What is an Accumulated Deficit?
An accumulated deficit is a term used to describe the amount of net loss that is incurred in a given year when a business shows a negative balance in its retained earnings. This type of deficit is realized when the company fails to make a profit for that particular year. While methods of accounting for an accumulated deficit vary somewhat, it is common for businesses to note the amount of the net loss under the stockholder equity carried by the firm. This makes it possible to document the loss in the company’s accounting records as well as identify the amount for purposes of claiming any applicable tax breaks for the period in which the loss occurred.
Identifying the accumulated deficit for a given period is important, since that amount impacts the amount of dividends paid out to investors. Essentially, when the losses offset earnings to the point there is no profit, there is a chance that dividends are not distributed for that period, or at least the dividends that are distributed are somewhat reduced. This is important, since a company that is not turning a profit cannot reasonably be considered capable of disbursing funds over the long-term to investors and still remain a viable business enterprise.
While any company can experience an accumulated deficit from time to time, many companies monitor profits and losses throughout the calendar year in an attempt to head off the possibility of experiencing a deficit at the end of the year. This often means identifying current trends with demand for the goods or services offered by the company, projecting the duration of those trends, and adjusting production accordingly. Doing so has several benefits, in that maintaining an inventory that does not greatly exceed demand means less money tied up in raw materials, lower costs for warehouse storage, and lower tax obligations on the finished goods in inventory. All these factors affect the amount of profit the business generates over the course of the year, which means they also have the ability to impact the accumulated deficit for the year.
The fact that a business does experience an accumulated deficit does not automatically mean the company is in financial trouble. For example, if the costs of the construction of a new building or an upgrade to production machinery is absorbed all in one calendar year, this could cause a negative profit situation for that one year, depending on how those costs were recorded in the accounting records. The following year would probably post a significantly higher profit as the business began to experience the benefits from those upgrades, resulting in avoiding the accumulated deficit altogether. When this type of deficit occurs, it is important to ascertain what led to the net loss, and take action that will prevent those same factors from exerting a negative influence on profits during the upcoming year.
Nothing worries shareholders more than deficits. While companies may be able to get away with one of these from time to time, those businesses that make a regular habit out of losing money need to get ready for a shareholder revolt.
Of course, if a company is losing too much money, it is doomed to bankruptcy and scandal, anyway.
Unless the federal government considers it to be vital and bails is out, of course. Apparently, some companies are allowed to lose money as they know Uncle Sam will foot the bill.
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