It’s not so much a set in stone requirement, as much as a practical reality of budgeting. If the business owner sees one department consistently not spending their full budget, they think that department doesn’t need that budget.

Now in large corporations the ones making those decisions are disconnected from actual operations, so they don’t know the broader context of why that budget wasn’t used

Tl;Dr: assholes with business degrees

If I give you 100 dollars to repair the sink, and you only spend 50 of it, next time I need the sink fixed I’m going to give you 50 dollars. The other 50 goes to other expenses or into savings.

Companies use the same philosophy. Budgets which aren’t spent go straight to the bottom line of that years accounting, leading to more profits.

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You answered your own question, so you don't get less next year. It will make more sense if you understand it's not done at the company level, but at an individual department level. If you're the head of the IT department and you have $100k left over at the end of the fiscal year, the CFO might say "IT saved us $100k, maybe next year they can save us $200k!" and cut your budget accordingly. Now next year you have to replace a server, but you don't have the money. You go ask for more money and some of your bosses say "well, the head of IT doesn't manage her money very well, who else we got?"

Depending on why the sink needs repairing, it might cost $50 to repair, or it might cost $100 to repair. If you give me $100, and I repair the sink and return the $50 I didn't spend, and you punish me for this by saying from now on I can never have more than $50 for repairing the sink, you give me a strong incentive to waste money on future jobs instead of returning it.

What you’re not taking into account is that you also helped with creating the budget, you need to justify the projected expenses. It’s not a punishment to reduce the budget. It’s in everyone’s best interest to run the company more efficiently and profitably. So rather than having frivolous spending at the end of the year, they reduce the budget.

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And yet, in real life people do try to spend their entire budget rather than risk getting it cut. For example, federal agencies spend an average of 4.9 times more in the last week of their fiscal year than in a typical week during the rest of the year. (Citation: https://www.nber.org/papers/w19481 )

Budget is power and status; there's no reward for returning unspent money to the company.

> Budget is power and status; there's no reward for returning unspent money to the company.

This is not universal. Many companies have internal policies where managers are rewarded for unspent budget.

There is also an increasing practice of zero-base budgeting, where the entirety of the budget is revisited every year (or period of years) and all expenditures must be justified again, regardless of previous year's spending.

So you could have just said, 'Managers can't understand details finer than what's right in front of them.'

The Office fans: Please refrain from posting only a link to that scene or a transcript. Remember that ELI5 requires explanations to be in your own words. You are welcome to include a reference to that scene in addition to an explanation in your own words.

Because, if one department isn't spending all of their allocated budget, they means they don't need the amount allocated to them. And if they don't need it, some other department surely can use it because they didn't have enough allocated to them.

So department's try to spend their entire allocation so that when they actually do need it, it'll be there.

You don't need the money, right up until you do. And when you do need it, if you don't have that allocation to your department, you're SOL, you'll have to try to get it for next year's/quarterly budget.

Spending it just tells the people who make the budget that you do in fact need the amount allocated to you and to not give some of it to someone else.

All comments forget the most important aspect: Any unspent dollar at the end of the year is profit, and profits are taxed

>Budget is power and status; there's no reward for returning unspent money to the company.

It's not just that. We do electroplating where i work. Stuff doesn't need to be replaced on a yearly basis. And when it does need replaced, it can be very costly, especially when one thing breaks and causes other things to break. And if that budget isn't allocated to that department, it can be a very bad time until the next budget comes out. So, spending money at the end of the fiscal year, in order to use up the entire budget, on stuff that just isn't needed, can be the difference between actually getting something replaced instead of slapping some duct tape on it and hoping it'll last until the next budget.

My company i worked for (large isp) bought all field service technicians new computers because we had to much money over If we didnt, next year they might give us a lower budget... So they spent money like crasy while looking for ways to save on other things. Like some money saving tactics were ridiculously backwards and making the job harder to do, but hey free laptops is ok. Companies are absolutely stupid

I work in a certain sector with both medical and marketing budgets. The curtain was parted a few years back that if they didn’t spend the budget, they lost it that year and it was dropped by 20% the following year also. Some crazy shit happens come year end.

GREAT FOR ME

Right.

I’m a volunteer fire fighter. Our captain is responsible for making a budget. It needs to be justified to the village. They base it on last years expenditures plus expected increased costs based on inflation. (Keeping it simple here because it’s ELI5, and I’m not directly involved in their budgetary planning).

They play it cautious throughout the year, in case there is something that comes up unexpectedly…if a hose blows out, or a truck breaks down…those expenses come first. But towards the end of the year, when we still have a surplus, they start buying things off the “nice to have” list, like upgraded nozzles to replace a functional but worn one. Or new PPE for the firefighters that is still within date, but a little rough. The nice thing about that, is replacing them would eventually be a need. This allows them to stay ahead of the curve year over year.

From an outsider, this may look like we spend more in the last month on frivolous things, when in fact they aren’t truly frivolous.

I don't think it's this half of the situation that people get confused by. What's confusing is that giant companies don't take a more sophisticated approach to things (or at least, many don't).

I work in quite a senior position at a big company and my boss sent an email several weeks back to me and other managers that was basically just 'we have lots of money left, send me your wishlists'. You would think that the company would realise what's happening when every year every department orders a bunch of fancy expensive tech in December, but it seems not...

Hopefully you’re able to at least justify the wishlist.

“This fancy computer will run CAD more efficiently, saving time, and allowing the engineer to process more projects throughout the year.” - especially when the unit was due for replacement next year anyways.

This is what's infuriating and confusing to me. If a typical family spends their budget like how a company does, there would be much less $$$ saved annually, just because we need to spend every single cent annually. I just don't understand why a company don't see savings can be stored in the coffers for future rainy days.

>. If the business owner sees one department consistently not spending their full budget, they think that department doesn’t need that budget

This kind of thinking is prevalent in my company too (a project manager told me the exact same thing), but isn't it mind boggling they will think like this? Why don't they ask the dept why? Perhaps they were really able to help the company save money? There should be a policy that saved monies can be carried over to future years which the dept can draw from in case of real emergency.

Just imagine the amount each company can save if everyone adopts a cost savings attitude

Storing money in a coffer isn't an inherent good. You should either be improving the company with that cash or returning it to shareholders.

If you let cash pile up the business with either issue a dividend, share buyback or make an acquisition, etc.

What difference does that make?

I don't think so.... How can unspent dollar from budgeting be treated as this year's profits? Profit is the amount gained from gross revenue less expenses. If I did not sell an item, how can the saved amount from expenditure be treated as profit? And doesn't this budgeted fund come from previous years earnings? So those would have been taxed before previously. If they taxed it again wouldn't it be double taxing?

I think everyone in the working industry is brain washed to think just because 100k saved means next yr that dept will get budget cuts... That's why this cultivates extravagant spending.

>Spending it just tells the people who make the budget that you do in fact need the amount allocated to you and to not give some of it to someone else.

Lol. An analogy of this would be a family has 10 children. Each meal, every kid is given an equal portion of food. Sometimes Timmy feels full and doesn't finish his food, so mom gives him less in the future. Because of this rule, every kid are forced to finish their food even if they're not hungry. And that's how the 10 kids got fat

Just imagine companies spend their money wisely. I'm sure everyone will get fatter bonuses in the long run since money saved benefits everyone on the company

Or how about giving it to the employees who made it all possible...

Sure, when a company has a good year bonuses are generally higher.

Our company operates both ways, depending on the year (or quarter). Sometimes every department must return $X million to the company. Sometimes we get to December and rush to sign a new contract by the end of the year to “use up” the budget.

Budgets can be pretty big, and buying a few things extra to fill out the budget isn't a big deal.

Budgets get changed all the time. If you don't use it this year it may be gone the next. Getting authorization to exceed budget can be difficult, while spending what's already authorized is easy.

Take the converse.. if everyone is hyper incentivized to come in below budget you get scrooges that pay poorly, understaff and remove free coffee from the office. You get a bad place to work.

you are right, the budget comes from prev year so it was already taxed, so saving money is good, thats why the stock goes up when a company decides to fire people=saving money.

But the company wants to save money but the departments want to spend it all so they dont receive less next year.

>giant companies don't take a more sophisticated approach to things

Giant companies are giant. It is difficult to give each group/department/division its own rules, so they prefer one-size-fits-all approaches, even if they are more inefficient individually. The amount of admiration overhead of having uniform rules means that it is more efficient for the entire company. In some cases, large divisions or unique groups are run more like individual companies: think of Gmail under Google, or the logistics arm of a retail chain.

>I work in quite a senior position at a big company and my boss sent an email several weeks back to me and other managers that was basically just 'we have lots of money left, send me your wishlists'. You would think that the company would realise what's happening when every year every department orders a bunch of fancy expensive tech in December, but it seems not...

Every year, people are limited to what they already decided they needed, and those decisions were often made the previous year. Then, once 95% of the year and 85% of the budget is gone, there is some discretional money left over that can be used for new lab equipment, better chairs, bigger monitors, or whatever else. This "extra money" is thought to be good for the morale, and it gives a chance to buy one-offs that were hard to budget for. My group often will buy equipment to do proof-of-concept or tester equipment, to evaluate if we should consider using new technology or not.

This "extra money", at least in cases I have seen, comes from the group spending less money than expected, often through intelligent employees, but sometimes just by dumb luck. In either case, it works as an incentive. If we figure out how to do the same job, but use 9 widgets instead of 10, then the money for that extra widget can be used to replace everyone's old nasty keyboards that year... The company does not care, since they expected to spend that money anyway, and we employees are happy when the pallet of new keyboards show up.

I do know there are some instances in the world where people request twice as much money as their group actually needs. My hope is that those are discovered and stopped, unless that group is making the company so much money that nobody cares...

I've never heard of this policy ever existing, anywhere. I doubt it does. What does happen is that companies are always trying to cut costs from the top down.

In a hypothetical well run company, everyone tries to save unnecessary costs.

In most companies, it's a constant battle of higher management trying to cut costs and those lower down the rung wanting to get the job done and go home with the minimum of stress.

Lower management want to hit budget to not get bollocked / to get their bonuses, but they don't actually give a shit about the company's bottom line. If they can spend the money on stuff that will make their employees happier and make the work go smoother without those above them getting pissy, they usually will.

Why not give bonuses for reducing costs? That's really hard to do well. Likelihood is you'll just have managers completely fuck the business long term to hit short term targets. Better for them to not cut costs all the way they can than to gut the company in a year.

I worked for the US government my entire career, and this always drove me batshit. My budget was a “mandatory spend”, whether useful or not. We’d buy promotional giveaways just to spend the money. Think about that…a federal agency buying can cozies because if we didn’t spend the money allocated to us, we’d get a smaller budget the following year. It just seems to encourage fraud, waste, and abuse.

That's the best metaphor I've seen so far.

I feel like there's a good story here not being told…

This reason of "get smaller budget next yr if don't spend" seems to be the universal reason .. but it's honestly ridiculous

> Giant companies are giant. It is difficult to give each group/department/division its own rules, so they prefer one-size-fits-all approaches, even if they are more inefficient individually.

The myth of Procrustes was he welcomed all travellers to spend a night in his bed for free; however, if you were too short, you were stretched to fit it the bed, and if too tall, some of you got lopped off. We use the same Procrustean 'one-size-fits-all' approach in many places in the modern world, from grade school, to government policies, to goddam 'one-size' socks that are either too short or too loose. I suggest it's an artifact of the mechanical age, which we are in the process of leaving behind.

The assembly line that so tremendously increased material production was based on identical parts, assembled in an identical manner, to create identical products. Our new computer-controlled systems have the potential to create unique parts, uniquely assembled, to deliver a unique product to you. (No, we're not there yet) We may be leaving the Procrustean model behind.

I worked as a data analyst. I remember 'strategic planning' in 1980 - using 6 to 12 month old data to predict where you were going to be in five years, and what you should be doing to get there. Now we have real time data available, and the computing power to process it instantly. Presumably, the greater flexibility of this process will filter down to the budgeting system, but that will probably take the retirement of the Boomer generation, who are still stuck in the Procrustean paradigm.

Otherwise they risk getting a smaller budget next year. People will argue that they didn't need the whole budget anyway.

The budget is derived from the previous year, but the money itself is not. It's not like they set up a savings account that ended on Dec 31 that they begin drawing from on Jan 1. Tracking cash flow is a job, and it goes from month to month and week to week. And business expenses count against your income in the current fiscal year, not the previous. Depreciation is also a thing, and it's why certain items would be paid for from different funds.

I worked in the Canadian Government for 10 years.

The one that drove me "batshit" would be us getting told from fiscal day 1, April 1st through to February that we have no budget. Then on March 1st we will get told someone found a couple of million and we have 30 days to spend it.

and whatever you buy needs to be delivered by March 31st.

It's true madness.

Depends on the Company. In corporations that use Zero Based Budgeting what you spent last year or what remained in your budget is irrelevant. You have to completely rejustify your budget every year. It’s definitely way more work than just carrying over the previous budget but discourages the above notion where departments want to fully spend the previous budget In order to keep that same amount the following year.

It’s not required, but not using full budget is a great way to get budget reduced the next year and few managers want that…

Different way of looking at it. Budgets are more like setting enterprise or department-wide financial targets.

If you want something more comparable between a company's spending and a family's budget (where they account for every dollar), look at the Statement of Cash Flow. Money comes in from operations (work), some comes in through financing (loans), some goes out the door when you buy new assets to make more money later on (car) then whatever is left over can get put into retained earnings (savings).

Incentive pay systems are a bitch to design, because people are so good at gaming them. One call centre I worked at had contests on Friday if weekly sales had been down. One woman, no matter how bad she was doing by lunch, always pulled out a bunch of sales in the afternoon, and was given the $50 cash prize.

I was the data analyst, and got suspicious. Sure enough, all most of those 'sales' would be cancelled on Tuesday or Wednesday of the next week. We listened to the tapes of her sales calls, and heard "I'll put the order in to reserve your spot; if you change your mind over the weekend, you can cancel." She didn't deny any of this when confronted with the evidence; she also didn't come back to work the next day, or ever after.

Also, the top performers on each team seemed to win week after week, which makes sense. They are the best sales people, so they generally sell more at all times. But an incentive that goes to the top performers most of the time only reinforces an "us vs them" mentality on the sales team, where the top performers are seen as getting the best leads (they do), and getting the most slack for things like being late, etc. (they did). As I said, designing a good, fair, working incentive system that can't be 'gamed' is not easy.

It's to prevent misuse of funds and overspending. In a big organisation like a company not every single person working in that company is aware of how much money they have and how its being spent, there's departments whose jobs it is to do that but the rest of the people working in the company don't know, aside from some management positions who usually get an abridged run down of expenses. Smaller branches of bigger companies or organisations have their own accounting departments that are in charge of tracking expenses, making the budget and requesting money from the central accounting department.

So from the point of view of central management they prefer not giving out more money than is needed because that could lead to misuse, or at the very least unnecessary spending. From the point of view of smaller subdivisions though they prefer their budget not being reduced because in the off chance they have unexpected expenses their budget doesn't cover, requesting money and getting it approved is a long drawn out process. Also it's less work for them to receive lump sums and allocate them as they see fit than having to individually calculate and predict all expenses to a near zero margin of error, because that's pretty much impossible but also a lot more work for them. So the general tactic is to track spending for some time and once they get an average of yearly spending to request a bit more than that which gives them more leeway with spending, and is less work for them. The year goes by and expenses are covered and catalogued, and when the year is nearing its end if they see they have left over money they simply find ways to spend the money which justifies them receiving it in the first place, so that to central management it will seem like they need that amount every year so they'll get it next year too. If they find themselves short on cash it gives off the impression that either their accounting department/management is incompetent or that they're overspending, even if that's not the case.

TL;DR, it looks better when a smaller subdivision requests the same amount of money every year. If they request more than they initially got it seems like they're incompetent or overspending. It's less work for them and easier to operate with a budget that allows leeway instead of trying to fine tune it to be exact, which is impossible since there's always unexpected expenses popping up throughout the year. Central management on the other hand does not want to overspend because that cuts into profits and of course they want to prevent embezzlement, so all money allocated has to be accounted for and spent on something with the receipts and invoices to prove it.

Businesses are not families, and I know lots of families that do spend their budgets like that. In fact my wife and I realized that we came in $5000 under our annual budget and are looking at things we could buy that would improve our life that we didn't think we could afford earlier.

Companies generally already have cash stores, but cash sitting is cash wasted. Cash can and should be invested, either back in the company, or elsewhere, used to pay down debt, or used to pay shareholders.

So if your budget is reduced because you didn't spend it. That money will not just sit for a rainy day, it will be transferred to another place where it can do work for the business.

A last example. Microsoft purchased Minecraft, because it had too much cash in the bank, and the interest return on that cash was less than they would get by buying Minecraft, so they did.

Every. Damn. Year. But if I tried to “overspend” on something necessary—knowing full well that the budget wasn’t going to be compromised in any way—I’d be scolded.

Correlation vs causation.

You assume that the 4.9 time spike at the end of the year is due to managers frivolously wasting their budgets to pad it out. And I have no doubt that some do this.

But there is also an equally plausible and much more rational explanation that would also explain the spike in spending at the end of the year.
The department has some low priority spending goals that their employees identified during the year, maybe things like upgrading keyboards, or even starting a new project that would be beneficial but is just low priority. Management does not know exactly how the year will go, so they delay committing to these things as long as possible, so that they have some money in case of an emergency. But as the deadline of the fiscal year approaches, they can get more confident that they can spend this money on the lower priority things, and not expose themselves to a risk of IL-liquidity in their budget, because it will be refreshed soon.

If a company spends its entire profit paying its employees, the slightest dip in revenue forces it to work at a loss, if the situation persists for long enough it can obviously lead to bankruptcy

Not to mention potential issues like equipment/machinery/whatever breaking and not being able to afford getting it repaired or replaced because you gave the whole profit to your employees

This is fundamentally incorrect for taxes in the US. The IRS only cares (on a very simple level) about your earnings minus your expenses only for the specific financial year. A budget is only for internal use and providing information to investors. The IRS doesn't care that my lemonade stand was budgeted to profit $50 million, if I only profit 10 cents then that's all I get taxed for

Edit: responded to wrong comment but the info is still relevant

>why do such policy exist?

To justify funding; If they don't use it all, then next budget isn't going to assume they need it, which may not be the case.

This is also the case if the business is in any type of program that relies on their requirements. If they spend less, they might get less next FY

>Isn't it better to carry over unused expenses to the next FY?

Not necessarily.

From an economical point of view, money sitting in a bank account is wasted potential. It should either be spent on making the company better, or paid to shareholders. Otherwise, it's rapidly losing value due to inflation.

Unfortunately I think most of the answers here miss the most important aspect of why senior leadership does this.

When the fiscal year begins the company commits to the Board of Directors that they will be spending a certain amount (the budget) and that they expect a certain output from that spend (the revenue).

Not spending your full budget is a big deal especially when you dont meet your revenue goals, mostly because it looks like you didnt try.

When companies dont spend their whole budget AND they dont meet revenue targets that looks really bad. When they spend their whole budget but dont meet their revenue targets thats still not good but its generally regarded a simpler issue to fix (efficiency)

When we see companies who havent met their committed budget thats a big red flag and usually means we're way hesitant to invest in them.

Edit: this is beginning to blow up a bit so I want to be very clear that I dont mean that companies should be spending unnecessarily JUST to meet budget but rather that if there's budget left they should spend on something beneficial to the growth of the company. I.e. lets say you spent 80% of your budget and met your revenue goals and now youre wondering what to do with the other 20%, so therefore you spend that 20% on getting another sales rep, or getting more advanced technical training for your workers etc etc. As opposed to going out for a big team dinner just to spend the surplus. When leadership asks you to spend your whole budget, theyre expecting the former not the latter.

Nobody in leadership wants meaningless spend. That type of thing gets you fired in the blink of an eye in most organizations.

A budget is arbitrary. We aren't talking about less goods sold in this situation, but adjusting expenses. If we can raise expenses we lower profits. Lower profits are lower taxes.

The previous years earnings are not double taxed, they are capital to use on expenses for the next year. The IRS only cares about the changes in assets from beginning of year to end of year

Edit: additionally, a project started but not completed, such as building and selling a house, or individual good sales, can be delayed until the next financial year if it is not sold or the project is completed.

Yes, but spending $100 to save $20 in taxes still nets you down $80.

That said, sure, if you're having a good year letting everyone spend every dollar in their budget makes sense. You'd reduce taxable income and leave some meat on the bone for next year in case budgets need to be slashed.

Some of that is due to the quarterly reporting requirements of many large (often public) companies. Once you go over a quarterly-- and especially a yearly-- boundary, that lack of spend gets "locked in" as profit. At that point it's subject to corporate taxes, and potentially even a portion returned to the stockholders or however else the corporate governance has agreed to disposition profits.

Amazon famously operated at a zero profit for a decade, re-investing all profits and owing no taxes on no income. If some manager had claimed to need a few million then didn't spend it (but prevented it from being invested elsewhere in the company), they'd probably be fired, not celebrated for "saving" money.

If you're tracking your spend throughout the year, and not spending the expected amount in one area, there are also potentially other ways to spend that money to get a better return than it sitting in someone's "unspent" account as cash. And if a manager is going to argue they still need it, they'd darn well better need it.

If you believe that the tools, equipment, and people you need next year will be cheaper, then saving money makes sense. But as things are consistently getting more expensive with inflation, it has almost always made sense to keep employees well paid and lots of equipment ready in order to turn money (always losing value) into other assets like people, tools, and land (typically gaining value) while also reducing taxes paid.

You would hate to hear about how the government does the same thing with our "tax dollars".

We regularly get calls from govt organizations that have budget for equipment. As an example, let's say they budgeted for $2000 for a laptop. I ask, what do you need to do with that laptop?

The answer is generally browse the web and check email, write documents.

I explain they can do that with a $750 laptop, so if they have $2000 budgeted, we can get 2 for them.

That's not acceptable, they need to spend that money on 1 laptop so when they show their inventory and assets report, there's no extra equipment.

So, they get a $2000 laptop.

It's maddening.

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Companies don't want to carry cash over to the new year. Then its profit that gets taxed. Spend it on business expenses and it is tax free. Ideally, you'd spend that money on investments that improve the company's performance. I work in manufacturing, there is always a rush to spend your profits in Nov/Dec to update equipment.

My employers spend their life explaining that THAT'S NOT HOW IT WORKS.

Idiot companies operate such policies because the middle-managers want to constantly keep upping their budgets to look important, so they have constantly growing budgets, that nearly overrun all the time, to make it look like they don't have enough. Then some idiot above them just approves more money.

The same kind of middle management is also after money on their own pet projects, so when you come in £10k under-budget on one thing, they will want to spent that £10k elsewhere on something they care about. You've now "lost" that £10k permanently. Thus the only way to combat such idiotic financial management is to always use up the budget each time so they can't justify cutting it.

In any company with an ounce of common sense or financial management, that's not how it works. Many of my employers over the last few decades have had to actually announce regularly that that's just not how it works, because people come in from elsewhere with the natural *impression* that that's how it works everywhere. It's not true. And, unchecked, it will repeat even in workplaces that don't practice such idiocy because of people expecting it to work like that.

I manage several budgets in the 6-figure ranges, I basically go out of my way to make them as cheap as possible without compromising on anything. It's usually easy to do so, because there's a lot of nonsense wastage like this everywhere I go. I sometimes do "deals" too - look, I will cut out this £10k piece of equipment that was budgeted, replace it with a £2k thing that does everything we need but, and this is important, I want £5k of that saving to go on that thing you denied the other day because we didn't have any money for it. Agreed?

More often than not the employer gets what they need, they get a saving AND I get the thing that my department's been after for years. I just started at a new workplace and have already done this twice.

Because they actually LIKE people who can cut their budget and say "Well, yes, I'm sure that's a lovely piece of kit... but we don't actually need that level of equipment, we can do everything we need to do with a cheaper version without compromising on time or quality."

When I was self-employed many years ago, I would promise my clients that I would save them AT LEAST as much money as it cost them to pay me... and I always did so. Because there is just so much unnecessary wastage because of nonsense like this.

Budget-holders have a responsibility to have a low cost, but also to fulfil all their needs - present and future - from that cost. You also have a responsibility to know what's necessary and what's not because you hold the budget and therefore you should know... because the people above you DO NOT KNOW.

Padding your budget is fraud, as far as I'm concerned, and customers and even your colleagues are paying for that. Every penny wasted is more money that doesn't end up in your pay packet, eventually. Even if that's just in the form of "Hey, Jeff, you saved us £50k this year! Have a £500 bonus!".

Places that operate like this often don't know that it's happening, don't want it to happen, or limited to only a layer of middle-management that do it for their own status-symbol gain (e.g. saving money to then spend on vanity projects and sucking up to the boss). It's partly the upper-management's fault for not keeping it in check, but also they can't micromanage every budget and have to trust budget-holders.

But nowhere where there's any actual sense of budgetary control is it actually "official policy".

It's more of a matter of if the thing is really needed or just a 'nice to have' while budget dollars are still available.

Some times it’s just not possible. Incentive comp hits EBITDA. There may be some bank covenants or loan requirements that need EBITDA to be certain amount or be above certain ratios or have certain amount of cash/AR on hand. There maybe a fee the company has to pay to the bank or lender for not being in compliance or even complete payback.

It’s amazing that this type of systemic business and management incompetence is perpetuated decade after decade.

In virtually every other discipline, humanity makes improvements every year (processes, efficiency, technology, etc.)

> a more sophisticated approach to things

You could substitute "sophisticated" with complicated. The existing method is simple. Yes, extra more gets spent each December, but it gets spent on stuff the departments would possibly be asking for later anyway. With the existing method, its easy to track, gives departments a little morale boost cus they get some cool shit, and a greater sense of agency.

The alternative is a complex system trying to balance who came in under budget, by how much, how often. Which department got that cool thing they asked for? Did they need/deserve it? they came in under budget 3 times and they've gotten additional funding they requested twice, but one of those times the funding vastly exceeded the amount of money they were under budget. What is fair? Is one department seeing favoritism?

You can see how complicated that can become... plus there would likely be additional accounting and management costs required for implementing it, so the net benefit would be reduced.

Yep. can't tell you how many government offices/conference rooms I saw with 80" flat screens and "smart boards" right next to the cheap dry erase board that actually got used 98% of the time. And this was back in the early 2000s when all of this was new/expensive technology. Easily $2000-4000 tvs and I dont even want to guess what the smart boards cost

What happens when they hit revenue goals without spending budget?

Kind of off topic, but I have a set of good friends that does exactly this. They live very nearly paycheck to paycheck, and if a windfall comes their way it is immediately spent. An uncle died an left them around $20k and they immediately upgraded their vehicle.

For a while this struck me as absolute madness, but I found out they didn't like the situation either. They get food stamps and other assistance and if their savings goes above a certain (very low) point they no longer qualify.

So if they saved $500/month, which they could, in 4 months time they wouldn't qualify for aid any more and would eat through those savings in a very short time and have to reapply for aid. And the time it takes to jump through the necessary hoops means they miss a rent payment, or have to skip on groceries, or whatever other unfortunate choice.

The system is set up to keep people trapped in it, not to help people become more productive and escape it.

For government departments if you don’t spend your budget they will ask why you are asking for more money the following year. So it’s best to spend it all

Then you get a smaller budget next year and the extra budget you had this year is used to cover other teams who ran over budget

Not like an ELI 5 but I thought this explanation would be a good follow up to the comment you just made. Maybe a bit long but I have a lot of experience in this area and you seem genuinely interested so I hope it's helpful to you.

You're absolutely right that type of thinking is prevalent in companies and that there is an enormous amount of value to be unlocked if everyone has a cost saving attitude. As someone who works in corporate financial planning I can tell you that most CFOs and people in Finance roles don't want the entire budget spent, particularly if its on fluff that's not needed. Alternatively, finance can also be ok with some areas going over budget. For example, the sales department is over budget because they have higher commission expense due to greatly exceeding revenue projections.

It's mainly a problem with human behavior based on outdated expectations and assumptions around how corporate budgets work. A lot of companies would historically budget just by taking last year's spending and then deciding to add %, keep it the same, or cut % based on business conditions. In that kind of environment front line managers are incentivized to spend because if they don't they get less funding, and they care more about their specific scope of work than the overall corporate profitability. Finance groups set controls and policy to try and mitigate this behavior.

There are still companies that operate that way, but many companies now are much more sophisticated than that and have a team dedicated to working with business leaders to set budgets based on bottoms-up business plans, zero based budgeting, or some other methodology which focuses on justifying all spend. Companies can tie funding to specific plans and then require a specific level of approval for when business requirements deviate from the plan in order to change it.

Senior leadership's role is to set constraints and ensure that the various business plans come together in a way that keeps the overall corporate financial picture right, and make trade offs if needed. They also approve or reject changes.

There are a lot of reasons why companies don't have a policy of letting each department keep their saved money for future years. Two main ones are the need to reallocate to different areas and also the tendency for people to overspend if they have control over contingency funding.

Here's one example to think about. The customer service department is under budget for the year because they have less customer service reps than they projected they would need, which saves the company $500k. From a finance perspective there can be good and bad reasons for that. Bad reasons might be things like recruiting wasn't able to hire enough reps, attrition was higher than expected because of bad work conditions, etc. In those cases you would expect to keep the $500k in the budget for the next year because the customer service group still needs to increase their headcount in order to meet things like customer satisfaction or average wait time requirements.

A good reason might be that the newest product release was smooth and complaints decreased which means that the call center can be sustainably staffed at a lower level. In that case you might want to take the $500k and either expect a higher profit margin or invest it into another department. Maybe the IT team can accelerate development on an application for customer service reps that will lead to more savings in the future.

TL,DR: Many companies actually do look at this stuff in great detail and try to plan logically. It's typically individual department heads and front line managers who make bad financial decisions. They do this because of the way there incentives are set up and human nature. Finance companies try to design control processes and policies to mitigate it.

It's stupid. I always believed in zero-based budgeting. Yes, you can use the previous year's budget as a guide, but rushing to spend money just leads to waste. I used to work for a large corporate software reseller and the amount of crap customers/governments would buy just before their fiscal year ended was insane.

I hope you can see how stupid this sound.

If you're in a situation where you know you can't reach target EVEN if all the budget is spent, the reasonable thing is NOT dump the extra money into anything so you can save face.

Big companies are a place where logic is not required, and not optional, it's actually undesirable.

As someone who works in this area, you're definitely right. It's more than just revenue goals though since every department isn't directly linked to revenue but they all have goals and expectations. People just have a tendency to spend everything that's given to them in a corporate setting, particularly if it advances one of their departmental goals, even if it isn't efficient or financially sound.

That's why it's important for companies to link funding to plans and have proper controls in place to make sure money is being spent in accordance with that plan, or changes are being properly reviewed and approved.

Insert thrown out the window meme

The interests of the company and the manager are not always perfectly aligned.

Overspending is bad and so most budget owners will aim to underspend for the year especially in the early months, so for example after 6 months of the year they’ve spent only 5/12 of their budget.

Having reached the final few months of the year, the manager now knows the risk of overspending has passed.

They now have a different risk - if they underspend this year then the base expectation would be the next fiscal budget would based on this underspend. (Budgettjng rarely starts from scratch and is an adjustment of them prior fiscal).

Therefore spending often increases in the later months so that over the full year the actual spending is within a few % of the planned spend, ideally on the underspend side.

I get your point and the other points in this thread about the morale boost from getting new things earlier than expected, but I think it’s still wasteful overall. Upgrading every time earlier than you need means you spend more and waste more in the long run—e.g., replacing the PPE every 2 years instead of every 3 years (however long it’s good for) is more expensive and wastes good PPE. If they donated the old but functional equipment, it would be more excusable (but more work since they have to find somewhere appropriate to donate to).

It seems a bit crazy but part of the measure of success of a capitalist economy is how quickly money cycles around the economy. You might be spending on useless promo items but that money is paying your supplier and their employees and some of that flows back into government coffers straight away in payroll and sales taxes and more later on in company tax. The rest of that spins out into the economy as those employees spend on groceries and cars and xmas presents.

Think of it like how taps work - you have to keep a high level pressure in the water mains to ensure that when you turn on your kitchen tap that the water comes out immediately and with decent strength. Government Taxes and Spending functions like a pump for the economy in general. Taxes draws the money in and Budgets and their Spending pumps the money out

Not entirely true that it’s losing money due to inflation. Companies to keep cash on hand and market investments for a variety of reasons. Airlines and logistics shipping companies for example tend to trade heavily on oil futures since one of their overhead costs is fuel. If they own a good part of the market, when their operating expenses go up because of inflation, so do the value of their investments which can either offset or even reduce the overhead substantially. Professional services companies similarly diversify in the types of companies they do business with so when one market sector is slow, others can pick up the slack. Having money on hand can help work as a reservoir to buffer the slower sectors at the same time.

And that's because spending the money in short delay when the necessity arises is too complex and suspicious for the CFO to approve it.

Which is not that complicated when you're working in a small shop and the owner actually understands what the equipment is for.

There's also taxes. Companies get tax cuts if their net revenue is below a certain point.

Basically, if a company makes a gross revenue of $1 million, but their operation costs were $750 thousand, then they get taxed on the $250 thousand that was their net revenue.

A lot of companies, such as Netflix when they started out, will take advantage of this system. They will purposely spend money to recklessly grow their catalogue, causing them to be in the red by the time taxes are due. Which gives them tax breaks that don't reflect the reality of how they are purposely gaming the system.

As someone who has worked in corporate financial planning for almost 10 years at a handful of big companies, I have never seen it be a policy.

All of them do a combination of top-down goal setting with bottoms-up planning to the goal. Discrepancies between them are negotiated amongst senior leadership with the goal of the CFO usually being to give out as much money as is necessary, but not anything extra.

This isn't the part that confuses me. I don't understand why companies dont reward you for coming in under budget, and reevaluate assumptions when you go over budget.

There's also the tax advantage that comes from spending their entire budget. Since corporate taxes, in the U.S. at least, are based on a business' net revenue as opposed to their gross.

The following is based on the assumption that corporate taxes are 30% of a company's net revenue.

Let's say a company has a gross yearly revenue of $1 million.

Their base operating costs were $600 thousand shortly before the end of the fiscal year. Because of smart employees they ended up operating severely underbudget without sacrificing quality and while maintaining the growth the higher ups wanted.

So the company would get taxed based on their $400 thousand in net revenue. That's $120 thousand.

However, the company didn't expect to be taxed on nearly half of their gross revenue. They don't have the funds on hand to pay that much in taxes. They only have around $80 thousand that they've set aside to pay their taxes with.

And so they tell the grouos to spend the rest of their budgets.

Then, when it comes time to submit their records to the IRS, because of the final spending spree, their net revenue is $200 thousand.

That means that with a 30% corporate taxe rate, they'd only have to pay $60 thousand.

That's half of what they should have paid, considering they met their corporate growth numbers while operating underbudget and $20 thousand less than what they budgeted for.

So that $20k goes into yearly bonuses.

Several companies, Netflix for example, utilized this system to their advantage. When Netflix was first starting out as a streaming service, they purposely went in the red while expanding their company. Doing so gave them several tax cuts that they could use in the future once they stopped recklessly expanding and started reporting net profits.

There is not usually an actual policy.

It's the fact that if a division shows that it can do the job with less resources then given they will be given less resources in the next budget, because why would it need more? it's shown it could do the job with less.

By spending the entire budget (even on seemingly stupid stuff) they can argue for the same or larger budget next time.

Oh that’s easy. They don’t do it because it would require the number crunchers up top to actually understand what is happening down below. Or care, for that matter.

The formula is to drive profits. That is all. A certain level manager might get a reward for coming in under budget, but their budget is going to get reconfigured.

The reasoning is different for different types of companies. But for a for profit company, every dollar spent requires a significant amount of effort to earn it. I worked in distribution for almost ten years, so this is my experience. Target gross margin on sales was 20 percent. So for every 100 dollars sold, 20 is profit. But that doesn’t take into account the cost to produce it. You’ve got to pay someone to source material, pay someone to take orders, pay someone to ship it, pay supervisors, warehouses, pay rent, cleaners, energy…etc. at the end of the year, we contributed like 2-3 cents on the dollar in NET profit. So for 1000000 in sales, 20-30,000 in net profit.

If you’re able to reduce 4 different departments budgets by 5000 each, you can double your net profit with the same sales. That’s a SIGNIFICANT motivation for the branches management to cut budgets. Because they DO get management incentives on that net contribution.

Let's say you run the IT department of a company. You had a great year with very few computer upgrades or replacements needed, so you only spent 4/5ths of your budget. Next year your budget gets cut by that 1/5th. Now you have a rough year where everything seems to break, and while you could have covered it with the old budget, you can't under the new one; and the higher ups have allocated that money elsewhere. Now your stuck trying to make do, and you look bad doing so.

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As a result, you waste/use up the remaining budget so it doesn't get cut next year.

Money left over is not being used to make more money, and should be allocated to areas that will use the money.

As a cost accountant who set annual budgets for 15 years, it is because we take the money away if you dont spend it. We are usually trying to account for increased supply costs of 3-5%, plus some random budget decrease upper managemnet pulled out if their butts, so uf you have a surplus, we will yank it so fast it will make your head spin.

If you have a good budgeting team they will. But generally we will let you keep it if we can manage to get the overall budget under whatever upper management expects the budget to be. No sense pissing everyone off if you dont have to.

If you start the year with an allocated budget, you are careful to make it last to cover emergencies and essentials. When you have limited time before the next budget arrives you can switch to the 'nice to haves to increase productivity/replace before they fail' it's basic common sense not rocket science. It is a tried and tested approach that works.

If you start the year with an allocated budget, you are careful to make it last to cover emergencies and essentials. When you have limited time before the next budget arrives you can switch to the 'nice to haves to increase productivity/replace before they fail' it's basic common sense not rocket science. It is a tried and tested approach that works. Underspending is a recipe for future unexpected expenditure.

Ot's a requirement at nonprofits that the whole budget gets used yearly. Because, you know, they're not allowed to make a profit

>Isn't it better to carry over unused expenses to the next FY?

To measure performance (budget vs actuals) the budget needs to follow GAAP rules. The income statement is closed and resets every year. For the actuals, it is not possible to carry over income/expenses. The budget needs to follow a similar pattern.

Then there's a matter of tracking. If you did carry over unused expenses, it would be a big hassle to track net expenses. Is this $1 counted against last year's saves or this year's budget? And you'd need to do this by invoice line and by account. It would be easy to game the system by always counting against current budget and letting the previous reserve grow. You'd have to use some type of inventory accounting, FIFO/LIFO so that dept managers couldn't game the system.

OK sorry, I'm rambling. Net effect is that for the income statement, expenses do not carry over into a future year. The budget needs to follow the same convention.

If a budget isn't spent, in a lot of cases it will be allocated elsewhere, so to maintain the budget, it all has to be spent.

ELI5 - If you're working on a craft as a group and the teacher gives you 10 glue sticks, they might notice you only needed to use like 3, and give you less next time because they realize they have you too much, and they can give it to another group that needs more glue. If you want to keep all the glue, the one way to show you needed all that glue is to use all the glue.

This was a big problem working (as a civilian) for the military. Budgets literally required acts of Congress to change and the massive amount of departments allocated to each of them were so far outside of my control. It could theoretically be done a thousand times more efficiently but that would require a whole bunch more micro research and management that ends up being considered more trouble than it’s worth.

But what about getting closer to target? Would you prefer to be $100k short or $10k short?

I always find this kind of stupid because it means you don't recognize that you're just making your best guess as to how things will go and nothing ever works out that way. It's kind of like going through the whole 'goal setting' process once a year but at least everyone recognizes that you goals will evolve as the the year progresses because of things that arose that you had no ability to predict or predict accurately.

Think of it as punishing you for not understanding your own budget properly - You set the budget, or at least contributed to setting it. If you asked for money you didn't need then there's a good chance that someone else missed out on funding for something because you said you needed the money. If it turns out that you were wrong, especially if you are regularly wrong then they'll start to think you're padding your budget estimates and cut them back on the assumption that you'll make do with a bit less since you usually don't spend it anyway

Why would the smaller budget be a problem though? If you're literally just buying random shit to get rid of money, you clearly didn't need that money in the first place.

People are bad at estimating things, and its much harder to get more budget at most companies. So if you underspend and lose the budget, you have instant FOMO for the next year, and if you actually need more, it's a pain to get.

You might think but its so easy to lookup that you gave up a million dollars last year, why would it be hard to get 20k? And that's just one of the great mysteries of corporate finance.

You also have a general lack of real responsibility for checking this stuff. Proper accounting and estimation for budgets and efficiency is hard and time consuming. Very few companies truly try to do it. So you've got department managers blowing remaining budget last second, and no one challenging it, and things just keep on chugging along.

So long as the total budget for the company fits at the end of the year, there's not a lot of time spent looking into the details of that.

You know what? I’ve never really thought about that angle. It still drives me nuts, but you’re right.

We didn’t in that particular budget cycle, for whatever reason. The budget was planned every year based on expected expenditures. Some expenses are more volatile than others.

You don't have enough info and are sounding like an idiot yourself.

Generally there will be an ROI target, so for every $1 invested, the company expects say $1.10. If you have been averaging a ROI of 9% during the year (so a $1.09 return for every $1 invested), you definitely still want to invest the extra money.

No business has a target of breakeven. There is a hurdle rate they are trying to hit that is a positive return.

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On top of this, because how fixed costs work, spending the last $100 in your budget will usually give you a better return than spending the first $100.

But you don’t know if the sink will break that year or how it will break. So you’re incentivized to budget for it breaking in the most expensive way possible every year just in case it does break you can cover it. And when it doesn’t break you still gotta spend that money because you budgeted it. You might go 10 years with no breaks wasting $1,000. But in year 11 years be glad that you have that $100 to cover it when it actually breaks that year.

If it’s Capex then who cares. If it’s opex it’s better to be on the right side of the coin. Large organizations should require their leaderships to work in FP&A for a quarter. It would eliminate a lot of these types of questions.

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The high level company goals are not going to change, though, especially at a publicly traded company. Regardless of the adversity through the year, the goal will still be to make money. A business trying to lose as little money as possible instead of trying to make money will have some big changes coming.

My worst job ever was mediating management meetings where they'd argue about why expenses were put under their department.

You're thinking with the mindset of a company that needs to save $50 so that it can make rent at the end of the month, and wasting valuable time and effort scrambling to scrounge up money.

Large companies looking to increase revenue can't operate like that. If they're going to penny pinch then that oversight alone to micromanage the expenses of the company with thousands of employees would probably cost more than the money it saves.

And not only that, lower the productivity of the entire company as everyone puts in weekly effort to justify every cent, instead of doing their actual work.

Management commits money for the budget it invests into the company and as far as they're concerned, it's spent.

They don't care about penny pinching to get back $500k of their $500 million budget. They're more concerned on whether spending that $500k could have raised their revenue by another $100 million and the only way to know is to spend it. A healthy company drives forward to maximize revenue, not look backwards to save a few cents.

Now I'm interested in that link.

Don't spend £20 Billion this year. Clearly don't need £20 Billion. Here's £10 Billion instead.

https://vimeo.com/27060669

Then you are showing that you can hit the goal with a smaller budget, and will receive a smaller budget next year.