Top down vs bottom up budgeting

Are you familiar with top-down and bottom-up thinking?

Top-down is prescriptive: do this.

Bottom up is data-driven: based on experience, we should do that.

In business, you can apply this to budgeting. Top-down budgeting or bottom-up budgeting.

In this article, you'll learn about the two approaches and the pros and cons of each.

Key Takeaways

• Top-down budgeting is centralized, quicker, and FP&A-driven, but typically lacks employee buy-in.
• Bottom-up budgeting leads to higher employee buy-in and more accurate budget, but might lead to over-budgeting as a whole or lack a focused directive.
• Neither approach is strictly better or worse than the other; they both have their own strengths and weaknesses.
• The best companies use both approaches and iterate until there's a cohesive story. 

Contents

What is Top-Down Budgeting?

Top-down budgeting is when senior management prescribes a budget for the entire organization.

Each department then has to allocate that amount for their own needs. But they're restricted by the number that senior management gives them.

Advantages to Top-Down Budgeting

There are a few big advantages to top-down budgeting:

• Time savings: Since only senior management is involved in the budgeting process, lower management is free to keep the business running without having to make time for the (often extensive) budgeting process.
• Highly strategic: Senior management has access to the entire company's finances, so they can use that data to make highly strategic monetary decisions that departments without the big picture might not see.
• Unified direction: Since the budget comes from a unified source, it accomplishes an objective.
• Guaranteed executive buy-in: Since executives are the ones who agree on the budget, there's no need to worry about whether upper management will have issues with the budget. 
• Easier to manage: Since the budget comes from upper management, it's easier to manage: upper management can make changes without needing outside buy-in or approval. 

In general, top-down budgeting is a central, strategic method.

Disadvantages

That said, there are plenty of disadvantages of top-down budgeting:

• Lack of on-ground knowledge: The employees who are doing the day-to-day tasks in the business know what will make the biggest impact for them. Senior management might not always know or understand that.
• Communication Mishaps: The above problem results from poor communication, which is sometimes unavoidable, (especially during the busy budgeting season). Regardless, communication mistakes can lead to teams not getting the money they need to make strategic changes.
• Lack of employee and lower/middle-management buy-in: If employees aren't actively involved in the budgeting process, they might feel like their input isn't valuable; this can lead to lower engagement and frustration on the job, neither of which are the intent.

In general, top-down budgeting isn't perfect and has some serious pitfalls to watch out for.

What is Bottom-Up Budgeting?

If top-down budgeting is prescriptive, bottom-up budgeting is descriptive.

With a bottom-up approach, the lower management and employees create a budget and send it up the management chain for approval, where it finally gets to the Office of the CFO.

Then, in an iterative process, the Office of the CFO suggests changes to the budget and sends it back down, and so on until everybody reaches an agreement.

In other words, the Office of the CFO creates a master budget with input from the entire company.

Advantages

Bottom-up budgeting budgeting has a few unique strengths: 

• Employee enrollment in the budget: Since employees are so involved in the budgeting process, companies that use bottom-up budgeting see more employee buy-in into the end product.
• Empowers employee ownership and stewardship of the budget: When employees are involved in the budgeting process, they feel a greater ownership of the end product. This also means that teams, as a whole, will have conversations over how to best use the funds in their budget. In other words, employees feel more motivated to meet the budget.
• More communication: Since bottom-up budgeting is an iterative process and involves both employees and senior management, it requires having more conversations between all parties. 
• Still centralized: At the end of the day, the Office of the CFO still has the power of the purse to allow or deny items in the budget. So bottom-up budgeting allows companies to both have a central strategy in mind while also including employee knowledge.
• More accurate budgeting: Because employees and the ones who know what individual items cost, bottom-up budgets are typically more accurate. 

Generally, companies that employ bottom-up budgeting will see overall more satisfaction with the end product. 

Disadvantages

That said, there are a few things that might make bottom-up budgeting less than ideal for you: 

• Higher spending, probably: When departments can ask for what they want, the Office of the CFO will likely end up with an asking total higher than what they're willing to give. After various compromises, the spending will probably be more than what the Office of the CFO had initially set out to spend. 
• More time intensive: Because of all the communication and because of the various inputs, both employees and senior management will need to spend more time on the budgeting process as a whole.
• Potential mismatch between departmental vs. organizational objectives: Because bottom-up budgeting is decentralized, it's possible to lose sight of organizational objectives if departmental asks don't lead to them.
• Can create a "spend it or lose it" mentality: If departments don't use all the budget they asked for, that can signal to upper management that they'll repeat that next year. This means departments might end up wasting any excess funds in their budget just to hit their number. 

When should I do Top-Down vs. Bottom-Up Budgeting? 

You might be wondering: which approach is the best for me? What will give me the best results?

And the answer is: it depends. 

Top-down budgeting is ideal for when you need to run a tight ship and use your funds in service of a few strategic goals. 

Visionary companies with FP&A teams that are highly attuned to each department will do well with top-down budgeting. 

Bottom-up budgeting is ideal for companies who want to give employees ownership of their budget and of the department's direction. 

Companies with a culture of transparency, strong interdepartmental communication, and a finance team that keep track of the larger organizational goals will do well with bottom-up budgeting.

The Best Companies Use Both Approaches

You might be wondering...do these distinct approaches have to be mutually exclusive? If they both have advantages, then why not both? ¿Por qué no los dos?

And the good news: you can do both. 

In fact, the best companies use both approaches and iterate until there's a cohesive story.

There are a few ways this could look:

In once example, the board might set top-down targets, then employees build a bottom-up model that meets those top-down targets within real-world constraints and with more granular pricing.

In another, management and employees each create their own budget in isolation, then come together to talk about the differences. They end the meeting with a universally accepted budget.

Now It's Your Turn

Now you know the difference between top-down and bottom-up budgeting. 

You know that top-down budgeting is centralized, mission-driven, and often quicker. 

You also know that bottom-up budgeting is more accurate and helps employees feel ownership of their spending.

Now I want to turn it over to you: which form of budgeting are you doing this year? Top-down, bottom-up, or a hybrid approach? 

Share this on LinkedIn and tag us to keep the conversation going.

A budgeting method where senior management prepares a high-level budget for the company

Top-down budgeting refers to a budgeting method where senior management prepares a high-level budget for the company. The company’s senior management prepares the budget based on its objectives and then passes it on to department managers for implementation.

Sometimes, the managers may put forward suggestions for the budget before the budget preparation. Whether their contribution to the budgeting process will be used or not is at the management’s discretion. After the budget is created, the management makes specific allocations to the different departments, which must then create their own budgets based on their budget allocation and goals.

Learn more in CFI’s Budgeting and Forecasting Course.

During top-down budgeting, the company’s management considers past experiences and current market conditions. They use the previous year’s budget and financial statements as a benchmark for making allocations to departments and functions. Senior management may take inputs from lower-level managers, which helps acknowledge the concerns of the regular staff who are tasked with implementing the budget. They also consider internal and external influences such as prevailing economic conditions, changes in tax legislation, margin pressure, increase/decrease in salary costs, profitability levels of their peers, etc.

The Top-Down Budgeting Process

The top-down budgeting process starts with senior management meeting to come up with the objectives for the year. They discuss and determine high-level targets for the company in terms of sales, expenses, and profits. When formulating these figures, the management takes into account the contribution of each department in the previous year’s revenues. Usually, department managers and lower-level staff do not participate in the meetings but may put forward suggestions for consideration. Once management finishes preparing the targets, the objectives are passed on to the finance department.

Budget Allocations to Departments

The finance department is tasked with making allocations to departments. The department may use the previous year’s figures to split the allocations. For example, if the marketing department incurred 10% of the overall expenses during the previous year, then the finance department may allocate 10% of the total expenditure estimates for the next year.

The allocation may be higher or lower depending on what the departmental managers presented to the senior management. For example, if the company plans to roll-out a new product into the market, the finance department may increase the budget allocation for the marketing department to cover the promotional costs of the new product.

Department-level Budgets

Once the finance department assigns allocations to the various departments, department managers take the targets and prepare a budget of their own. Ideally, the work of the department manager is to take the revenue and cost estimates and develop a budget that shows how the department will spend the allotted funds to generate the desired revenues.

Department-level budgets should include the specifics of expected expenditures, e.g., purchasing computers and office equipment, and salaries, as well as the projected number of products that the department aims to sell to generate revenues.

Harmonization of Departmental Budgets

Each department within the organization is then required to submit their budgets to the finance department for harmonization. The finance department reviews the department budgets to make sure they are aligned with the overall objectives of the company. If there are departments with insufficient or excess budgets, the finance department may send the budgets back for revision, and the allocations may be adjusted upwards or downwards.

Once the department budgets are completed and finalized, they are loaded onto the financial system to track monthly expenditures. Management deploys resources based on targets set by the budget. The departments receive monthly or periodic reports to show the amount of expenses incurred from the allocated budget, as well as the revenues generated vis-à-vis the department’s targets.

Advantages of Top-Down Budgeting

• The budget features an overall corporate functional approach because senior management is concerned with the overall growth of the organization. It allows management to allocate resources to departments with a view to propelling the growth of the company, starting with the most critical departments.
• Top-down budgeting saves time for lower management. Rather than spending time creating a budget from scratch, lower-level managers are given an already-formulated budget to implement. This saves both time and resources that the managers would’ve had to use to formulate the budget.
• Top-down budgeting creates one budget at a time, rather than allowing departments to develop their budgets and later combining them. As a result, the budgeting process will be less tedious, since senior management will formulate a single budget that the departments will follow. The departments are only allowed to create their budgets based on the targets set by the original budget from the top management. This makes the budget process quicker than bottom-up budgeting.

Disadvantages of Top-Down Budgeting

• The level of motivation decreases since the managers who are required to implement the budget do not own the budget-making process. The managers do not take part in the preparation of the budget and may, therefore, lack incentive to ensure its success.
• Senior managers are not involved in the day-to-day operations of individual departments, so they may not have realistic expectations of the expenses related to each department. Therefore, lower-level managers may find it difficult to implement the budget because they are unaware of how the top management arrived at the set targets. Also, the budget may be inaccurate since the targets for revenues and costs may be overstated or understated.

Bottom-Up Budgeting

Unlike top-down budgeting, bottom-up budgeting starts at the department level and moves up to the top management. The departmental heads/managers prepare their budget based on present information and past experiences and present it to senior management for approval. They take into account margin pressures and market conditions to make the budget more realistic and attainable. The budget presented to top management contains an explanation of each item indicated in the budget.

Related Readings

Thank you for reading CFI’s guide to Top-Down Budgeting. To learn more and expand your career, explore the additional relevant CFI resources below.

• Budget Head
• Operating Budget
• Zero-based Budgeting
• Guide to Financial Modeling