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What Is a Deficit?

A company would run a deficit if an investment in new equipment was not offset by increased profits.
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  • Written By: Mary McMahon
  • Edited By: O. Wallace
  • Last Modified Date: 10 September 2014
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In economics, a deficit is a situation in which more is spent than is made, characterized by flow rather than static debt. Deficits can involve a number of intersecting issues which cause income to fall below expectations, needs, or requirements or cause the cost of living or doing business to rise. Many nations have deficits, financing their activities through credit, and deficits can also occur on a smaller scale with businesses and even individuals. In the case of governments, information about the national deficit is usually available to curious members of the public.

In a very simple example of a deficit, losses exceed profits, or a business spends more than it takes in. In this case, balancing the deficit involves rectifying the imbalance to increase profits and reduce losses, bringing the balance of the books back to normal. Companies may do this by cutting expenses, raising prices, and engaging in a variety of other activities which are intended to address the imbalance. Persistence of the deficit may force the company to close.

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Another issue occurs when liabilities exceed assets. There are a number of situations in which people and institutions can run at a deficit which may not be harmful. For example, people with outstanding mortgages who are moving real estate around may have liabilities which exceed their assets, but in the long term, their financial position will be healthy because they will end up with assets. Furthermore, the more they spend on the properties and the more they pay off on the mortgages, the more equity they will have, gradually bringing their finances into balance. A negative net worth characterizes this type of deficit.

In a situation known as a trade deficit, imports exceed exports. This can occur when a company is not producing enough domestically to meet its needs, forcing it to import products to keep the population fed and happy, or when other countries are not interested in buying, leaving countries with unsold inventory. A trade deficit can also arise as the result of sanctions which limit a company's exports and imports. Sanctions may be used to penalize nations which the international community believes are behaving inappropriately.

Deficits can be identified by studying financial statements which disclose information about loans, income, and other financial matters. At times, operating at a deficit is a form of calculated risk which is designed to pay off in the long term, while in other cases, it may be unavoidable as a result of the economic client. In either cases, being in this state can make people and countries vulnerable to economic problems.

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