Shortfall

What is Shortfall?

Shortfall occurs whenever there is a mismatch between supply and demand. It is applicable to a variety of financial situations. The situation may be an actual circumstance that exists here and now, or the shortfall may be a projected possible future occurrence.

For example, when a business experiences a cash flow problem that creates difficulties in making its required debt payments, it is a situation where there is a shortfall of needed cash. An example of a projected shortfall may be when a company’s executives forecast that the next quarter’s revenues will fall short of their previously stated sales targets.

A shortfall may be viewed as either a temporary, short-term shortfall or as a long-term or ongoing shortfall.

Shortfalls may occur in relation to the finances of a company, other entities (such as a government or non-profit organization), or an individual. In a government, the deficit represents the shortfall between revenues and expenditures for the year.

Shortfall Situations for Individuals

A financial shortfall for individuals is usually the result of either reduced income or an unexpected increase in expenses, or financial obligations.

Many individuals who are paid by the hour experience temporary financial shortfalls when their hours are unexpectedly cut back. They experienced what turned out to be more of a long-term shortfall following the implementation of the Affordable Care Act.

Facing massive increases in health insurance premiums – which would’ve created a significant, long-term shortfall situation for them – many companies opted to reduce some employees’ hours to below 30 hours per week so that they wouldn’t be obligated to provide insurance coverage for those employees.

Unfortunately, the company’s solution for its own projected shortfall actually created a long-term shortfall condition for the employees affected by the change.

Successfully adjusting your monthly budget to deal with a sudden, unexpected loss of one-fourth of your income, coupled with the loss of employer-provided health insurance – which will probably mean an extra monthly insurance expense for you – is likely to be quite a challenge.

Unless you can drastically reduce your monthly expenses, the only workable solution may be to either secure a second part-time job or look for new full-time employment.

How Companies Deal with Shortfalls

Nearly all companies, at least periodically, experience financial shortfalls of one kind or another. On a broad, general level, overall economic and marketplace conditions are constantly changing, and it is impossible to predict the impact that such changes may have on a company at a given time.

Temporary financial shortfalls may be virtually inherent in a company’s business model. For example, if a business is seasonal (e.g., a winter ski resort), then the bulk of its annual revenue is received during a limited time frame.

During the rest of the year, when revenues are either small or non-existent, the company must be able to manage its temporary cash-flow shortage to survive over the long term.

Some seasonal businesses work to establish other streams of revenue outside of their primary business operations. For example, a ski resort company may publish books and instructional videos on skiing that can be sold year-round.

Other Potential Causes of Shortfalls

• Loss of a major customer/client that provides a significant amount of a company’s revenue
• Problems with accounts receivables (e.g., an overall downturn in the economy may translate to customers becoming slower than usual in making payments on credit sales).
• Delays in production temporarily reduce sales and revenues.
• New governmental regulations reduce profit margins.
• A downturn in the stock market reduces investment returns for an employee retirement plan (such as a pension fund), creating a shortfall between fund obligations and fund assets.
• Cost overruns on a major capital project extend well beyond budget projections for the project.

How to Address Shortfalls

Generally speaking, shortfalls are best managed with good contingency planning. When working on next year’s budget, a company’s financial team needs to pay attention to any notes from company executives on future projections, together with the most recent financial statements.

Be conservative in budget planning – lean more toward over budgeting instead of trying to precisely predict expenses. In other words, pad budgets generously with cushions for additional, unexpected expenses.

Just as individuals are advised to maintain at least six months of living expenses to cope with things such as job loss, so, too, are companies advised to create and maintain a sizable cash reserve fund to help deal with any shortfalls that may arise.

Also, since it may be necessary to take out a loan to manage a temporary shortfall, company executives can take steps to deal with such problems in advance by making a concerted effort to develop and maintain strong relationships with lenders.

More Resources

CFI is the official provider of the global Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:

• Cash Budget Template
• Demand Shock
• Forecasting Cash Flow
• Revenue Streams
• See all economics resources