What is Undercapitalization?
How Does Undercapitalization Work?
Let's say Company XYZ is a jewelry company that begins getting huge orders from several national department stores. Company XYZ has to ramp up production and has to get some more factory space. However, it does not have the
In some cases, a company can be so undercapitalized that it is running out of cash and thus can't pay its lenders.
Undercapitalization is a common problem and major threat among young and growing companies.
Why Does Undercapitalization Matter?
In many ways, being undercapitalized is a good problem to have, because it typically signals that there is demand for a company's product. However, if an undercapitalized company is unable to obtain funding quickly enough, it can see capital can that a company ends up paying a high interest rate or agrees to less than favorable for capital.
For these reasons, management and cash planning are crucial for virtually every company, regardless of size.