What is Revenue Deficit?
The revenue deficit is a situation wherein the actual net income generated by the business is less than the projected income assumed by the business. This situation comes up when the actual revenue generated expenses incurred by the business are below the anticipated values of revenues and costs.
It is deemed to be the opposite of revenue surplus; wherein there is a deficit in the revenues whenever the actual net income achieved by the business is below the projected net income. The revenue surplus is a situation wherein the actual income earned by the business is above the net income that the analyst or the organization had previously projected. It generally indicates that the business is heading in the negative direction and basis which there is the development of lag in the actual net income generated by the business. In such a situation, the management has to devise a strategy that limits or reduces the deficit levels. A broader probability should be to generate sufficient net income resulting in a revenue surplus for the business.
Whenever a business faces impending distress costs and a financial crunch in terms of numbers, the business generates income that results in a revenue deficit. It broadly indicates that the business has failed to perform and meet up to the expectations as defined by the management of the business or as aligned with the benchmarks established in the industry. As a result, the business does not have sufficient monies to cover its day-to-day costs. In the situation of revenue deficit, as emerged in the given quarter, the business cannot continue the business operations for the next quarter as the business has no cash in hand to supplement the business operations; whenever the business reports a revenue deficit, the management plans for external financing arrangements.
The external financing arrangement can be in the form of short-term to medium-term debt and selling the equity to the financial market. The business to handle such situations generally tries to identify those costs resulting in a deficit in overall income. The governments generally plan to raise taxes. Therefore, it can only be handled by incorporating strategic decision-making.
On a general level, the formula for revenue deficit would be expressed as follows: –
Revenue Deficit = Actual Net Income – Projected Net Income
Where the Actual Net income < Projected Net Income.
How is Revenue Deficit Calculated?
- As the first step, determine the projected levels of expenses that the business anticipates incurring.
- The second step involves the determination of income sources from where the business anticipates earning income and marking them as the projected income.
- The third step involves deducting the projected expenses from the projected income to arrive at the projected net income.
- The fourth step determines the actual levels of expenses that the business incurs.
- The fifth step involves the determination of actual income sources from where the business earns income, and they have to mark them as actual income.
- The sixth step involves deducting the expenses from the income to arrive at the actual net income.
- Lastly, deduct the projected net income from the actual net income to arrive at the final variance, which could be either revenue deficit or revenue surplus. If the actual net income is below the projected net income, this results in a revenue deficit.
Let us take the example of ABC company. The management has anticipated that it would incur $30,000 as expenses for the financial year and by incurring the costs, then anticipate earning $50,000. However, the business earned actual revenues of $35,000 and bore expenses of $30,000. Therefore, help the management to determine the revenue deficit.
Compute the projected net income as displayed below: –
Projected Net Income is calculated as
Projected Net Income = Projected Revenues – Projected Expenses
- Projected Net Income = $50,000 – $30,000
- Projected Net income = $20,000
Actual Net Income is calculated as
Actual Net Income = Actual Revenues – Actual Expenses
- Actual Net Income = $35,000 – $30,000
- Actual Net Income = $5,000
It is calculated as
Revenue Deficit = Actual Net Income – Projected Net Income
- Revenue Deficit = $5,000 – $20,000
- Revenue Deficit = -$15,000
Therefore, the business has a revenue deficit of -$15,000.
How is Revenue Deficit Met?
If the business persistently incurs a revenue deficit, the management must re-do their cost analysis. They must quickly identify expenses, develop strategic plans to control such costs, and regularly check or monitor them. The cost-cutting measures should identify the suppliers who offer raw materials at lower or reduced costs, followed by investing in a more productive workforce rather than counterproductive. Finally, the business should look at vertical integration with the supply chain process. For governments, they can always plan up or chalk out the financial plan that helps them arrive at the tax rate, which helps them make collections of revenue.
Lastly, if all the measures fail and the business makes a revenue deficit rather than a revenue surplus, the business should look out for external financing. In external financing, the business can choose among the available source of finance, such as short-term to medium-term debt, or selling some portion of the equity to the general public. This ensures that the business has some money to supplement the business operations. However, if the business has to make a good amount of interest payment on the debt they undertake from the financial market. Concerning raising equity to finance, revenue deficit always corresponds to a negative signal on the business.
Some of the advantages are given below:
- The situation of it helps the management to conduct a cost analysis.
- While doing cost analysis, they tend to identify variable costs, allowing them to eliminate such costs.
- They additionally identify a productive workforce from a counterproductive workforce and basis which they invest more money in a productive workforce.
Some of the disadvantages are given below:
- The continuous revenue deficit would cause the business to eventually collapse as there would be a situation where the business won’t be able to sustain business operations.
- The sustained revenue deficit also reduces the chances of attracting new potential investors to the business. So there would be a situation where the business gets the wind-up.
It is a situation wherein the actual income earned by the business is below the anticipated income projected. In the event of a revenue deficit, the management has to re-structure their cost situation or broadly plan for external financing available in the financial market.
This is a guide to Revenue Deficit. Here we also discuss the introduction, how it is calculated, and its advantages and disadvantages. You may also have a look at the following articles to learn more –