What is deficit financing?

Adopting one of several deficit financing techniques is what many countries do when the government does not have enough of money earned through taxes to cover expenditure. Here is what you need to know about deficit financing in a country, and whether or not you will ever have to encounter it while working in a company.

Definition of Deficit Financing

Governments borrowing money to meet expenditure when revenue from taxes fall short is what constitutes deficit financing. Most often governments resort to deficit financing and deficit spending when there is a need to bring an economy out of recession or when it is in a downturn, and it helps kick start recovery and bring growth rates up. Currently the fiscal deficit, which is arrived at after subtracting the expenditure from the cash inflow without including any sums that are borrowed, is the factor that is considered to be important in an economy.

The Myth of a Balanced Budget

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In companies and even in the case of countries the world over a balanced budget does not happen every year. Especially in countries that are highly developed a balanced budget every year is no longer a major factor. While there are several drawbacks of deficit financing such as a country being indebted to foreign lenders there are also many positive aspects, which often result in companies and governments planning ahead to deal with a budget deficit for a year.

Planned Budget Deficits

Much like a country, a company might plan for a budget deficit in a year. There are also instances when businesses prepare for a budget deficit in a particular quarter in the year and as a result deficit financing comes into play. In some companies the need for deficit financing comes up ever year when a particular quarter sees a downturn in sales. Downturns during winter mostly happen in companies that supply materials for construction and as a result sales people have less work. In such a situation borrowing allows the business to keep running and for employees to be retained on the rolls, even if there is a loss incurred in one quarter. As sales improve in the following quarter the company can run smoothly bringing in a profit.

Often companies that are operating in a economy that is slowing down or having to take on increasingly aggressive competitors also plan to invest more than what they are earning into expansion or creating new products in an effort to bring in more customers and hence increase sales.

Advantages and the Pitfalls

Deficit financing has some well known advantages leading to its increased prevalence, but it also comes with a number of traps which can hamstring a country or company both in the short and long term. One of the main advantages of deficit financing is that it allows a company to grow by acquiring other companies. While an important pitfall is that it makes governments borrow from funds in the capital market or look for creditors outside the country.

The factors leading to deficit financing might be improperly planned acquisitions or in the case of a country a shortfall in taxes gathered for the year. Irrespective of why deficit financing is required it is obvious that it will be around for a long time and is no longer viewed as undesirable when compared to a balanced budget.

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