Deficit

A deficit is the negative balance in retained earnings that is caused by cumulative losses exceeding the amount of equity. A deficit can be the result of a large amount of startup costs for a new business, which will (hopefully) be offset by profits in future reporting periods. A deficit may also be the result of the ongoing inability of a more established organization to generate a profit on a consistent basis. Common causes of deficits are:

  • Product prices are too low
  • Product returns are higher than anticipated
  • Unit volumes sold are too low to offset fixed costs
  • Scrap and shrinkage rates are higher than expected
  • Production and administrative expenses are higher than anticipated

Investors are exceedingly wary of accumulated deficits, since they are a strong indicator that the investors are unlikely to earn a return on invested funds, and may even lose any investments made.

It is not possible for an organization to sustain deficits for any period of time, unless investors are willing to continue pouring funds into the entity.

A related concept is a budget deficit, where a budget is constructed that has a built-in cash outflow; in effect, it is assumed that there will be a loss.