Top-Down vs. Bottom-Up? What You Need To Know To Build Your Budgeting Process

When it comes to budgeting, where does your organization stand? Do you start at the top or build it from the bottom up?

While there are plenty of ways to go about your corporate budget, most fall under two categories: Taking either a top-down or a bottom-up approach. The process you choose can affect your business in different ways--and each comes with its own pros and cons.

To make the right decision for your organization and to determine which will best enable you to execute on your financial operating plan, consider both models in turn.

Top-Down vs. Bottom-Up Budgeting

While the end goal may be the same--a company-wide budget--both top-down and bottom-up budgeting approaches have different starting points and get to the finish line using distinctly unique routes. So what are the fundamental differences between them?

What Is Top-Down Budgeting?

Top-down budgeting starts with senior management. It's up to them to create a budget for the entire company, allocating resources to each department according to company-wide objectives and organizational targets for the year ahead. Past performance and current market conditions are taken into consideration, while the previous year's budget and historical performance help determine which departments should get what--with an eye on how departments contributed to past goals.

Departments build their own budgets from there, based on the resources they've been allocated. Often, though, some funds will be set aside at the corporate level, allowing for final shuffles or extra calls for resources if departments feel they don't have what they need to meet their individual goals.

Top-down budgeting, in other words, is a form of "budget allocation." It starts with a set amount and allocates funding and resources accordingly across departments, leaving it to them to develop new plans or reduce their existing ones based on the resources they've been allotted.

What Is Bottom-Up Budgeting?

Bottom-up budgeting, meanwhile, begins exactly where you'd expect: the bottom. That is, departments prepare budgets for their teams based on what they need for the next year: the initiatives they want to run, the programs they already have in place and the hires they want to make. To ease the process, company-wide objectives and expectations are often shared with departments first, to give them organizational-wide visibility as they make their plan and provide protection against siloed requests.

Departments present their budgets for approval, and the finance team or budget committee goes through each from there, to approve or disapprove line items according to those larger organizational objectives. A company-wide budget emerges from that work.

One example of a bottom-up budgeting approach is zero-based budgeting, which starts with a clean slate every time in order to justify and prioritize every departmental expenditure.

Top-Down Budgeting: Pros and Cons

Neither approach is inherently better than the other--and certain types of corporate budgeting, such as driver-based budgeting, will work with either model. The key is to understand how your own organization works and to make your budgeting process a natural extension of it. It's also critical to understand the advantages and disadvantages of each model before choosing one.

A top-down budgeting process, for example, empowers you to allocate resources based on company strategy and an overall picture of organizational performance and goals. As with any type of top-down management style, though, aligning your departmental teams behind the results may be more difficult.

Pros of Top-Down Budgeting

• Executive buy-in is built in. Since management is involved early on, you know that your budget will be aligned with their viewpoint and goals--and that it will reflect the future growth plans and strategic direction of your business as a whole. And by capping departmental budgets based on overall goals, you make departments more accountable to those objectives.
 
• It can be faster. A top-down budgeting approach is generally faster than a bottom-up method--and at the same time can create organizational transparency into business-wide spending.

Cons of Top-Down Budgeting

• It can be more difficult to get departmental buy-in. Given that individual departments aren't involved in the budgeting process, they may not be motivated to see it succeed. Intra-departmental strife may also result if one department feels their goals are being deprioritized in favor of another department's objectives.
 
• It can create a "if you don't spend it, you lose it" environment. As a finance team what you see as an attempt to be efficient with your spending, departments may perceive as a threat to future resources. Which means they may feel the need to spend what they have even if they don't need it to meet their goals--or risk having their next budget cut.

Bottom-Up Budgeting: Pros and Cons

A bottom-up process ensures that your budget contemplates the needs of every department so that they have the resources they require to achieve their goals and put your organization ahead on its larger strategic objectives. It's generally a slower process for your finance team, though, as you incorporate all of the departmental requests into a cohesive overall plan.

Pros of Bottom-Up Budgeting

• It's often more efficient. Departmental teams, in general, have a closer eye on the resources they need to accomplish their goals--which means bottom-up budgeting is generally based on a more efficient and often more accurate assessment of where resources need to be allocated to get results..
 
• It's more aligned with departmental needs. Since the executive team doesn't always have deep visibility into the individual programs or initiatives each department is planning, they may not know how or where to allocate resources to get the best results. Departments do, though. And since departments--and their managers--are ultimately the masterminds of their own budgets in a bottom-up approach, they're also more likely to rally behind the overall results.

Cons of Bottom-Up Budgeting

• It can lead to over-budgeting. Since every department wants to truly ensure they have the resources they need to meet all of their goals, managers will often pad their requests to give themselves wiggle room for changes--something that can throw off the entire organizational budget if you don't keep an eye out.
 
• It can take longer to create (unless aided by the right technology). Bottom-up budgeting starts with a series of smaller budgets that are then combined together into something more cohesive for the entire organization. Making those smaller budgets work together--and going through each line item to incorporate necessary changes to fit company objectives overall--can take both time and resources to achieve. It's also something a tool like Excel wasn't traditionally designed for so it can require a more sophisticated technology to make it work.

(Check out The Ultimate Guide to Budgeting and Forecasting to help you better formulate strategies, plan for the future and align your company's goals.)

Figuring Out What's Right for Your Business

Choosing which approach is most effective for your business means understanding the psychology of how your organization operates. Do teams work better when ideas are their own, or do they prefer your leadership to come to them with the best plan of action? And how is your organization at creating transparency in their goals and strategies so that you can pivot and reallocate resources faster?

In some cases, you may not even opt for one model or the other, instead approaching your budget from both directions as a way of ensuring you have visibility into both departmental and organizational goals or to meet specific objectives. You may introduce a longer-term plan that takes a more top-down approach, for instance, then implement either a rolling or traditional plan for the nearer term using a bottom-up method. Or some years, you may choose to go into more detail on the cost structures of your goods or services--building a bottom-up budget from there. Other years, you may want to take the opposite approach.

After all, in the end, the point of both top-down and bottom-up budgeting approaches is the same: to make sure resources are allocated intelligently and in a way that gives everyone what they need to build towards your overall business strategy and goals. If everyone has an eye on that, either model is bound to be successful.