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Undercapitalization

Definition

Under-capitalization refers to any situation where a business cannot acquire the funds they need. An under-capitalized business may be one that cannot afford current operational expenses due to a lack of capital, which can trigger bankruptcy, may be one that is over-exposed to risk, or may be one that is financially sound but does not have the funds required to expand to meet market demand.

What is 'Undercapitalization'

When a company does not have sufficient capital to conduct normal business operations and pay creditors. This can occur when the company is not generating enough cash flow or is unable to access forms of financing such as debt or equity. If a company can't generate capital over time, it increases its chance of going bankrupt as it loses the ability to service its debts. Undercapitalized companies also tend to choose high-cost sources of capital, such as short-term credit, over lower-cost forms such as equity or long-term debt.

Explaining 'Undercapitalization'

Being undercapitalized is a trait most often found in young companies that do not adequately anticipate the start-up costs associated with getting a business up and running. It can also occur in large companies that take on significant amounts of debt and suffer from poor operating conditions.

If undercapitalization is caught early enough, and if the company has sufficient cash flows, it can replenish it coffers by issuing stock or debt, or obtaining a long-term revolving credit arrangement with a lending group. However, if a company is unable to produce net positive cash flow or access any forms of financing, it is likely to go bankrupt.


Further Reading


Fundamentals of small business financial management for start up, survival, growth, and changing economic circumstances
www.emerald.com [PDF]
… Ph.D., Associate Professor of Finance, Department of Economics andFinance, College of … Under capitalization results from several errors made during the initial stages of … FOR START UP, SURVIVAL, GROWTH, AND CHANGING ECONOMIC CIRCUMSTANCES", Managerial …

When losses turn into loans: The cost of undercapitalized banksWhen losses turn into loans: The cost of undercapitalized banks
papers.ssrn.com [PDF]
… Ph.D., Associate Professor of Finance, Department of Economics andFinance, College of … Under capitalization results from several errors made during the initial stages of … FOR START UP, SURVIVAL, GROWTH, AND CHANGING ECONOMIC CIRCUMSTANCES", Managerial …

Prompt corrective action and bank efforts to recover from undercapitalizationPrompt corrective action and bank efforts to recover from undercapitalization
www.sciencedirect.com [PDF]
… Ph.D., Associate Professor of Finance, Department of Economics andFinance, College of … Under capitalization results from several errors made during the initial stages of … FOR START UP, SURVIVAL, GROWTH, AND CHANGING ECONOMIC CIRCUMSTANCES", Managerial …

Examining bank SEOs: Are offers made by undercapitalized banks different?Examining bank SEOs: Are offers made by undercapitalized banks different?
www.sciencedirect.com [PDF]
… Ph.D., Associate Professor of Finance, Department of Economics andFinance, College of … Under capitalization results from several errors made during the initial stages of … FOR START UP, SURVIVAL, GROWTH, AND CHANGING ECONOMIC CIRCUMSTANCES", Managerial …

Non-recourse, no down payment and the mortgage meltdown: Lessons from undercapitalizationNon-recourse, no down payment and the mortgage meltdown: Lessons from undercapitalization
heinonline.org [PDF]
… Ph.D., Associate Professor of Finance, Department of Economics andFinance, College of … Under capitalization results from several errors made during the initial stages of … FOR START UP, SURVIVAL, GROWTH, AND CHANGING ECONOMIC CIRCUMSTANCES", Managerial …

Are systemically important Eurozone banks undercapitalized? A stress testing approachAre systemically important Eurozone banks undercapitalized? A stress testing approach
papers.ssrn.com [PDF]
… Ph.D., Associate Professor of Finance, Department of Economics andFinance, College of … Under capitalization results from several errors made during the initial stages of … FOR START UP, SURVIVAL, GROWTH, AND CHANGING ECONOMIC CIRCUMSTANCES", Managerial …

Managing financial constraints: undercapitalization and underwriting capacity in Spanish fire insuranceManaging financial constraints: undercapitalization and underwriting capacity in Spanish fire insurance
onlinelibrary.wiley.com [PDF]
… Ph.D., Associate Professor of Finance, Department of Economics andFinance, College of … Under capitalization results from several errors made during the initial stages of … FOR START UP, SURVIVAL, GROWTH, AND CHANGING ECONOMIC CIRCUMSTANCES", Managerial …

Why European Banks Are Undercapitalized and What Should Be Done About ItWhy European Banks Are Undercapitalized and What Should Be Done About It
onlinelibrary.wiley.com [PDF]
… Ph.D., Associate Professor of Finance, Department of Economics andFinance, College of … Under capitalization results from several errors made during the initial stages of … FOR START UP, SURVIVAL, GROWTH, AND CHANGING ECONOMIC CIRCUMSTANCES", Managerial …



Q&A About Undercapitalization


How is capitalization calculated?

The formula for calculating capitalization is Net Worth / Number of Shares Outstanding = Capitalization Per Share.

How do companies become undercapitalized?

Companies become undercapitalized by not generating enough cash flow and unable to access forms of financing such as debt or equity.

What does capitalization mean in finance?

It means how much money an organization has available for future projects or investments.

What are the effects of being undercapitalized on a company's ability to service its debts?

The effects are that it increases chances of going bankrupt because it loses the ability to service its debts.

How can undercapitalization occur?

Undercapitalization can occur if the company is not generating enough cash flow or cannot access forms of financing such as debt or equity.

Is capitalization also a term used in finance?

Yes, it can be used in finance as well.

What is capitalization?

Capitalization refers to writing a word that has the first letter uppercase and the rest lowercase.

What is undercapitalization?

Undercapitalization occurs when a company does not have sufficient capital to conduct normal business operations and pay creditors.

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