Bottom-up vs. top-down budgeting: Which is best for your company?

Budgeting season's closely approaching. So, will you go for a bottom-up, top-down, or hybrid approach? Find out which method's right for you and your team by checking out this complete article.

The process of budgeting is an essential part of running a financially sound business. You might choose between a top-down or bottom-up approach when creating your annual budget.

However, if you want the most beneficial outcomes, it's best to use both methods. A comprehensive study of a major consulting firm revealed that implementing more strategic budgeting practices reduced costs by over thirty-seven percent, primarily due to increased certainty around spending patterns and improved resource allocation decisions.

While it takes work, time, and involvement from more people in your organization, employing both approaches concurrently with the help of budgeting software lets you better align your financials and create a more comprehensive outlook for both management and individual teams.

So what's the difference between top-down vs. bottom-up budgets?

This article's here to break it down for you. Read on to learn about the essential differences between bottom-up vs. top-down budgeting so you can discover the best approach for you and your Finance team.

What is Top-Down Budgeting?

Top-down budgeting is a method you can use if you're in upper management to create an annual budget for the upcoming financial year. Typically, you'll rely on key data from the previous year to guide you, including a review of financial statements and each department's previous budget allocation and actual expenditure. A top-down model also factors in your organization's growth goals for the year ahead, as well as market developments like changes to trade conditions or tax obligations.

You'd then distribute this budget down your organizational hierarchy to departmental and team managers. In a top-down budget, departments are usually confined to deciding how to spend their share, which still needs approval from those higher up.

Top-Down Budgeting Process

Step 1: Assess Organizational Goals

To begin your top-down budgeting process, you should define your high-level organizational goals. Reviewing past performance, market outlook, and company plans will guide you in setting targets.

Step 2: Allocate Department Budgets

From these goals, you'll define broad revenue and expense targets for each department. Then Finance can review your initial proposal and assign individual budgets in line with the overall plan.

Step 3: Harmonization and Approval

Once you've allocated budgets, departments can propose how they'll spend their funds, and Finance will finalize one master budget. This strategy ensures alignment across teams and keeps everyone on track toward the same high-level objectives.

What is Bottom-Up Budgeting?

A bottom-up budget differs from top-down budgeting because your employees create it from the ground up. Instead of upper management dictating each department's budget, your teams share what funding they need and how they'll spend it. Of course, you need to keep proposals realistic, and you'll either approve them or request adjustments.

A bottom-up model is often more accurate than a top-down version because you and your team know your department's day-to-day operations. Specialized employees typically have a more precise understanding of where to allocate funds for their area of expertise.

Bottom-Up Budgeting Process

Step 1: Establish Department Ownership

Identify the budget owners in each department. These individuals should come from all levels of management for a well-rounded perspective.

Step 2: Identify Detailed Expenses

Work with each department to create a list of all costs, from salaries to office supplies. Remember to account for variable or unexpected expenses.

Step 3: Consolidate and Approve

After departments finalize their proposals, you'll review and either approve them or request revisions. Once approved, Finance combines each proposal into a single, organization-wide budget.

Pros and Cons of Each Approach

Here are the key top-down vs. bottom-up budgeting pros and cons:

Top-Down Budgeting Pros:

It's a streamlined process with fewer stakeholders involved.
Upper management has a big-picture view and can align the budget with overall goals.
Future changes are faster to implement without extensive back-and-forth.

Top-Down Budgeting Cons:

You might miss out on specialized insights from your employees.
Departments can feel frustrated if they have little say in budget decisions.

Bottom-Up Budgeting Pros:

You get a more accurate budget since each team member contributes their expertise.
Employees feel ownership and empowerment, boosting motivation and retention.

Bottom-Up Budgeting Cons:

It takes longer and involves more people.
Departments might not have an organization-wide perspective, causing misalignment.
You could miss out on strategic insights from upper management.

Choosing between top-down or bottom-up budgeting ultimately depends on your company's size, structure, and goals. If you're a startup that needs tight financial control, a top-down budget might serve you better, especially if your founders and C-suite already have deep knowledge of each department.

Recent research indicates that ninety-nine percent of financial services respondents experienced a ransomware attack within the past three years, directly influencing budget priorities and allocation decisions.

Top-down vs. Bottom-up Budgeting: Which One is Better?

If you're part of a larger organization with more complex hierarchies, a bottom-up approach can help bridge any disconnect between upper management and specialized departments. It also works well if you have the financial means to invest in long-term resources necessary for sustainable growth.

Using FP&A technology to get the best of both worlds

When discussing top-down vs- bottom-up budgeting, there’s not always a straightforward winner. In reality, both methods of budgeting have their pros and cons. Going with one over the other will lead to a certain set of benefits, but it will also take away another set.

For this reason, the approach that the most successful companies choose is to execute both methods at the same time. While it is more demanding, using both approaches is oftentimes the best solution for organizations. It ensures that both upper management and on-the-ground employees have their say in how the company allocates funds.

Upper management benefits from seeing each department’s insider take, whereas departments benefit from upper management’s unique insights and organization-wide viewpoint. Moreover, it positions companies to better align individual department and wider organization outlooks. However, pursuing both methods creates more complexity. To execute in an effective, efficient manner, companies use solutions-focused financial planning software.

Abacum’s FP&A technology enables organizations to streamline the annual budgeting process by optimizing cross-functional collaboration and transforming the process of data collection and application. The result is that businesses are able to create highly precise, data-driven budgets for the year ahead.