Definition: A deficit, also called a loss, refers to the surplus of expenses over revenue for a certain time period. In other words, it’s when a company’s expenses exceed its revenues during a period. Sometimes this is also referred to as running in the red or having a loss for the year.
What Does Deficit Mean?
Deficits are common the business world, especially in start-ups. It’s not uncommon for a company to lose money in the initial first years of existence. Tech companies are notorious for operating at a loss for the first few years. These companies stay a float through investors’ funds and increasing rounds of capital raising. Of course, an infamous non-business example is the United States government. Each year the US spends more money than it takes in from taxes and other collections.
Let’s look at an example.
The company Operating, Inc. has been in business for multiple years running a consistent profit. However, the business has experienced a rough patch and sales have dropped considerably this year. Total sales for the year are $100,000 while expenses are $150,000. Thus, the company sustained a loss this year.
Now, where can the company cover the shortfall from this annual deficit? Operating, Inc. must either use money from its past-accumulated profits or obtain a loan to cover the $50,000 loss. This loss is recorded just like the previous profits were in prior years. The loss account is closed at the end of the period reducing the retained earnings in the company.
Eventually, if the company keeps losing money year over year, the retained earnings account will be reduced to zero and will eventually become negative. Since there is no such thing as a negative retained earnings account, it becomes an accumulated deficit. This means the company has used all of its excess profits from prior years past and now the company’s net assets are negative. If the company can’t make a profit, it will either have to borrow money from banks or investors, or raise more capital from investors to maintain its operations.