Budgetary Slack

Updated on January 3, 2024
Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

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 company’s actual performance is better than that of the budgeted goals. It is done by the management specifically when their bonuses or performance appraisals are based on their targets.

Example of Budgetary Slack

For example, the manager of the company responsible for preparing the budget estimates that for the next financial year, the company’s sales 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 company’s top management 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 company’s top management in terms of budgetary performance, the manager reduced the budgeted salesBudgeted SalesThe sales budget forecasts the quantity that the entity expects to sell and the amount of revenue generated from the sale of such amount expected in the future, based on the management’s judgment related to the competition, economic conditions, market demands, and market demands past trends.read more from the actual selling capacity of the company. Due to this slack of $ 10,000 ($ 80,000 – $ 70,000) and the lower performance benchmark that the manager concerning actual selling capacity has set, it is more likely that the manager will receive a 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 revenueSales RevenueSales revenue refers to the income generated by any business entity by selling its goods or providing its services during the normal course of its operations. It is reported annually, quarterly or monthly as the case may be in the business entity's income statement/profit & loss account.read more by underestimating for the budgeting purpose.

Budgetary-Slack

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Advantages

Disadvantages

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 time while preparing the budget.
  • When large numbers of employees are involved in the preparation of budgets in the organization, generally, there are more chances of introducing 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, some organizations still introduce budget slack to get a good picture of the business, thinking it will work in favor of their organization.
  • To prevent the practice of budgetary slack, the company’s top management should limit the manager count that is allowed to prepare the budgets and should not make the budget the basis of the evaluation of the company’s performance.
  • It could result in a decrease in the efficiency and performance of the company employees because, in that case, the company employees will work only within their capability of attaining the goals.

Conclusion

In a business, when the management deliberately over-estimates the budgeted expenses or under-estimates 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 their targets. Moreover, when large numbers of employees are involved in the preparation of budgets in the organization, there are more chances of introducing 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 if the reason for the creation of budgetary slack is ethical or unethical. Top-level management should review previous years’ budgets and assess variances between the budgeted and actual numbers to overcome the same.

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