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