Budgetary SlackIs it harmful for your business?

Patrick Louie

Date Published: April 21, 2022

Preparing a budget plan for your business is not always an easy task.

It’s not something that only the owner can decide on his/her own.

Budgets usually need the input of several people, especially for more complex organizations.

The department heads/managers know better how much it costs to operate their departments.

The sales and marketing teams provide valuable insight into how much sales the business can generate.

Even the accounting and administrative teams can provide useful inputs for budgeting.

You will be needing the input of these people (and sometimes more) to make an effective budget plan.

However, even with a well-constructed budget plan, there will be times when it’s not strictly followed.

Actual expenses may be higher or lower than what’s on the budget.

Or the business may perform better or worse in terms of revenue generation.

Sometimes, something that cannot be reliably predicted occurs such as a global pandemic or an economic crisis, which directly affects revenue and/or expenses.

Be that as it may, there are valid reasons why the actual expenses or revenue isn’t equal to the budget.

That said, sometimes, having a difference between the budget and actual expenses or revenue is intentional.

For example, a department manager may knowingly overstate his/her budget for operating costs.

Or that the sales manager may intentionally understate sales goals.

This underestimation of revenue or overestimation of expenses is what we refer to as budgetary slack.

In this article, we will be learning its definition.

We will also be learning the effect of budgetary slack on a business.

Is it beneficial?

Is it harmful?

Or is it both?

Read on to find out.

What is Budgetary Slack?

budgetary slack

Budgetary slack refers to the overestimation of expenses or underestimation of revenue in the budgeting process.

It acts as a cushion that makes it easier to reach or even beat the budget.

In a way, it allows the management to meet the budget a tad bit easier.

Budgetary slack is generally frowned upon due to its negative connotation, especially if bonuses are on the line.

Businesses often only award bonuses when a department meets or exceeds the budget.

As such, managers are incentivized to make budgetary goals easier to achieve.

This potentially results in a situation where managers prioritize making their numbers to secure their bonuses and positions.

This isn’t automatically a bad thing.

What makes it unideal is when it costs the growth of the business.

Rather than pushing business performance to its maximum potential, the managers would rather secure personal incentives.

That said, there are situations where budgetary slack is justifiable.

For example, the current economic situation makes it hard to make an accurate budget.

Or it could be that the business plans to release a completely new product to which demand is hard to ascertain.

Due to the uncertainty, the management might want to be conservative with the budget.

While budgetary slack is usually intentional, there are cases too where it is not.

For example, there is insufficient data to make an accurate cost or sales projection.

As such, the budgeting team has to settle with “best estimates” which aren’t always reliable.

 Or it could be the case where the budget was erroneously based on a previous period where expenses and revenue are not normal.

Forms of Budgetary Slack

There are two forms of budgetary slack:

Setting low targets for positive factors

This form of budgetary slack is where you underestimate a target.

This makes it easier to reach or even exceed the budget. It also makes it easier to look like business performance is improving.

For example, the budgeting team underestimates the budget for revenue, which in turn makes it easier to achieve or overcome.

Other positive factors include productivity, cash inflow, accounts receivable conversion, sales turnover, employee retention, etc.

Setting high targets for negative factors

This form of budgetary slack is where you overestimate a target.

This makes it harder to reach or exceed the target.

It creates an image that the business is saving on costs by presenting a higher figure for expenses.

For example, the budgeting team overestimates operating expenses and the cost of sales.

This makes it easier to appear that the business isn’t going over the budgeted costs.

Other negative factors include losses, cash outflow, doubtful accounts, employee turnover, customer complaints, etc.

Why Budgetary Slack Can Be Harmful to Your Business

budgetary slack

While budgetary slack can be justifiable under certain circumstances, it still poses potential harm to your business.

And this goes whether it’s intentional or unintentional.

A budgetary slack may be okay once in a while if it’s deemed to be necessary.  

For example, the global financial situation has become unpredictable.

This makes it hard to make appropriate budget targets.

As such, the budgeting team will want to make conservative estimates until such time that the situation eases up.

But having budgetary slack year after year usually leads to not-so-favorable situations for the business.

By constantly skewing budget targets toward the management’s favor, business growth will be stumped.

It will lead to business mediocrity where employees (from the rank-and-file to the executive positions) operate within their comfort zones rather than pursuing the drive to improve the business.

This is especially dangerous if the business operates in an industry where the competition is fierce.

Producing constant mediocre results to the business getting left behind by its competitors.

Not only that, but constantly producing mediocre results can manifest itself in the value of the business, such as its stock price.

This can cause alarm to the business’s shareholders.

It will also scare away new investors from making the investment.

Due to the business losing its competitiveness, employees will eventually choose to leave for a better one.

This makes employee retention and turnover a major concern for the business.

What’s even more harmful is if the business loses a great employee due to it.

Analysts will eventually catch wind of the business underperforming despite meeting (or exceeding) its targets.

By constantly underestimating revenue targets, it may communicate to the analysts that either the business is doing it on purpose, or that it really is having trouble reaching its maximum potential growth.

Some Tips on How to Prevent Budgetary Slack

Budgetary slack is entirely preventable.

You only need to put the necessary controls in place.

Here are some ways to prevent budgetary slack:

Limit the number of managers who contribute to the budget

Only allow your most trusted managers to create the budget.

Make it as lean as possible: only include the necessary ones in your budgeting team.

Quality over quantity as they say.

Also, make sure that they also have the business’s best interest in mind.

Having too many managers in your budgeting team can lead to budgetary slack.

They do this to downplay the business’s expectations of them.

This makes it easy for them to meet the downplayed expectations.

Aside from that, having easy-to-achieve targets may lead to employees losing the motivation to perform better.

Without the challenge, employees won’t have the drive to be as productive as they can.

On the other hand, a lean team responsible for the budget will more likely put the business’s best interest in mind.

They are more likely to make a budget that is challenging yet still achievable, pushing the growth of the business to its limit.

Having challenging targets will motivate employees to do better, leading to more growth for the business.

Disassociate the budget from performance

Most businesses use performance to decide whether they will grant a bonus or not.

And what’s one of the easiest ways to measure performance?

That’s right! It’s the budget.

These businesses will use the budget to measure employee performance for a certain period.

Employees or departments that reach or exceed their targets receive performance bonuses and awards.

On the other hand, those who don’t meet their targets are reprimanded.

Simple right? But this can lead to budgetary slack.

If performance is tied to meeting budget targets, the management will then make them easier to achieve.

This ensures that they’ll be evaluated to be performing well. Don’t forget the performance bonus too.

To remedy this, just don’t use the budget as a way to measure performance.

Use other metrics instead.

Disassociating the budget from performance (and consequently, bonuses) will discourage the managers from cheating the system.

They don’t have an incentive to make easy-to-achieve targets.

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  1. Georgia State University "The Effects of Reputation and Ethics on Budgetary Slack " Publication. April 21, 2022

  2. Penn State "The Relationship between Trust and Budgetary Slack: an Empirical Study" White paper. April 21, 2022