As used by accountants, the term “deficit” has a meaning similar to its everyday usage. That is, a firm that is running a deficit is spending more than it makes. The exact meaning of deficit in financial accounting is defined more precisely, and the definition varies somewhat depending on the context in which the term is used.
Deficits on the Balance Sheet
If you look in the shareholders’ equity section of a firm’s balance sheet, you’ll see a category called “retained earnings.” Retained earnings are the accumulated profits the company has made since it started that have not been paid out as dividends. In financial accounting, the company has a deficit if the retained earnings figure is negative. This indicates the firm’s equity is less than the amount investors originally paid for the stock. Deficits typically occur when the company incurs sustained losses because it sets prices too low, has unexpected expenses or doesn’t sell enough to turn a profit. Sometimes a startup firm will show a deficit because sales and profits haven’t yet caught up with the expense of getting the company up and running.
Cash Flow Deficit
Cash flow refers to the amount of current assets a company has available, meaning how much money is on hand to pay its bills. A firm’s cash flow statement tracks changes in current assets. A cash flow deficit occurs when the current assets have declined during the previous accounting period.