We often hear about deficit spending by governments but businesses have deficits, too. A budget deficit happens when expenses add up to more than revenue. This is an indicator of a company's financial health – yet a budget deficit is not always bad. Most new companies endure a few years of deficit spending, for example, so it's good to start your business with some capital to get through the early years.
Pro: They Can Help You Launch
It’s not uncommon for a company to operate at a loss in its early years. But if the business plan is sound and the product or service is something that has a broad appeal or fills a need in a niche market, operating at a loss in the first few years can pay off in spades. Deficits also occur when an expensive new product is launched. But again, with good planning, a little confidence and patience, you may emerge with a new source of profit.
One of the best examples of this strategy is Amazon. This massive company began in 1994 and went public in 1997. However, it didn’t turn a profit until 2001 and was mostly in the red until 2009. Because the company used its debts to invest in innovation and get ahead of competitors, Amazon became the most valuable company in the world, according to Inc. Even in the years it operated at a loss, Amazon was able to show revenue growth, and that kept investors coming back. Your company can do the same, even if on a smaller scale.
Other companies that didn’t make a profit for many years include Tupperware, Federal Express, ESPN and Turner Broadcasting System. Turner, which merged with Time Warner in 1996, launched CNN in 1980. It didn’t record a net profit until 1991. Tupperware began in 1946 selling its products in retail stores, but it didn’t do well financially until it hit upon the home party concept in 1948, and by 1951, Tupperware was generating profits and selling exclusively through home parties.
Con: Investors Can Disagree
If the company is investing in a new product, it will do well to give that product time to succeed. You may feel confident that the new offering will take off like a rocket. However, your investors may sour on the losses. If you see this coming, it’s likely a good time to focus more on products that help the company’s bottom line and keep you in the black.
Pro: Deduction on Your Taxes
If you’re a sole proprietor of your business, you can deduct any losses your business takes on. You can deduct these losses even if you have income from another job, your spouse's job or from an investment. If you own a limited liability company, or LLC, you can deduct your share of the company’s loss. A corporation owner can’t deduct business losses on personal tax returns. This is where you would want to use the net operating loss, or NOL.
Most small business owners, like Amazon in its early days, don’t see a profit the first year. Your business may experience up and down years as it gets going. You can use this loss as a tax advantage by filing a net operating loss, or NOL, deduction. This allows you to offset one year’s losses against another year’s income. You can do this to offset the taxable income in the previous two years. If you’re confident you’ll be earning a profit in future years, you can carry a NOL forward.
Con: More Vulnerable to Disaster
For every success story like Amazon's, there are dozens of businesses that did not make it through the early days. Sometimes a company is profitable for years before coming upon hard times. Sales can drop, disasters can strike, or the economy itself can tank. Having an excess of profits, rather than a deficit, can get your business through these times.
On the other hand, if your business operates at a deficit, it will either have to borrow money from banks or raise capital from investors. If the external factors that hurt your business damaged financial institutions as well, it could be difficult to get the money you need.
- My Accounting Course: What Is a Deficit?
- The Verge: Amazon Is Wildly Profitable But it's Still Taking Huge Losses Overseas
- BizFilings: Business Losses Can Generate Net Operating Loss Deduction
- The Tax Foundation: Some Corporations Pay Zero Federal Taxes - And There's No Problem With That
- Patriot Software Accounting Blog: Know How Financial Loss Affects Your Small Business
- CNN Tech: Uber Is Losing Billions: Here's Why Investors Don't Care
- Investopedia: Budget Deficit
- Inc: The 10 Most Valuable Brands in 2018