Budgetary slack definition
/What is Budgetary Slack?
Budgetary slack is the deliberate under-estimation of budgeted revenue or over-estimation of budgeted expenses. This gives managers a much better chance of "making their numbers," which is particularly important for them if performance appraisals and bonuses are tied to the achievement of budgeted numbers.
Examples of Budgetary Slack
Here are three examples of budgetary slack:
Underestimating revenue. A sales manager might deliberately forecast lower sales figures than realistically expected. For instance, if the manager believes that sales will likely reach $1 million, they might budget for only $800,000. This creates a cushion, making it easier to exceed the target and appear to outperform expectations, potentially securing bonuses tied to achieving sales goals.
Overestimating expenses. A production manager might inflate budget estimates for raw materials or maintenance costs. For example, if maintenance costs are usually around $50,000, the manager might budget $70,000. This excess allocation makes it easier to stay within budget and potentially frees up funds to cover unexpected expenses without appearing to overspend.
Padding labor costs. A department head could budget for more staff hours or higher wage rates than actually needed. For instance, if a project realistically requires 1,000 hours of labor, the manager might budget for 1,200 hours. This creates a cushion that reduces the risk of going over budget and makes it easier to report favorable variances.
What Causes Budgetary Slack?
There are several underlying causes of budgetary slack, which are as follows:
Uncertainty about future events. Budgetary slack may occur when there is considerable uncertainty about the results to be expected in a future period. Managers tend to be more conservative when creating budgets under such circumstances. This is particularly common when creating a budget for an entirely new product line, where there is no historical record of possible results to rely upon.
Desire to earn bonuses. Management will use budgetary slack to make it easier to achieve their targeted goals - which in turn triggers bonus payouts. This is the most common cause of budgetary slack, since there is a direct monetary reward associated with it.
Use of participative budgeting. Budgetary slack is most common when a company uses participative budgeting, since this form of budgeting involves the participation of a large number of employees, which gives more people a chance to introduce budgetary slack into the budget.
Outside reporting. Budgetary slack can arise when senior management wants to report to the investment community that the business is routinely beating internal budget expectations. This cause is less likely, since outside analysts judge a company's performance in relation to the results of its competitors, not its budget.
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How to Avoid Budgetary Slack
Budgetary slack is less likely to occur when a small number of aggressive managers are the only ones allowed input into the budget model, since they can set expectations extremely high. This is especially likely to be the case when senior management routinely identifies and terminates the employment of lower-performing managers.
Slack is also less likely when there is no link between performance or bonus plans and the budget. In this situation, managers have no reason to pad the budget.
Disadvantages of Budgetary Slack
There are two key disadvantages associated with budgetary slack, which are as follows:
Does not support enhanced performance. Budgetary slack interferes with proper corporate performance, because employees only have an incentive to meet their budget goals, which are set quite low. This can result in reduced profits and cash flows, which in turn give a business less funding to support its future initiatives.
Causes a competitive decline. When there is budgetary slack for multiple consecutive years, a company may find that its overall performance has declined in comparison to that of more aggressive competitors who use stretch goals. Thus, budgetary slack can have a long-term negative impact on the profitability and competitive positioning of a business. In the worst-case scenario, budgetary slack can be a contributing factor when an organization goes out of business.