Budgetary Slack

What is Budgetary Slack?

Budgetary Slack is the practice of underestimating the budgeted revenue or overestimating the budgeted expenses of the company intentionally by the person responsible for setting the budget with the motive of increasing the chances that the actual performance of the company is better than that of the budgeted goals. It is done by the management specifically when their bonuses or performance appraisals are based on the targets achieved by them.

Example of Budgetary Slack

For example, the manager of the company who is responsible for preparing the budget estimates that for the next financial year, the sales of the company would be $ 80,000. Still, he shows the budgeted sales to be $ 70,000 for the year by deliberately reducing the budgeted sales by $ 10,000. It was done because, in the past years, the top management of the company was not satisfied with the sales performance of the company as there was a vast difference between the budgeted sales they were checking from the past budget of the company and the actual sales during that period.

So, to look successful in the eyes of the top management of the company in terms of the budgetary performance, the manager reduced the budgeted sales from the actual selling capacity of the company. Due to this slack of $ 10,000 ($ 80,000 – $ 70,000) and lower performance benchmark that has been set by the manager concerning actual selling capacity, it is more likely that the manager will receive the favorable evaluation and review in the eyes of the top management of the company and might receive the incentive as well for the same. So this was the example of the budgetary slack where the manager kept the slack of $ 10,000 in sales revenue by underestimating for the budgeting purpose.

Budgetary-Slack

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Advantages

  • If the budgeted cost in the company is overestimated, then the expenditures can be shifted to future years.
  • When there is uncertainty about the future as possible in the case of the creation of a budget for the new product line, then budget slack may provide flexibility to the management while performing business operations.

Disadvantages

  • It could result in a decrease in the efficiency and performance of the employees of the company because, in that case, the employees of the company will work only within their capability of attaining the goals.
  • In case of there is budgetary slack by the understating the revenue of the organization then due to this understatement of revenue there are chances that the management will also cut the budgeted expenses of the vital function of the company such as the research and development expenses, advertisement expenses, production expenses, or administrative expenses, etc. this reduction of the expenses may also be responsible for hampering the company’s long-term viability.

Essential Points about Budgetary Slack

  • It is the intentional over-estimation of the budgeted expenses or under-estimation of the budgeted revenue of the company during a point of time while preparing the budget.
  • When large numbers of employees are involved in the preparation of budgets in the organization, then generally, there are more chances of introduction of budgetary slack into the budgets by them so that they can easily achieve the targets.
  • Even the senior management can introduce inventory slack into the budgets if they want to report a good picture of the achievement of their targets to the investment community. Although the analysts judge the performance of the business by comparing the actual results of the business with that of its competitors but still some organizations introduce budget slack for getting a good picture of the business, thinking it will work in favor of their organization.
  • To prevent the practice of the budgetary slack, the top management of the company should limit the manager count that is allowed to prepare the budgets and should not make the budget as the basis of the evaluation of the performance of the company.
  • It could result in a decrease in the efficiency and performance of the employees of the company because, in that case, the employees of the company will work only within their capability of attaining the goals.
  • The top-level management gets misled about the actual profitability of the business due to the budgetary slack, no matter the reason for the creation of budgetary slack is ethical or unethical. To overcome the same, top-level management should review the budget of previous years and assess variances between budgeted and actual numbers. With this, they might be able to correct the slack if any prevailing in the current budget and the future budgets of the company.

Conclusion

In a business, when the management deliberately over-estimate the budgeted expenses or under-estimate the budgeted revenue, then that cushion created by the management to increase the probability of achieving the better targets than the budgeted is a budgetary slack. It is done by the management, especially when their bonuses or performance appraisals are based on the targets achieved by them. When large numbers of employees are involved in the preparation of budgets in the organization, then there are more chances of the introduction of budgetary slack into the budgets by them.

One more reason for budgetary slack can be the uncertainty of the expected results shortly. Under those circumstances, managers of uncertainty managers generally tend to follow the conservative approach while preparing budgets. The top-level management gets misled about the actual profitabilityProfitabilityProfitability refers to a company's ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company's performance.read more of the business due to this slack, no matter the reason for the creation of budgetary slack is ethical or unethical. To overcome the same, top-level management should review the budget of previous years and assess variances between the budgeted and actual numbers.

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