in other years. If the beginning growth of the business was rapid but profits are fairly passive, then you may be setting yourself up for undercapitalization problems. There are ways to avoid this problem though.
- Get proactive in your planning process. Make sure that you current business plan and any future changes have a “just in case” plan based on the growth of your business. If you business begins to grow too fast, have a plan B for incase a sudden decrease in revenue occurs.
- Find an investor; this can be a trustworthy relative or friend, who can act as a pinch investor. This is someone who can bail you out in case of a dramatic business slump.
- Get a line of credit at the bank
- Always have an emergency plan. This can go as far as selling some of your personal assets, such as your car. Many people rather want to see a personal asset be taken away from them than for their business to be taken away.
- Raise your prices to stem the tide of customers
Review your expenses at the end of each month and make changes if needed.
It is very important for business owners, especially new business owners to have a business plan that ensures their business assurance. Many business owners find it beneficial to obtain secured or unsecured business loans and cash advances from companies. This helps the financial stability of your company, and helps with undercapitalization problems.
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