What is Budgetary Slack
Budgetary slack is a cushion created in a budget by management to increase the chances of actual performance beating the budget. Budgetary slack can take one of two forms: an underestimate of the amount of income or revenue that will come in over a given amount of time, or an overestimate of the expenses that are to be paid out over the same time period.
BREAKING DOWN Budgetary Slack
Budgetary slack is generally frowned upon because the perception is that managers care more about making their numbers to keep their seats and gaming the executive compensation system rather than pushing company performance to its potential. Managers putting a budget together could low-ball revenue projections, pump up estimated expense items, or both to produce numbers that will not be hard to beat for the year. However, sometimes it is genuinely the case that management is unsure of the numbers. Economic forecasts are fuzzy, industry changes are rapid, or a new slate of products are about to be launched. Management could be exonerated in such cases for publishing a lazy-looking budget. The best way to avoid budgetary slack is to install a management team with integrity.
The Harm of Budgetary Slack
Budgetary slack year after year can lead to business mediocrity. If management is intentionally creating soft targets for the company, it will not drive the business forward in competitive markets. Shareholders hold management and the board responsible for creating value; if they are not working hard, they are not working hard for shareholders. Such leadership will eventually manifest itself in the stock price of the company, and among the rank-and-file there will be growing concern that their company is losing competitiveness. Jobs at the company will be at stake. Star employees may choose to jump to a stronger competitor, which would place the company at a further disadvantage.