Top down budgeting explained in small details – everything you have to know

The concept of budgeting is universal, spanning schools, small businesses, governments, and large corporations. Each department is allocated a set amount of money that they must work within in order to achieve the necessary objectives. Department heads are responsible for adjusting their strategies to fit the budget they have been given.

The concept allows for saving money and ensuring things run smoothly if done correctly. It obviously has both advantages and disadvantages. Most commonly, it is based on the previous year’s budget, how it worked to accomplish organizational goals, and what the current situation is like.

Now, what is top down budgeting, and how does it work?

What is top-down budgeting?

The top down budget is set by senior managers. The budget revolves around the goals of the company and aims to improve profits and reduce risks.

Apart from the previous year, the current conditions are also taken into consideration. Other factors such as inflation, payroll adjustments, and the profitability of the organization are also taken into consideration.

Senior managers often solicit ideas from those directly involved in the process as they are more familiar with the situation and typically have more practical solutions. For example, department managers and even general staff will be asked about how the previous year worked and what could be better.

The purpose of top down budgeting

The main goals of top down budgeting include saving time for lower management, reducing expenses throughout the company, having a bigger image of the financial situation, and being more organized in terms of reaching objectives. 

All these have the general role of growing the company.

Top down budgeting can also go in more directions and growth may occur in different ways. For example, it could be related to expanding the business or maybe skyrocketing sales. Maybe it is about starting a new marketing campaign or hiring more people.

In order to make the most of top-down budgeting, it's important to have a goal in mind – be it expansion or cost reduction. Without this objective, there will be no way to know whether you're doing it right or not.

Top-down budgeting is more effective in big businesses with multiple layers of management. On the other hand, smaller companies usually have just one layer of managerial authority and a more intimate working environment. This means that every employee can offer their opinion on how to manage finances

Top down budgeting example

To help you get a better idea, this top down budgeting example will make things clear.

Imagine a furniture manufacturing company that has multiple departments and is running operations across them. One of these departments is responsible for providing and preparing the wood, one deals with paintwork, one gives finishing touches, and another one for marketing and sales.

In top down budgeting, senior management will have some targets for sales and profits, which will inevitably affect the expenses too.

Each department receives a target, which is passed to managers. Managers will have to adjust accordingly, but they may also reply with suggestions regarding the staff required, materials, or other potential expenses.

When top down budgeting is executed properly by top management, the finance department will implement the budget. Senior management can review monthly reports to gauge if all employees are adhering to the plan.

In some cases, budgeting goes in the other direction. It starts with the staff making requests based on the company's goals. These requests are passed to department managers before being sent over to senior management. This is known as bottom up budgeting.

Top down vs bottom down budgeting

Top down and bottom budgeting approaches are similar, but they work in opposite directions.

Top down budgeting is more common in large corporations, especially global companies. Bottom up budgeting is more effective in small businesses without too many employees, where discussions take less time and offer a deeper insight into the process.

The top down budgeting approach is different and less likely to target departments. The bottom up budget idea comes from people who are not financial experts but know the craft. Top-tier management is not as involved.

Department managers do not always have too many options. In some companies, they are asked for advice and ideas, since they know better what is going on at a lower level. In other cases, they need to adjust without the possibility to ask for more.

The bottom up budgeting approach is more complicated and requires more time too. Bottom up budgeting starts from the bottom and with the past year’s numbers in mind.

If a marketing department was given $100,000 last year and only spent $50,000, it may receive $75,000 or even less for the next year. Each company has its own rules in terms of budgeting. Some will stick to whatever the department has spent in the last year, while others will go above it in an attempt to find the perfect number.

Now, what are the imposed budgeting advantages and disadvantages?

Advantages of top down budgeting

Detailed budget allocation

Top down budgeting offers a detailed budget for every department manager. From this point of view, the approach offers a clear view. Managers and staff in various departments know exactly what senior management expects in terms of goals and objectives.

Faster allocation of resources

Unlike the bottom up approach, top management can allocate resources faster than department managers. While not always a general rule, some department managers may ask for more than what they actually need, only to ensure there will be no unexpected situations on the way.

Less work for lower management

Lower management will save time by not having to do all the work themselves. Instead of planning budgets without knowing senior management’s goals, they can focus on internal processes. Of course, adjusting to top management’s requests will still imply extra work, but it is less than doing everything from scratch.

Effective and simple

Senior management will prepare budgets for each department based on the previous year’s numbers or future goals. Working on a single budget is more straightforward than combining budgets from different departments. This process is not only simpler but also eliminates potential headaches when it comes to completing the budget.

Disadvantages of top down budgeting

Employee demotivation

Lower-level managers are not always involved, meaning their motivation drops. They do with whatever they are given if they are not involved in the budget planning process. For maximum effectiveness, they should be consulted upfront.

At the end of the day, it depends on the scale of the company.

Low level of accuracy

The involvement of top management in the internal processes of a company may differ depending on its size. Senior managers may not have a hands-on approach in organizations with multiple levels of management and they might not be aware of all proceedings at a lower level, such as expenses or profits.

Large global enterprises employ senior executives who require full understanding from their lower-level managers. Many entrepreneurs, like Steve Jobs or Bill Gates, got involved in the early stages and thus knew exactly what was needed for success. However, this is not always the case for larger organizations. When misapplied or overused, budgets can cause more harm than good.

Chances for disappointment

Not knowing the needs and expenses of lower departments means they may not get enough resources with this budgeting method.

There is a waste of money when the finance department allocates more money, as well as a struggle when the high-level budget is not enough.

Top down budgeting process step by step

Top down budgets tend to follow the same overall process, with small adjustments based on each company’s needs. Upper management deploys resources based on some factors, while the entire organization must comply and make it work.

Meanwhile, a different department can track monthly expenses to ensure day-to-day operations work according to the plan.

Step 1: Setting targets

This is the first step in a top down budgeting approach. It covers the preparation from management, who will do it based on goals and previous performance. Each departmental budget will be assessed in detail.

Step 2: Allocating individual budgets

Once the goals are set, business departments will receive different allocations, with the most critical departments getting more. Department-level discussions will go on from that point and may include all the staff involved in processes.

Step 3: Preparing individual budgets

Low-level managers may not find budgets sufficient to meet their expectations and requirements. Depending on the operating system of the company, there may be an opportunity for them to voice their opinions. As budgets move from one side to another, if they believe they do not have enough funds available, they can devise a new deal that matches the desired goals more accurately.

Step 4: Adjusting the allocated budget

Senior management considers suggestions from department managers, gaining a broader understanding. Department managers explain why the proposed budget is inadequate and what needs to be revised. Acceptance of recommendations or further discussions may follow, resulting in an adjusted budget that serves the company's objectives accordingly.

Step 5: Implementing the budget

Finally, when everything is settled, and budget proposals are accepted by both parties, the money is allocated by the finance department

The budget-making process does not always give much room for negotiation to a department head. Monthly expenses might be too high, or perhaps the budget-based allocation simply cannot be higher, especially if the company is struggling financially.

The Verdict

As a short conclusion, pretty much every manager out there goes through top down budgeting at some point or another. Bottom up planning could also be an alternative, but it depends on each company's goals.

As you can see, budgeting takes a lot of experience. Disadvantages at the top include the fact that senior managers may not have a crystal clear view of processes, hence the necessity of further negotiation for better results. They mostly look at monthly expenditures, processes, and profits.

Different companies do it in different ways. At times, it could be a well-structured process that involves discussions with department heads and even the staff, but within some limitations. It depends on how big the company is.

In other cases, top down budgeting is a matter of gathering everyone in a meeting and discussing different possibilities. This option is more viable for small businesses and may even go in the opposite direction, bottom up budgeting.

One way or another, every senior manager needs to go through this process in order to keep the company on track.

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