Undercapitalization and business failure

:: 00:00

Have you ever wondered the most common reason for why some businesses become financial failures? Undercapitalisation is that reason, and in this podcast, I'm going to look at what it is, why it's a problem, and how to avoid it.

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You are listening to the I Hate Numbers Podcast with Mahmood Reza. The I Hate Numbers podcast mission is to help your business survive and thrive by you better understanding and connecting with your numbers. Number love and care is what it's about. Tune in every week. Now, here's your host, Mahmood Reza.

:: 00:40

Hi folks. Welcome to another weekly episode of I Hate Numbers, the podcast that's there to improve your money mindset, help you make more profit, save tax, and time. What's not to love? Let's crack on with the podcast. Now, undercapitalisation, a seven-syllable word, is effectively when your company doesn't have enough money or resources to run your business properly. You don't have money to pay your ongoing bills, which can create problems.

:: 01:06

When you don't pay bills on time, you have a reputational impact, a supply disruption, you are unable to pay yourself, your staff, you can't invest in new equipment or staff training, which means it's going to have an impact on the quality of the service that you offer. If you wish to pivot, if you wish to develop new products and services, you'll be unable to because you just don't have enough money.

:: 01:29

And by money, we're talking cash. Ultimately, if this continues, you'll be forced to become a financial basket case. You'll go into bankruptcy and lose everything. Having identified what undercapitalisation is, which is effectively running out of money, and it's not a problem that just affects startup businesses, it affects startups, businesses that have been established for a long period of time.

:: 01:53

Once that money runs out, once you become undercapitalised, do not pass go, do not collect 200 pounds. Having identified what it is and why it's a problem, let's think in terms of how we can actually avoid that. The biggest reason, perhaps why businesses become undercapitalised is because costs and resources are underestimated.

:: 02:15

People typically do not factor in the investment that's required to get your business started. So, if you are a startup business, you may be just considering what you need just to get the show going, just to get started. But there's also resources and money that is needed to keep your business on track.

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Business owners underestimate how long things take to get started, how long it takes to get customers in, and in the meantime, bills have got to be paid. Business owners underestimate how long it takes to develop new products and services. Underestimating the time and underestimating the cost, and even not being appreciative of what those costs are, will all contribute to undercapitalisation.

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Imagine your business as a car. Your car is the business, but in order to operate that car effectively, in order to get the most out of the car, you need to make sure you've got resources to cover any future repair bills, the cost of the car tax, the cost of the car insurance, the cost of any upgrades that you might need to have.

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If all you are thinking about the fuel costs here, and you've underestimated and omitted the costs in terms of running that vehicle, then you will not be able to use your car effectively. When it comes to that point, and it needs repairs, and you don't have that money to hand, the car is going to come off the road.

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It's the same in your business. Not appreciating the resources that you need to keep the business going, not appreciating the time lengths there will be between selling things and receiving money, not appreciating that supplies have got to be paid on time, otherwise, that affects your operational ability,

:: 03:48

not appreciating that investments may need to be made in new equipment, new fixtures, new machinery, again, we'll have a severe impact on your ability to continue. What is it we can do to try and avoid that undercapitalisation in our business? And remember, this is something that affects not just startup businesses, but it affects businesses at any stage in their business cycle.

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Most critical thing you can do is to make sure you've developed a financial plan. A financial plan is just a route map, saying that as we go forward in the future, what is it I need in terms of cash, what is going on to make sure that my business not only just ticks over, but can actually achieve those objectives and goals that I've set out. A financial plan.

:: 04:32

It affects you like a shopping list for your business. You identify the resources that you need to keep the show going. You identify the resources that you need if you wish to grow and expand. What does that mean in terms of freelancers, staffing, in terms of offers, resources, in terms of marketing spend, identifying what they are,

:: 04:49

and then translate that into what the financial impact actually is. Those businesses that do not plan, those businesses that do not think about the future are much more likely to hit the skids and not survive. So, as a bare minimum, you need to figure out, you need to have a financial business plan, and I would suggest you have that for at least the next 12 months.

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The second thing that's really useful is to build up a reserve. Anticipate the situation where perhaps your business may not have any customers for at least say three months. Three months to me would be the minimum, and build up a cash reserve that can take you through those lean periods and you can survive that three-month period. If you are factoring in additional investment in equipment and machinery,

:: 05:34

factor that in, but in terms of the operating ability, make sure you build up reserves to cover at least three months. So, we've talked about a financial plan. We've talked about building up resources, building up a reserve. The other thing is make sure you are aware of the access to capital, the access to funds that are out there.

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The choice of funds will be dependent on what it is you need those funds for, and there are many and varied from grants to investors, crowdfunding, factoring, overdraft facilities, loans. Make sure you match the funding for the needs of the business. So, when you talk about the operational capital that you need, the money to keep you ticking over,

:: 06:17

consider whether applying for overdraft facilities would be a useful thing for your business. Yes, there is a take-up in extra risk, but it may be something that helps you to operate. If you're looking for major investments in terms of buying new equipment, new machinery, then perhaps a loan may be the thing that you require for your business.

:: 06:36

So folks, let's round up what we've got. Undercapitalisation is a very posh term for effectively running out of money, and it's the most common reason why businesses do not survive. And by money, we're talking about cash. The thing that flows in and out of your bank account. Undercapitalisation applies to startups and to businesses that have been established.

:: 06:59

And once you do not have the money to actually pay supplies on an ongoing basis to service loans, pay yourself, pay the bills as they arrive, then you will have real financial headaches on your hand. I hope you found this podcast useful, I'd love it, obviously, if you could subscribe. Share it with those who feel, who may get some benefit from that.

:: 07:17

Until next week, folks, have a good week. We hope you enjoyed this episode and appreciate you taking the time to listen to the show. We hope you got some value. If you did, then we'd love it if you shared the episode. We look forward to you joining us next week for another I Hate Numbers episode.