Revenue Deficit Meaning
Revenue Deficit is the situation where the company’s actual net income during a particular quarter or fiscal year is less than the net income projected at the start of the period and could be the result of change in business that has affected the company in the negative direction and that is responsible for the lag in the actual net income.
What Does Revenue Deficit Imply?
When a company enters into revenue deficit, it implies that they did not do enough business to cover the costs for the upcoming time period. The net income for that quarter is not enough to let the operations run for one more quarter. In such a condition, the company has to borrow the required amount from an external source: which in most cases will either be debt or equity. When the company borrows via debt, it has to pay interest, which increases the financial leverage of the companyFinancial Leverage Of The CompanyFinancial Leverage Ratio measures the impact of debt on the Company’s overall profitability. Moreover, high & low ratio implies high & low fixed business investment cost, respectively. . But if the company raises money through equity, the company need not pay any additional interest. However, equity is a partnership in the company, and in the situation of revenue deficit, raising equity is generally seen as a bad signal for the company.
Example of Revenue Deficit
Let us take an example of a fictional car company, Edison: a manufacturer of fuel cell cars. To make their cars, they import batteries and motors, to which they add additional fittings and form the car. Each car is sold at one hundred thousand dollars, and they predict that they will sell ten thousand cars. But, to import the materials, they have two hundred million dollars to the battery provider and 600 million dollars to the motor provider. So, the company expects revenue of one billion ( or thousand million dollars) from which they have to pay 800 million dollars and keep the rest as net income.
If the company did not sell 10,000 cars as expected and they only sold 8500 cars, then their net income will be short by 150 million dollars.
- Sold Cars: 85,000
- Revenue : 850,000,000
- Operational Expenses: This does not change because the company prepays for the engine and batteries. Hence this will remain at 800,000,000.
- Net Income = 850,000,000 – 800,000,000
- Net Income = 50,000,000
This is 150 million short of the expected 200 million.
It might negatively affect the company. If the company is a growth company, the company might need to have additional capital to maintain inventory. If the company has taken a loan for which the interest costs are more than the current net income, then the company does not have enough working capital to cover the interest expenses. In such cases, the company has to sell off its assets to make sure they cover the expenses. It is the beginning stage of bankruptcy.
A revenue deficit does not mean the company has started losing money. However, it does have implications that go far beyond a single number. From analyst’s estimates to companies working, revenue deficit is a significant number that is used to gauge the workings of a company and how it might behave in the upcoming future.
- The most obvious way is how the analysts are going to look at the revenues in the upcoming time periods. In most cases, analysts use predictions to analyze stock prices. Net income is one of the essential factors in predicting stock prices. A change in such prediction would adversely affect the analyst’s stock value and, in turn, most probably, market value.
- Having a revenue deficit would adversely affect how the company is going to perform in the upcoming time period. The revenue deficit size tells us the details about whether a company has enough money left to pay its interest charges. Or whether it has enough amount to have the growth rates it is predicting to have.
- Many corporates get their loans on interest rates determined by their credit ratings. In such a system, credit rating is one of the most critical metrics for a company. The process for credit ratings is that the company gives details regarding how it can manage its loans, and the credit rating agency takes that into consideration while giving out the credit rating. A revenue deficit might signal to the credit rating agencies that the company is not good enough and does not have as much expected business or market share or operational efficiency as the agency has expected. This signaling might force the credit rating agencies to reduce the credit rating of the company. It increases the financial risk of the companyFinancial Risk Of The CompanyFinancial risk refers to the risk of losing funds and assets with the possibility of not being able to pay off the debt taken from creditors, banks and financial institutions. A firm may face this due to incompetent business decisions and practices, eventually leading to bankruptcy..
There is no argument that the revenue deficit is bad. The point is to check whether the company is on the wrong path or the analysis is in the wrong direction. A company can correct itself by doing vertical integrationVertical IntegrationVertical integration is a corporate approach to take charge of its value chain or supply chain functions. It is the process of holding and managing the distributors, suppliers and retail locations at the company's discretion., being more operationally efficient, or creating a better financial structureFinancial StructureThe financial structure refers to the sources of capital and the proportion of financing that comes from short term liabilities, short term debt, long term debt, and equity to fund the company's long term and short term working capital requirements.. It is obvious upon the higher management in the company to determine if this is an operational failure or financial failure or systematic market risk. The decision on how to control the revenue deficit depends on what the basis of the root cause is.
This article has been a guide to what is revenue deficit and its meaning. Here we discuss key implications of Revenue Deficit along with examples, disadvantages, etc. You can learn more from the following articles –