- What is Top-Down Budgeting?
- What are The Pros and Cons of Top-Down Budgeting?
- What is Bottom-Up Budgeting?
- What are The Pros and Cons of Bottom-Up Budgeting?
- How to Choose Between Top-Down and Bottom-up Budgeting for Your Business?
Creating a spending plan for your cash inflows is crucial to the success of your business. But with so many techniques to arrive at an appropriate budget, it can be challenging to be sure of what each one involves and which of them would be the most pertinent to your business needs.
Two of the most encompassing budgeting approaches are top-down and bottom-up. While the top-down approach looks at the big picture first and then moves on to the details, a bottom-up approach builds on the little details first to get to the big picture.
Regardless of whether you employ a top-down or bottom-up budgeting approach, it should serve you well to know what either of them entails. After that, you can make an informed decision about which of the two would suit your needs and those of your business better.
What is Top-Down Budgeting?
Building on what we introduced, the top-down approach as top-down budgeting is much similar. Here, 'the big picture' refers to historical data, market trends, and the direction that the C-level management wants the corporation to take.
With top-down budgeting, senior management sets the goals and objectives for the entire organization, whether they be financial, social, or directional. The budgeting activity need not be any different. Since the senior management has to disburse the funds to the departments at the end of the day, it makes sense that they evaluate the projects and milestones each department is responsible for and allocate their budget pool accordingly. In this manner, each department gets a certain percentage of the total corporate budget. It always adds up to 100% of what the management initially set aside in their budgeting activities.
This budgeting – or rather budget allocation – activity takes into consideration historical data about the performance and needs of each internal department. It may also deliberate on the market trends to perhaps shift from the historical perspective. For instance, the human resources department may be allocated a more significant portion of the budget than their previous performance or requirements warrant, perhaps if the employee retention policies need a competitive nudge.
Each department then further categorizes the budget allocated to them to optimize spending to maximize performance and returns to the organization. Each team within the department could also reclassify the funds allocated to them from their department manager. Thus, the budgeting activities trickle down from top to bottom in a waterfall or cascading manner.
The budgeting decisions taken by the senior management following the top-down approach need not be set in stone, however, and some funds may be set aside in case any department comes forward with a justified need for additional allocation.
What are The Pros and Cons of Top-Down Budgeting?
Having understood the concept of top-down budgeting and what it entails, you should weigh its pros and cons to better compare it with its counterpart.
Top-Down Budgeting Pros
- The budget set out in the annual, semi-annual, or quarterly budgeting activity can be followed to the T. The results at the end of the period can be critically evaluated to assess its success, execution, and applicability to the next period.
- Since only one team, the executive management, is involved in the process, it is likely to be completed in a much faster and more streamlined manner allowing for swifter and smoother implementation.
- The burden is lifted from the lower-level management and individual teams, who can then focus more on the implementation of the directives set by the organization leadership.
Top-Down Budgeting Cons
- Senior management does not usually have the time or need to go into the minutiae of each department's projects and, therefore, might miss out on critical avenues that justify the increased budget allocation.
- Individual departments may be harder to get on board with the overarching resource allocation, especially if they feel their input did not contribute to its development.
- The implementation of the assigned budget may not be as smooth as expected due to a lower level of ownership possibly exhibited at the department or team level.
What is Bottom-Up Budgeting?
In complete contrast to top-down budgeting, a bottom-up budgeting approach entails starting at the department, or rather team, level and making your way up the ranks. Thus, the budget keeps on accumulating as it reaches the final number, which is then presented to the senior management.
As far as starting from the bottom goes, the more specific, the better. For instance, one might think that starting from an overarching department with a mid-senior level manager should suffice. After all, it is still a separate department that can contribute its input into the company's budget. Be that as it may, the department may have teams with their own managers, milestones, projects, and timelines. Accordingly, they would evaluate their needs for the budgeting period and pitch in their expense forecasts to acquire the required budget.
Once each team presents their budgets to the department manager, they would then present an overarching budget for the department to the finance team until the final budget reaches the senior management. Thus, the budget travels from the bottom to the top in an uphill manner.
Even though the bottom-up approach starts at, well, the bottom, the process is not independent of the management's influence. For instance, organization-wide objectives for the budgeting period might be trickled down to the team level. These objectives would then guide each team's objective-setting and budgeting activities. This also gives a chance for each department to justify its expenditures.
What are The Pros and Cons of Bottom-Up Budgeting?
As was the case for the top-down approach, the bottom-up approach has its characteristic pros and cons as well that make it distinctly different from its opposite number.
Bottom-Up Budgeting Pros
- Each team or department has a better or somewhat more realistic idea of their goals and timelines, resulting in a more hands-on budgeting approach.
- It can result in increased efficiency across the organization due to the interdepartmental collaborative efforts, driving synergy and an air of trust and delegation.
- Since each department's inputs are incorporated into the final budget rolled out, you can expect increased ownership of both the process and the implementation resulting in better adherence, further increasing efficiency.
Bottom-Up Budgeting Cons
- Departments may feel the unwarranted need to request a greater budget allocation, which may unfairly affect other departments' more justified needs.
- It may lead to over-budgeting or higher spending targets than its counterpart since it is harder to put constraints over each department's specific needs.
- It takes more time to develop because of the increased number of stakeholders and possible reconciliation needed to bring the budget in line with the organization-wide objectives.
How to Choose Between Top-Down and Bottom-up Budgeting for Your Business?
One cannot objectively say that one approach is better than the other. As mentioned above, either method has its benefits and limitations, making both stand above the other in varying circumstances. The key then lies in having a clear idea of:
- The corporation
- The organizational objectives
- The hierarchical structure
- The operational strategies
- The mindset of the workforce
- The segregation and delegation of duties
For instance, a top-down budgeting approach may serve you well in the first few years after your company's inception when you, as senior management, have a better idea of the direction you want your business to take. You can allocate resources accordingly and get the support of each department as there are probably fewer but more dependable people across the organization.
On the contrary, a bottom-up budgeting approach may come to your aid when there is no ambiguity around the organization-wide objectives. Each department understands its role within the organization perfectly. They can then be allowed a level of independence in the budgeting and resource allocation process which could prove to be more fruitful if appropriately justified.
While either approach from top-down and bottom-up comes with its strengths and weaknesses, you can attempt to bridge one's limitations with the other's benefits and devise a more holistic approach that encompasses features from both. In this manner, you can ensure the highest levels of efficiency and ownership.