Colleges are warning of job cuts and course closures because their budgets have been frozen.
fforwm, the organisation representing Wales's 25 FE colleges, says provisional allocations for the year beginning August 2006 do not even take inflation into account, leaving the sector unable to deliver on the Assembly government's plans for improving lifelong learning in Wales.
But the government says the sector has benefited from significant increases in funding, in particular for increasing lecturers' pay to the same level as school teachers and for improving college facilities and buildings.
And it says the allocations announced this month are subject to further negotiation.
This is the first year of a new national funding system for all post-16 providers, including schools and colleges, developed by ELWa, the sector's now defunct funding agency.
fforwm has supported the development of the national planning and funding system (NPFS), but says provisional budgets drawn up suggest it "will have a huge negative impact on vocational learning and learning in the workplace, as well as adult learning, community learning, outreach work, and on the numbers of part-time learners".
It believes the new system prioritises funding for 16 to 18-year-olds on academic courses, and warns that colleges will be forced to compete with schools for these learners.
But the Assembly government's Learning Country 2, its education programme to 2010 published earlier this month, envisages more co-operation between providers to widen teenagers' study options.
It says the FE sector has a key role in delivering post-16 education and training to school-leavers, and offering courses to adults who want to retrain or upgrade their skills.
Dr John Graystone, fforwm's chief executive, said: "The budget freeze came out of the blue. Colleges had no idea that they were going to be facing long-term cuts.
"However, we have been told that the funding allocations have not been finalised yet. We have met with the Assembly government to explain that a budget freeze will mean cuts in vocational learning, adult and community learning, courses, and in the number of part-time learners.
"We hope it will revise the funding to make sure that we can deliver what learners need."
An Assembly government spokesperson said: "These allocations are the first announced under the new NPFS, which has been introduced to ensure equity in funding throughout the post-16 sector. Colleges have already been informed that the figures are provisional and subject to refinement in light of the Assembly government's commitment to work closely with fforwm to ensure the new system best meets the needs of learners in Wales.
"The FE sector has seen a significant increase in funding over recent years, including an additional pound;34 million to ensure parity of pay between FE lecturers and school teachers."