What is Undercapitalization?
Undercapitalization occurs when a company does not have enough cash to conduct its operations.
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 theto do so, which means it is undercapitalized.
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.slump (in our example, the department stores are only going to wait a few weeks for their orders) and jeopardize the future of the company. Additionally, being in a rush for
For these reasons, cash planning are crucial for virtually every company, regardless of size.