What is deficit financing?

When a business spends more in any operating cycle than in receives in revenue, a deficit is created, which is an amount of expense that exceeds total revenue. This amount represents an operating loss, a deficit, which needs to be covered or someone, a trade creditor or vendor, or a service provider, or maybe even an employee, won’t get paid. It is a “shortfall” that needs to be covered, or in other words “financed”.

So, the business owners have to find a way to “finance” the deficit so they can pay all of the amounts they owe but don’t have enough revenue to do so.

There are only two ways to finance a deficit: you can finance it with debt or with equity. Financing a deficit with debt means that you go out and borrow money, perhaps from a private party or a lending institution. Financing with equity means that the owners put more of their own money into the business (out of pocket), or they bring in another partner who can add money (capital) to the business.

There are lenders that specialize in deficit financing. One of the most common credit facilities used is a “revolving line of credit”. These usually finance deficits on a “short-term” basis, meaning the financing needs to be repaid within a year or less.

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