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What is Deficit Financing?

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When working with budgets, the aim of the exercise is to have enough money to pay debts and  bills, as well as some money over for unexpected events. Usually this is achieved relatively easily as budgets are adapted to conform to the amount of money available. There are, however, situations when there is a deficit in the budget, i.e., there is a gap between the money that you collected (or are paid) and the amount of money that you need to meet your budgetary commitments.

When this occurs, you need to make a decision about how you want to remedy the situation. One of the solutions that you can consider is deficit financing. This strategy is most often used by government, large corporations and the entertainment industry.

Deficit financing is undertaken to stimulate the money creation part of the business/country. When this is done, the long-term outcome for the budget holder is an increase in finance and a healthier budget.

Example

An example of deficit financing is that of a studio filming a new series that it wants to sell to a specific network. The studio doesn’t have all the money it needs for the production of the series and therefore approaches the network for finance. The finance that they negotiate is called deficit finance as the studio will only need to finance the portion that the studio lacks. When the network buys the series, it is worth millions and the risk to both the studio and the network is negligible. Both parties had covered their gaps effectively when financing the production of the series and now both stand to make a handsome profit from the exercise.

Government also uses deficit financing to stimulate an economy that is going through a recession. The government part-finances several income producing projects in order to raise a profit which then covers the deficit that was financed. Once the project is on its feet, the government then monitors the progress of the financial growth of the project and ensures that no further gaps occur. In so doing the government ensures that jobs are created and further business opportunities arise.

Conclusion

Deficit finance is a very clever way of making money without having enough money to cover all the bases. It is, however, not something to be toyed with as it functions like any other financial tool. There are always risks involved and it is better to be aware of them beforehand than later when the problems start to occur.

Using deficit finance for a new project can help to generate an enormous amount of capital (and later profit) if managed properly and applied with the necessary prudence. It is a good idea to do your homework on the finance that you’re asking for (and getting) before making any contractual commitments. Know who your financiers are and exactly what they want out of the deal. If you’re satisfied, you can probably look forward to some handsome rewards.

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Meet the Author

Anthony Carter currently resides in Fife, Scotland with his wife Lisa, and their three wonderful children. As a senior editor for various publications, if he's not reading and writing, you would find him photographing and traveling to some of the most far-flung locations around the world.

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