What is Budget Padding?
Budget padding is the process of preparing a budget by overestimate the expense and underestimate the revenue. The management usually links their bonus with the company performance which is the net profit. So they may wish to achieve the target by low down the revenue and increase the expense which will reduce the net profit. Budget padding will make the target easy than the actual and guarantee the achievement.
Negative Impact of Budget Padding
- Not maximize the company performance: The company’s performance will not reach its own potential as the management try to low down the target to ensure a guaranteed hit. If the company can achieve one million sales, the employee may reduce to 800,000 to make sure that it will not miss. It the same expense as the company aim to minimize but the budget controller tries to overstate.
- Overpaid the expense: the management will try to increase the significant expenses to reduce the net profit. They will not worry about the expense when they are higher than expected as it already overstates.
- Fraud indicator: staffs may take this chance to spend on unnecessary expense or personal expense. They do not need to worry about saving and keep spending under budget as it already overstated.
- Under utilize sale team: The sales team will not work at their peak potential as they know that the target is already within their rank. They do not need to work hard, but still manage to get achieve the target and get a bonus.
- The incentive is not reflected in performance: The incentive is provided to booth the company performance to maximize the profit. However, budget padding will let the management and staff to receive a bonus without achieving the potential net profit.
How to prevent Budget Padding?
- Compare with industry growth: the shareholder and owner can compare company growth with the industry average. It should be not much different from the competitors in the market. If any is much different, they should seek an explanation from the management.
- Compare with prior year: The company growth should be consistent from year to year unless there are some significant changes such as a new product, new branch, or a huge expansion. Each year, the company should have similar growth in a stable market. Any unusual variance must be attached with a proper explanation.
- Compare between revenue and expense: revenue and expenses are always connect with each other. Variable costs will increase or decrease due to the sale volume. The number of staff increase will show company expansion. The increase of branches means that the company sale should be increased too. These are the simple example which we can link between expenses and revenue. The significant increase in expense with little growth in sales is an indicator of budget padding.
- Strictly review all significant expenses: To ensure the basics for the following years, we should strictly review all significant expenses. The next budget should rely on the first year and mark up at a certain percentage. For next year, we could select other accounts to review and use as a basis for the following year.