What Is Budgetary Slack? Reasons And Ways To Prevent It

By Indeed Editorial Team

Published 29 June 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

A company's budget helps it to define financial strategies and best practices, so it can continue to be profitable and successful. Budgetary slack can often hinder growth and cause incorrect financial projections. If you work as a finance professional, learning about the concept of budgetary slack can help you create high-quality budgets that align with the growth prospects of the company. In this article, we discuss the question ‘What is budgetary slack?', explain why it occurs and provide tips to prevent this scenario.

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What Is Budgetary Slack?

If you work in finance, you may wonder ‘What is budgetary slack?' Budgetary slack is a surplus amount resulting from an underestimation of revenue or an overestimation of organisational expenses. It can also result from an estimation of both higher expenses and lower revenue. Budgetary slack can cause companies to create budgets that are more achievable and less competitive. In most cases, eliminating budgetary slack can help companies create more precise financial plans and improve productivity.

In some cases, budgetary slack can be beneficial. For example, if the company is unsure of the economic future, such as during a new product launch, it can overestimate the expenses. This helps in covering any unpredictable company spending that may arise during the new product development and marketing.

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Reasons For Budgetary Slack

Here are some reasons a company management team may create budgetary slack:

Economic uncertainty

In some scenarios, it can be difficult for the management to gauge how well the company can perform in the future. For example, if a company is launching a new product, it may not have any historical data on product revenues. Another situation is when a company is planning an acquisition. In such cases, the new company's history may serve as data for preparing a budget, but it may not be precise, as market dynamics can change through acquisitions.

The third example in this category is when a company enters a new market. In this case, they may not have any historical data about their performance in that market. In all the above scenarios, it can help if the company reduces the revenue forecast to make up for any unforeseen expenses.

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Incomplete information

The budget department of a company typically consists of senior executives who rely on department-level managers to provide them with accurate information. Especially in a big organisation, every department has separate budgetary allowances, targets, resources and sales data. It becomes the responsibility of the department heads to manage this data efficiently and communicate it with the executive, who can form a historical basis for the organisational budget.

Often, because of lack of communication or internal resource-management issues, departments may not communicate this data effectively. Lack of coherence in data can provide incomplete inputs to the senior executives, who create a budget based on this data. This is when the final budget can overestimate expenses or underestimate revenue, resulting in budgetary slack.

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Internal incentives

Some managers prefer to create budgets that are easy to attain. This is because many organisations have a culture of issuing incentives based on individual goals of reaching the allocated budget. Modifying the budget to make it more achievable helps managers to get these rewards without working too hard.

Encouragement of this practice can lead to a work culture that lacks competitiveness. When individual goals are the priority, it becomes challenging to create an organisational budget that can make the company compete fairly in the market. Companies that promote incentives based on monetary achievement indirectly create teams of employees who lack the motivation to work for productivity, ethics and customer satisfaction.

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Ways To Prevent Budgetary Slack

Here are some ways to prevent budgetary slack, so you can create an organisational budget that promotes a healthy work culture and increases a company's competitiveness:

Design a small team for budget creation

Creating a budget requires experienced professionals. By setting up a small group of such professionals, an organisation can expect the budget to go through appropriate assessment. A small group of senior professionals in the team can ensure that only experience-based decisions influence the terms of the budget. It can also help limit multiple directions of thought and improve the focus of the budget-creating team to align it with organisational goals and values.

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Dissociate rewards from budgetary accomplishments

Often, departmental heads try to deliberately create a budgetary slack so that it becomes easier to meet targets. They do this because organisations associate rewards and bonuses with budgetary goals. Organisation leaders may process the budget with the slack under the impression that the budget is an accurate reflection of costs. The result is that the company lacks competitiveness in the industry. To counter this, the organisation can remove budgetary accomplishments as a metric for rewards and instead use other metrics, such as resource allocation, customer satisfaction and the organisation's industry positioning.

Instil ethics and integrity in employees

If the employees value individual goals more than company goals, then budgetary slack may occur. While it may make individual goals more achievable, some employees may not consider the fact that the company's budget directly affects its competitive edge in the industry. To prevent this, the company can ensure that its employees work ethically. There are two ways to do this. One way is to hire people with the right attitude. You can do this by creating a specially trained hiring committee, which can evaluate the behavioural aspects of potential employees before offering them work.

Another way is to instil ethics and integrity among existing employees. At an organisational level, senior executives can conduct seminars or events that reiterate the values and mission of the company. The company can also form specialised departments that impart mandatory training to all employees to help them understand more about ethical work, integrity within an organisation and how to align individual goals with those of the company.

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Encourage effective communication

Typically, the different departments of a company have a wide range of data that are essential for creating a budget. This data may include the expenses and profits of a team or department. The department heads are usually responsible for communicating this information to the senior executives who create the company budget. If there is a lack of communication, it becomes challenging for the senior executives to design a budget that is truly beneficial for the company. This may cause budgetary slack.

One way to prevent this is to encourage effective communication between departments and executives. The executives can schedule monthly or quarterly meetings where department heads can present their periodic expenses and profits. The executives can also conduct ad-hoc checks with the department heads to see whether they are conforming to the company's mission while working with the given budget.

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Manage resources efficiently

The designated team that prepares the organisational budget can often do a better job if they have access to relevant resources. One example is a team that gets ample time to create a budget, as opposed to a team that hurries through the process. The first team can get enough information by communicating with each department and finding out the expenses, profits and benefits of the allocated budgets. The second team may miss out on crucial information while they try to finish the budget quickly. This may cause budgetary slack.

Along with time, several other resources can help the executives create a good budget. These include smart tools, software, charting and human resource reports, such as training and capital.

Research other budgets in the industry

In the case of a new product launch or entry into a new market, budgetary slack can occur because the organisation has no historical data to refer to. The team that prepares the budget can minimise this slack by researching other organisational budgets in the industry. For example, in the case of a new product launch, the company can gather data around a competitor's revenue that has a similar product. Although expenses and profits vary between companies, this can provide a better idea of how to prepare a budget that benefits the company.

Improve data collection processes

The more data the budgeting team can work with, the lower the chances of creating budgeting slack. This is because more data helps teams analyse expenses and profits in detail and reduces the chance of errors. To achieve this, the company can deploy teams that work specifically on data analytics. These teams can gather relevant data from both internal and external sources. They may then apply statistical analysis and big data analysis techniques to understand which models generate the highest profits for the company with minimum expenses.

The teams can then present this analysis to the executives that prepare the budget, who then make informed decisions. Advanced charts, trend analyses and metrics help the team create a budget that improves the company's position in the industry while making the internal work culture more competitive.

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