Choosing your business’s right budgeting method is crucial to how effective it will be for your company in the long run.
In this article, let’s explore the two main types of budgeting and forecasting, top-down vs. bottom-up, so you can choose what is right for your business.
What Is Top-Down Budgeting?
Top-down budgeting is a type of budgeting where senior management prepares a high-level budget based on historical data and current market conditions. Based on the organization’s objectives, senior management then sets aside an amount for individual departments.
Top-down budgeting is guided by financial statements and budgets from the previous year and uses this to shape how they allocate funds for departments and functions. Senior management also consults with other managers to define how the budget is implemented across all staff members. Top-down budgeting is useful because it explores both internal and external factors in preparing the budget. This makes the budget more in sync with the current demands as it puts into perspective the current economy, profitability, salary costs, taxes, and many more.
Senior managers prepare targets for the company by looking into every department’s contribution in terms of profit, expenses, and sales. When targets are set, this is then passed on to the finance department responsible for allocating resources to every department. Finance departments also typically refer to the previous year’s figures to allocate budgets and consider departmental projects pointed out by department heads to senior management. For example, rolling out a new product may require increasing the allocated budget to support marketing and promotional expenses.
Top-Down Budgeting works because it enables senior managers to allocate the necessary resources to a specific department, which allows them to control the company’s overall growth. The top-down approach saves time as department heads can easily refer to a prepared budget formula rather than create a budget from scratch. This method also improves the efficiency as senior managers make targets and formulate a budget based on that other department heads can follow through.
However, this can also be a problem for low-level managers as they do not own the budget-making process, leading to a lack of incentive to deliver projects and drive success. As senior managers are not in the front line of the company’s daily operations, they may have set unrealistic targets about the needs of individual departments. As a result, low-level managers will struggle to implement these budgets, which will often be overstated, understated, and overall, inaccurate.
What Does Bottom-Up Budgeting Compare?
Bottom-up budgeting is the opposite, as budgets are formulated from low-level departments and make their way up to senior management. Department managers are tasked to prepare and present budgets to senior managers for approval. Department managers will explain each budget item to validate the need for such when presenting their case to senior managers.
Since department managers know the ins and outs of their day-to-day operations and have a good understanding of the current needs, pain points, and market conditions, bottom-up budgeting can be more practical and achievable.
Based on what is presented, senior managers can approve or revise this budget as needed. Once all department budgets are approved, senior management then comes up with a master budget.
What Budgeting Method Is Right For You?
Whether top-down budgeting or bottom-up budgeting is right for you, you’ll need to consider the structure, size, and needs of your organization. It’s worth mentioning that a top-down approach can work well for smaller organizations as it can be easier to align with all the managers involved. Larger organizations can benefit from a bottom-up approach as this method gives every department a voice and increases the likelihood that all their needs are addressed. Getting the buy-in of other department heads can promote better collaboration to prepare an ideal budget that can empower the organization to achieve its goals and objectives rather than act as a barrier.
When the right budgeting and forecasting approach is paired with an integrated FP&A tool like Performance Canvas Financials, which equips teams with financial planning, forecasting, reporting, and consolidation on a single web platform, companies can effectively plan and implement these budgets to help them scale.
