What is an Accumulated Deficit?
An accumulated deficit is a negative retained earnings balance. This deficit arises when the cumulative amount of losses experienced and dividends paid by a business exceeds the cumulative amount of its profits. It can be quite difficult for a business to obtain a loan when it has an accumulated deficit, since this is a sign for lenders that the business is not generating sufficient cash flow to pay off the loan.
How to Interpret an Accumulated Deficit
An accumulated deficit signals that an entity is not financially stable, since it requires additional funding. However, this may not be the case for a startup business, where substantial initial losses are expected before sales begin to take off. It may also signal that the owners are winding down a business, selling off assets and transferring the resulting cash out of the business in the form of dividends.
Example of an Accumulated Deficit
An organization generates $100,000 of profits, pays out $25,000 in dividends, and then experiences $150,000 of losses. Its accumulated deficit is calculated as follows:
$100,000 Profits - $25,000 Dividends - $150,000 = $75,000 Accumulated deficit
