As we know undercapitalisation occurs when a business cannot maintain a healthy balance between operational expenses and short-term capital. Undercapitalisation occurs in a range of circumstances, but one that we see a lot is where a company grows rapidly without the same rapid intake of revenue to support the operational growth. Undercapitalisation is particularly prevalent in small businesses whose growth is then limited when they lack the financial resources to pay for the necessary service expansions.
When a company lacks consistent revenue and has no other means of attracting capital, they are ill equipped to ride out fluctuations in the market due to disruption or economic factors. In a sense these businesses are holding on to the hope that everything will be okay and that their business will land upon the revenue in time to meet their obligations. As I often say, mere hope alone is not a strategy.
While the unexpected does occur from time to time, there are a few ways in which small businesses can avoid undercapitalisation from the outset.
1. Stay in your lane.
The more you know the industry your business operates within, the more likely it is that you will able to foresee fluctuations and identify problems on the horizon. Leaders who are familiar with their industry have a network from which they can passively acquire market intelligence. Industry experience also allows leaders to make more informed strategic decisions from the outset, which helps in forming the overall strategy for the business.
2. Strategy. Strategy. Strategy.
A good business plan and holistic strategy will clearly identify the amount of capital required during the establishing phase. The strategy needs to consider all eventualities and have a contingency plan for every possible crisis situation. When the capital doesn’t flow in as expected, the temptation can be to immediately modify the strategy. There are times where course correction is required, but other times new businesses just need to stick to the strategy and ride out the uncertainty as best as they can.
3. Be realistic.
For most small to medium sized businesses profitability can being cyclical. It is important for business leaders to resist the desire to overestimate the longevity of a successful month, only to find that sales have dropped in the following month. It seems basic, but until there is a substantial capital buffer accumulated, leaders need to be stringent in how the early profits are distributed.
By the same token, be realistic about your personal skills as the business leader. If you are not skilled with managing finances or hiring the right people to fulfill the strategy, be willing to get other people in to handle those areas.
4. Seek advice.
Good leaders are humble and are willing and eager to accept timely advice from trusted people. It’s never pleasant to hear that a leader has failed to make the necessary decisions and strategic corrections simply due to naivety or a lack of financial acumen.
5. Know your market and connect with them.
New business owners often get caught up in the process of establishing the business and its operations, unintentionally assuming that the market will automatically respond. While this would be ideal, it is rarely the case. Taking the time to get to know your market – what they want, what the need, how they find services, how they buy products, what great customer service looks like to them – will allow you to make more informed marketing decisions. A strong customer service focus will help to build a sustainable revenue stream.
