A deficit net worth is basically a negative net worth. This type of situation exists when the amount of capital stock currently issued along with the other financial assets of the company, are not sufficient to offset the current liabilities of the company. While it is not unusual for successful companies to experience short term deficit net worth from time to time, the condition usually indicates there is a need to make changes in the general operating strategy of the company.
Often, the reason for the creation of a deficit net worth has to do with some type of operating losses recently incurred by the company. The losses can sometimes be due to short term situations where new equipment has not been in use long enough to pay for itself. A sudden rise in the cost of raw materials can also create a deficit net worth by raising general operation expenses in the short term. The market for the goods or services produced may demand that the company lowers the price per unit in order to remain competitive, meaning the company generates less revenue. Essentially, any event that either creates additional expenses with the operations effort or generates a decrease in the unit price can lead to a deficit net worth.
The occurrence of a deficit net worth is easily identified on a balance sheet. Since the format for the balance sheet includes both assets and liabilities, it is relatively easy to determine if the company is currently operating with a net profit or is in fact operating at a loss. When a loss is present, it is not unusual for the corporation to begin identifying ways to correct the situation and restore the company to profitability.
Often, the data used to determine if a deficit net worth currently exists will also yield valuable information in how to effectively address the problem. In some cases, resources that are no longer producing revenue may be sold at a profit as one means of bringing assets and liabilities close in line. This is particularly true if the asset in question is also using up resources that could be used in other areas of the company’s operation.
At other times, the company may need to revamp processes and procedures so that the flow of production is more efficient. Doing so may eliminate an undesirable amount of waste during the production process and thus reduce the costs of creating products for sale. Reducing costs means that each unit produced will generate a higher rate of return per unit sold and also help to narrow the gap between assets and liabilities.