Funding Gap
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Funding Gap
What is a Funding Gap?
The funding gap, alternatively referred to as the financing gap, is the discrepancy between the amount of capital a business requires to finance its activities and the amount of capital it currently possesses. It is the gap that exists between how much a company needs to spend and the amount of capital that it actually possesses and can easily spend.
The funding gap may either be short-term (a cash flow problem as the firm waits for customer payments) or long-term (a structural problem in which case more capital must be raised to meet the funding gap). If the gap is not sorted out, it could make it difficult for the company to meet its obligations and continue its operations.
Funding Gap Formula
The funding gap formula is calculated as:
| Funding Gap = Total Capital Required − Total Capital Available |
- Total Capital Needed = Expenses, Investments, Obligations in the specified period
- Total Capital Available = Cash balance, Committed equity, and available debt/credit
Example
A newly established business forecasts that they need $2,000,000 in the next 12 months for covering the salary, product development, and marketing. They have the following:
Cash Balance: $600,000
Line of credit (committed): $200,000
Total Capital Available = $600,000 + $200,000 = $800,000
Funding Gap = $2,000,000 − $800,000 = $1,200,000
The Importance of Addressing Funding Gaps
- Operational risk: An unfilled funding gap may fail to pay salaries, stockouts, or late payments to suppliers.
- Risk of growth: Firms with funding gaps must reduce hiring, postpone their new product launch, or decrease marketing efforts even when there is market demand.
- Fundraising: The earlier a funding gap is recognized, the more time a firm will have for fundraising without any constraints or stress.
- Confidence of investors and lenders: A company that understands its funding gap and knows how to fill it will be better positioned to raise funds than a company dealing with a cash shortage.
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