Deficit

Deficit
A deficit occurs when an individual or company doesn’t have enough money to cover their expenses and debt—it is the difference between cash inflow and cash outflow.

What is a Deficit?

A deficit is the amount by which something, especially a sum of money, is too little—it is an excess of expenditure over income in a given period. For example, the U.S. government’s federal deficit is $504 billion because its total spending exceed its total income for a financial year.1

There are two common types of deficits:

  • Trade Deficit – This type of deficit exists when a nation exports less than they import. For example, if a country exports $2 billion and imports $3 billion for a given year. In this situation, the country’s deficit would be $ billion because they took in more than they put out.1
  • Budget Deficit – A budget deficit occurs when a government’s revenues (incomes) are lower than its expenditures (expenses). If a small country has $15 billion in revenue and its expenditures were $20 billion, they would have a budget deficit of $5 billion.

Two ways of measuring a government deficit are:

  • Primary – This refers to the deficit without the inclusion of interest payments on loans taken out to finance the operation of the government.
  • Total – This measures the deficit with interest payments on loans taken out to finance the operation of the government, and the interest on the loans.

And, depending on the economic and political climate of a given country (such as the expansion of the economy), the deficits will vary. This can be the same for an individual when taking deficit into account, the amount can vary depending on the amount of money you are bringing in versus spending. When you don’t have to borrow anymore, your deficit lowers and you can begin paying down debt.

Overcoming a Deficit

Everyone runs into personal financial difficulties like losing a job, being unable to afford tuition, struggling with bills, or more. When this happens, it’s easy to find yourself “running a deficit” or spending more than you earn. Regardless of what causes you to have more payments than income, it is important to know how to handle your deficit.

  • Decrease Expenses – While this might seem obvious, it’s very important to figure out where to cut costs. Since you have more money going out than coming in, try to reduce your spending. Take a look at your food budget and try cutting it by 20% or skip that new outfit at the store—you might need to stick to a strict budget for the next money to get out of your deficit or it will turn into long-term deficit, or debt.
  • Increase Your Income – It’s easier than it seems. Are you owed a raise at work? Can you host a garage sale or pick up a side job? Try picking up a part-time job, or freelancing if your career allows you to do so. These odd jobs can help in the long run.
  • Save More When You Can – When you have extra money, don’t just spend it all—save more! By saving more than normal, you can prepare yourself for a potential deficit. In doing so, you can prevent further debt and even pay off more debt.

And, most importantly, don’t let running a deficit become a habit. It is normal to go through a period where your income is less than your expenses, but if you keep letting it happen you’re only hurting yourself (and your wallet) in the long run.

What is the difference between Deficit and debt?

Deficit and debt are not the same thing—debt is money owed, a deficit is the difference between what money is going out versus coming in. For example, a government can be $15 trillion in debt, but have a deficit of $1 trillion, but not the other way around. Each year, a government (or household) takes in and spends money. The government typically takes in revenues through income taxes, social insurance taxes, etc. It also spends money every year on social security, defense spending, and so on.

If the government spends more than it takes in over the course of the year, it is a deficit because it applies to just one year.  An example would be, if the government takes in $15 trillion dollars, but spends $12 trillion dollars that year, then it will have a $3 trillion-dollar deficit and must borrow money to make up the difference.

On the other hand, debt is accumulated deficits. If the government (or household) must borrow money every year, the debt will continue to grow. Debt will not disappear unless the government elects to try and pay it down, and is inevitable because an economy can’t function without borrowers and lenders. Think of it this way, debt is the accumulation of years of deficit (we don’t have one without the other).3

What’s the risk of a Deficit?

If you are running a deficit, you are accruing debt. And, over several years, if a deficit is large enough, it can wipe out value for an individual or a company’s shareholders. Eventually, the only option would be for bankruptcy. For a government, the negative effects of deficits might include lower economic growth rates (budget deficits) or devaluation of the domestic currency (trade deficits). Running a deficit can increase unnecessary debt, negatively impact your credit score, and cause you to run into many other problems.

Remember this: a deficit occurs when expenses exceed revenues, imports exceed exports, or liabilities exceed assets.

References:

1 “What is the Deficit?” USGovernmentSpending.com. Accessed February 23, 2017. http://www.usgovernmentspending.com/federal_deficit_chart.html

2 “Deficit” Investopedia. Accessed February 23, 2017. http://www.investopedia.com/terms/d/deficit.asp

3 “Debt vs Deficit: Understanding the Differences” Investopedia. Accessed February 23, 2017. http://www.investopedia.com/articles/personal-finance/081315/debt-vs-deficit-understanding-differences.asp