Definition: Budgetary slack is the practice of underestimating revenues or overestimating expenses when preparing a budget in an effort to make it easier to achieve. In other words, it’s a way for management to prepare a budget with built in flexibility that will allow them to meet the budgeted goals easier.
What Does Budgetary Slack Mean?
This is a common practice in many companies that defeats the purpose of the budgeting process. A true budget must be honest and hold management accountable to the overall financial goals of the company. Many times lower-level management and subordinates don’t want to be upheld to these strict standards and budgetary restrictions.
Rather than communicate honestly about the projected revenues and expenses of their departments, they pad their numbers to give them breathing room and circumvent the boundaries of a tight budget.
Example
Budgetary slack can be used for ethical or unethical purposes. For example, if the department is estimated to make $100,000 in sales for the year, the department management might only estimate making $80,000 in sales. By underestimating departmental revenues, the department might be immune to across the board cuts. In this respect it’s a hedge against company wide programs that could unintentionally hurt the department. Although this can mislead the top-level management, it is done to better the company.
On the other hand, if the department purposefully underestimates revenue to mislead top-level management, it can be unethical. For instance, underestimated sales figures are much easier to hit and could result in bonuses for the department that exceeds the estimated numbers.
Whether slack was created in the budget for ethical or unethical reasons, it typically misleads top management to the true profitability of the departments. That’s why it’s important for management to review the prior year’s budget and evaluate the frequency and size of variances between the actual and budgeted numbers. This process might help them correct slack in the current or future budgets.
