What is 'Revenue Deficit'
A revenue deficit occurs when the net income generated, revenues less expenditures, falls short of the projected net income. This happens when the actual amount of revenue received and/or the actual amount of expenditures do not correspond with budgeted revenue and expenditure figures. This is the opposite of a revenue surplus, which occurs when the actual amount of net income exceeds the projected amount.
BREAKING DOWN 'Revenue Deficit'A revenue deficit impacts cash flow in future months. Many states and cities have operated with revenue deficits, which create serious funding issues for public pensions and other required government expenditures. Running a deficit may lead to a cut in a municipality’s credit rating, since the city or state cannot reliably generate enough cash inflow to pay for services and fund its principal and interest payments. The City of Chicago, for example, issued variable rate debt securities in 2015 that received a junk bond rating from Moody’s Investor Services, and the interest rate paid was higher as a result of recent credit downgrades for the city.
How a Revenue Deficit Impacts Profit
Assume XYZ Manufacturing uses the target net income formula for monthly budgeting purposes, which is stated as: (sales – variable costs – fixed costs = target net income). During the budgeting process, XYZ makes these assumptions for the budget: ($1,000,000 sales – $400,000 variable cost – $500,000 fixed costs = $100,000 target net income). During the month, XYZ generates revenue of only $800,000, and since variable costs are 40% of sales, variable costs total $320,000. However, XYZ operates at a loss for the month because the total expenses of $820,000 are greater than revenue.
Examples of Cost Cutting
A company can make improvements by cutting variable costs, which are typically material and labor costs, by finding other vendors that can provide materials at a lower price. The company can also invest in training so employees can work faster and make fewer errors. Fixed costs are more difficult to cut because XYZ may have contracts for some costs, such as a lease on a factory building. Over time, however, fixed costs can be reduced, and these cost-cutting measures help the company avoid revenue deficits in the future.
Factoring in Cash Flow
A revenue deficit also affects XYZ’s ability to generate enough cash to operate in future months because lower revenue means the company collects less cash. In this case, XYZ collects 20% less cash than the budgeted amount, and if sales increase sharply in the next few months, the company may not have enough cash inflow to operate. Assume, for example, next month’s sales are estimated to be $1.5 million and the variable costs for those sales total 40%, or $600,000. XYZ’s total costs are projected to be $1.1 million once fixed costs are added to the variable costs, and XYZ may have to borrow money or sell equity to meet those cost requirements.