What is Budgetary Slack?
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.
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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 creating a budget for the new product lineProduct LineProduct Line refers to the collection of related products that are marketed under a single brand, which may be the flagship brand for the concerned company. Typically, companies extend their product offerings by adding new variants to the existing products with the expectation that the existing consumers will buy products from the brands that they are already purchasing.read more, 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 company employees because, in that case, the company employees will work only within their capability of attaining the goals.In case there is budgetary slack by the understating of the revenue of the organization. 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 expensesAdministrative ExpensesAdministrative expenses are indirect costs incurred by a business that are not directly related to the manufacturing, production, or sale of goods or services provided, but are necessary for the smooth functioning of business operations, such as information technology, finance & accounts.read more, 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 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.
The top-level management gets misled about the actual profitability of the businessProfitability Of The BusinessProfitability ratios help in evaluating the ability of a company to generate income against the expenses. These ratios represent the financial viability of the company in various terms.read more due to the budgetary 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 budgeted and actual numbers to overcome the same. With this, they might be able to correct the slack, if any, prevailing in the company’s current budget and future budgets.
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.
Recommended Articles
This article has guided what budgetary slack is and its definition. Here we discuss budgetary slack’s example and its advantages and disadvantages. You can learn more about accounting from the following articles –
- Flexible BudgetBudgetary ControlOverview of Capital BudgetingMaster Budget
