Whether you are making a budget for your home, or small business, or a big company, there are two most common approaches you can use. One is top-down budgeting, and the other is a bottom-up budgeting approach.
In this particular article, we will be analyzing corporate budgeting and the two major types of budgeting techniques – top-down vs. bottom-up budgeting, used by almost all companies.
Before we delve into details about what is top-down vs. bottom-up budgeting, and which one will be better for your business, we will discuss why budgeting is important for your business.
Why is budgeting important?
At the start of the fiscal year, all businesses tend to work out their budgets in relation to sales and spending targets, to determine the future path of the business.
Let’s say, you want to reach a particular destination and you know where the place is. However, you are not aware of how to get there and what means you will require to reach there. Will you be able to reach there smoothly? Certainly not.
However, if you had a map and knew what means you would require, the journey would surely be easy for you.
Now apply the same scenario in terms of setting a budget for sales targets that a business needs to achieve during the year. If you have a documented plan, you know what actions you must take, and will always make an informed decision.
To carry out the process, many businesses use the two common practices for budgeting; top-down budgeting and bottom-up budgeting. Both have their advantages and disadvantages. To find out which one may fit better with your business model, read below.
Top-down vs. bottom-up budgeting
Definition and analyses of top-down budgeting
To understand the top-down budgeting approach, focus on the name. If a company is using a top-down budgeting process, then the top management will allocate the budget to all the departments. The allocation will be done on the basis of the budget available, last year’s performance, and current market trends.
Moreover, the senior management will also decide what portion of the budget each department should receive. Other than this, the company may also decide to set aside some resources and funds in case of any emergency.
Advantages and Disadvantages of top-down budgeting
One of the major advantages of top-down budgeting is that since the management is involved, the budget is allocated to each department, everyone in the company is on the same page, and everyone is aware of future goals and strategies. Moreover, as the departments have a set amount of budget allocated, they are also accountable to complete their goals using the available resources. Other than this, a top-down method is easier and faster as you do all the work collectively.
However, it can also prove to be a disaster. Not only can it cause intra-departmental strife, but it can also demotivate the departments, as they are not involved in the budgeting process. Moreover, this can create internal competition among the departments, which may affect the productivity of the company as a whole.
What is bottom-up budgeting and is it good for the business?
The bottom-up strategy is the opposite of the top-down strategy. In the bottom-up strategy, all the departments are asked to prepare an individual budget for the next year. Then the budget is proposed to the higher management. Now it is up to the top management if they approve or disapprove the budget on the basis of priorities.
Before the departments derive their strategies, the departments are given an overview of the bigger plan that needs to be achieved by the year-end. Then the departments prepare their budgets keeping in view some important factors: the costs of the initiatives they will be taking, costs related to hiring the right people, what programs they will run to ensure that they achieve the set targets, etc.
Pros and cons of bottom-up budgeting
As far as the pros of bottom-up budgeting are concerned, there are many. One of the best advantages is that every department is liable to prepare their own budget, they will ensure that they achieve their strategic targets properly. Moreover, often the management may not have a deep insight of what is going on, or they may allocate the resources wrongly, which may result in losses. However, the department managers know about the intricacies involved, and can easily devise a workable budget for their department.
However, as the initial budgeting is in the hands of the departments, they may increase the budget. When the managers decide to allocate a budget, they may not come up with a solid strategy. In fact, they tend to keep a little room to make things right if the strategy doesn’t work out as panned. It means that each department may increase the budget. Moreover, it may take longer to derive a strategy as the process for this type of budgeting is longer than the top-down budgeting strategy.
In this article, we have explained top-down vs. bottom-up budgeting in detail. Now you can make an informed decision by analyzing both strategies. It’s up to you to choose one that best suits your business. At the end of the day, you know your business well.