Top-Down Budgeting Explained

Top-down budgeting is a financial planning process that allows executives to set budgets before handing them over to department managers. Middle managers then implement their departmental budgets based on the allocations.

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This budgeting process benefits businesses by eliminating the need for individual department heads to plan their finances from scratch. Middle managers receive allocations, making it easier to draft department-level budgets and implement specific objectives. Top-down budgeting promotes financial control, saves time, and helps ensure accountability.

In the sections below, we take a deeper look into top-down budgeting.

• What is top-down budgeting?
• The top-down budgeting process
• Top-down vs. bottom-up budgeting
• 3 Advantages of top-down budgeting
• 3 Disadvantages of top-down budgeting

What is top-down budgeting?

A top-down approach enables senior management to draft a budget based on the company’s overall objectives. Executives look at the big picture and prepare the budget to effectively manage returns, risks, and strategic resources.

Current market conditions, the previous year’s budget, and past experiences can factor into a company’s budgeting decisions. Other influential factors include the profitability of the competition and fluctuations in payroll costs. Senior management often pulls ideas from managers and staff during the planning process, but the focus remains on achieving high-level goals.

A company might use top-down budgeting when looking for ways to boost certain aspects of their business. For instance, an organization that has suffered from a slump in sales may need to increase its marketing budget allocation to focus on marketing campaigns. Executives can also use this budgeting approach to cut down overhead costs for specific departments or the entire company.

Small businesses, in particular, find the top-down budgeting method appealing given their more compact management structure. Senior and middle managers tend to work more closely in small businesses than in large corporations.

Additionally, some large businesses may prefer the top-down approach because bottom-up budgeting can create more work for finance departments, which have to ensure different departmental budgets are feasible and realistic for the company, among other things.

The top-down budgeting process

Now that you know what top-down budgeting is, let’s take a deeper look at how it works.

1. The executive sets company goals and targets
2. The finance department allocates a budget to each department
3. Department heads take targets and prepare their own budgets
4. The finance department reviews budgets to ensure they align with company goals
5. Budgets enter the financial system to track monthly expenses

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1. The executive sets company goals and targets

The process begins with the preparation of the budget by top management, who assess the company’s performance to determine critical objectives, like reducing payroll to cut down overall expenditures or even increasing payroll to boost performance.

The executive team also looks at individual departments to determine their contribution to the past year’s expenses and revenue. Senior management may invite lower-level staff and middle managers to suggest budget ideas. However, submissions may or may not influence the final decision by the executive.

2. The finance department allocates a budget to each department

Once the executive team sets the budget, the department heads receive their allocations from the finance department. This handover triggers department-level discussions. Depending on the requirements of each department, the finance department may split the budget in line with the previous year’s numbers.

3. Department heads take targets and prepare their own budgets

Department managers then prepare their own budgets, including specific operational requirements based on department-level forecasting. With forecasting, managers ensure accuracy by aligning current budget plans with future goals, including revenue and expenditure expectations. The budget shows how the department intends to spend funds allocated by the top management.

These projections should align with the company goals identified during the early stages of the top-down budgeting process. A department may list expenditure items, such as advertising costs, staff training, and software upgrades.

4. The finance department reviews budgets to ensure they align with company goals

The middle managers draft their budgets and give them to the finance department for approval. The department analyzes the budgets to see if they align with company goals. Any insufficient or excess budgets may require revision. Managers may have to rework allocations depending on feedback from the finance department.

5. Budgets enter the financial system to track monthly expenses

Having finalized departmental budgets, the finance department records the projections in the company’s system for tracking purposes. Tracking monthly expenditures helps management assign resources in line with budgetary targets. Each quarter, department heads get a report on how much money they earned and spent.

Obviously, a lot goes into top-down budgeting. As a business owner, you might not have time to do everything yourself. That’s where hiring an independent financial manager can help. Look up qualified independent financial experts on Upwork today.

Top-down vs. bottom-up budgeting

At this point, you might be wondering how top-down and bottom-up budgeting differ. Well, the bottom-up process works from the ground up: Lower-level managers come up with budget proposals—making sure they align with the company’s strategic goals—and then present them to executives.

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Department managers draft budget proposals after reviewing expenses, department-level initiatives, company goals, and other metrics. This helps create a balanced budget that’s more likely to get approved by top management.

The major difference between the two budgeting methods is that, unlike the top-down approach, the bottom-up method allows individual departments to create their own budgets before handing them to executives for approval.

These budgeting approaches have the same goal — creating a realistic, comprehensive budget that will enable the company to advance its goals.  Both processes factor in company targets, previous financial performance, market conditions, upcoming activities, and past experiences.

Decision makers then allocate funds to priority areas to help the business grow.‍

3 Advantages of top-down budgeting

The top-down budgeting method has several advantages.

1. Encourage synchronization between departments

The top-down approach encourages companies to synchronize their business targets across all departments. This benefit is due to the holistic view adopted by the executives. In contrast, the bottom-up approach involves individual departments developing their own targets and budget proposals. So, there’s a chance some budget ideas won’t mesh well with company goals or targets.

2. Save time for small businesses

A top-down approach works best in environments with a shorter chain of command.

The main advantage of top-down budgeting in a small business setting is that it simplifies the whole process. Department managers don’t have to build a budget from scratch, which saves time. Rather, managers receive a ready-made budget from top management.

3. Foster the growth of the organization

Executive input at the start of the top-down budgeting process makes it easier for middle managers to align their budgeting ideas with the growth-oriented strategies adopted by senior management. Department heads are then accountable for executing company plans.

3 Disadvantages of top-down budgeting

As you assess the suitability of the top-down approach for your budgeting needs, don’t overlook the drawbacks. Here are some downsides to starting at the top.

1. May be less accurate

Top management’s holistic thinking doesn’t always lead to better planning. Accuracy may suffer without the input of department heads and staff who have a better understanding of their department’s day-to-day operations. The top-down approach could lead to departments getting too much or too little money.

2. Could result in biases from executives

Another potential downside of this budgeting method is that executives may make the wrong decisions due to their subjective views of the company’s (and each department’s) goals and needs. There’s a chance that bias will lead to underfunding or overfunding of some departments, making everyone’s job harder.

3. May lead to over- or under-allocation of resources

Executives making unrealistic allocations to departments can impede operations in the affected departments. As a result, middle managers might blame underfunding for poor department performance. At the same time, lower-level managers in overfunded departments might overspend just to avoid budget cuts the following year.

Find the best budgeting method for your company

The budgeting process plays a major role in deciding your company’s direction. Given the amount of work involved in top-down budgeting, it can help to have a financial manager in your corner.

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