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What is a Deficit

A deficit occurs when a negative value exceeds the corresponding positive value. It is typically used in a financial context. For example, a deficit may occur if a company’s expenses are higher than its turnover or its liabilities are greater than its assets. A country may run a deficit if its imports are higher than its exports. The opposite of deficit is surplus.

Understanding deficits

The term “deficit” can sound negative. In reality, however, it’s very common for new businesses to run a deficit in the early stages of their life. In fact, it’s practically unavoidable. Even if you set up a freelance “side hustle” with equipment you already have, your time still has value. Your company owes you for that time. Until you get paid, therefore, your company is running at a deficit.

Larger companies, especially tech companies, can run deficits for years until they become profitable. For example, Amazon launched in July 1994. It only posted its first profit in January 2004. This reflects the cost of equipping, staffing and growing an operation of this size. Of course, the rewards for investing in such companies can be equally high.

Even once companies are established, they may need or choose to run deficits. In some cases, this is a natural result of their business cycle. In others, it may be a strategic choice. For example, a company may choose to run a deficit to finance investment.

Deficit versus debt

A deficit simply means that a company is operating with some kind of shortfall. Generally, this shortfall will need to be plugged. Debt is one way of doing this. It is, however, not the only one. For example, startups often run on investment capital rather than debt. Even if they do get loans, those loans often have to be guaranteed by the company’s owners. Effectively, therefore, they’re still investments.

Established companies may simply tap into accumulated profits. For example, if a company runs a cyclical business, it may just set aside money during its profitable quarters to cover it for when it runs a deficit. Similarly, if a business knows it is likely to need to pay for investments, it may reduce, or eliminate, dividends to shareholders.

That said, debt is certainly one way of dealing with a deficit. Sometimes, it can be the only practical option. For example, if a company is hit with an unforeseen expense, their only option may be to resort to credit. Sometimes, however, it is a very strategic choice. For example, when interest rates are low, companies may be willing to take on debt, especially if it is to finance growth.

Deficit and strategy

Running a continual deficit is unsustainable. Running temporary deficits can, however, be a useful strategy. It is often seen in businesses aiming for maximum growth at minimum speed. It can, however, also be used on a much greater scale, for example, by whole countries. The secret to a successful deficit strategy is to have a clear view both of the cost of the deficit and of the expected benefits it will ultimately produce.

Of course, expectations aren’t always justified. That’s why it’s important to think about the potential worst-case scenario as well as the best-case scenario. For example, with regular commercial loans there is a risk that you might run into payment difficulties. This risk can, however, be mitigated by taking on paid employment to minimise the amount of money you need to borrow.

We can help

If you’d like to learn more about deficits, then get in touch with our financial experts. Find out how GoCardless can help you with ad hoc payments or recurring payments.

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