Budgeting is an essential tool for companies that takes place at different times of the year and in different ways. It helps company leaders plan for the following year and to look back at the current/past year to make better financial decisions. Budgeting usually takes a team or teams of employees experienced in finance and accounting, and there are many ways to approach a budgeting process. In this article, we’ll review two of the most common approaches: the “top-down approach” and the “bottom-up approach” (also known as “zero-based budgeting”).
The top-down approach is the more common approach because it applies actuals (historical data) as a baseline target number for the following year. This can be assigned as a total or be broken down to the individual departments or business units.
The pros of this approach include each department having a good understanding of their budget target because they know how their actuals are trending for the year. This removes a lot of debate or arguments in terms of adjusting their budget target. For leadership, this sets a consistent number, and they know what to expect when it is time for the budget presentations and approvals.
This approach has some potential drawbacks as well. It allows department owners to add items to the budget for the following year, even if certain projects may not be necessary. Due to the set budget target, department leaders often try to hit their budgeted number even if business needs may not justify it. On the flip side, a department with a justified need to increase their budget for the following year may find it difficult to do so because their budget target is already set. Adjustments can be made along the way, but the precedent makes it more difficult to make them.
I once worked for a company where the precedent was using the top-down approach when it came to budgeting. There was a system in place and a timeline that was consistent year over year.
On my team, budget presentations were in October and November, and we started the process in August. We would work with the individual departments to corral the data, and then we would roll up the data and create reports/presentations. The finance teams and the department owners found comfort in the consistency, and everyone was aware of the budget “season.”
This approach was familiar, but it removed opportunities for exploration and advanced strategy that would have been possible with a more detailed approach to budgeting. For example, we could have paid more attention to continuous projects that were allocated for year over year, which may not have been as important in generating revenue compared to shifting the spend to other strategic projects.
The bottom-up approach, also known as “zero-based budgeting,” is used when leadership wants to see all departments’ justifications for each individual initiative or project. This approach does not set a budget target. Instead, each budget is built from the ground up, and every expense is added to form a budget.
The pros of this approach include giving leadership a better view of everyone’s needs and justifications for the following year. It also provides more detail and insight into the projects and initiatives being planned.
This approach’s drawbacks include a potentially lengthier path to approvals. Finance teams may need to collect more data and have more meetings to be able to corral the information into a consolidated presentation. It could also result in budgets having a greater variance than the current/past year’s historical data. For example, the budgets may add up to a lot more than what leadership expects, which could create difficult decisions as not everything can be approved.
One year, in the same company I noted above, leadership wanted to change our budgeting approach from top-down to zero-based budgeting. This was a completely new process for many of the finance teams. It took major adjustments, and teams started the budget process much earlier than we had before. There was some pushback from the budget stakeholders due to the newness of the process and because it would create risk that their budgets might be reduced/changed from prior years.
This change, however, allowed more insight and details into the initiatives the different departments were planning. The downside was a greater variance in the budgets, which surprised leadership and made for tougher decisions.
In my case, I had to partner with the new incoming Chief Marketing Officer to go over his budget and help him through the bottom-up approach. It took a lot longer and more meetings than the year prior, but we got a lot more detail into what his group wanted to work on and prioritizations. I got a better understanding of his entire organization, and it helped me have a better partnering relationship going forward. For example, an event promotion that we put on every year got reduced to a much simpler version, and that allocation went to a new marketing brand strategy that the leadership deemed more necessary and revenue generating at that time. Ultimately, it came down to the need, justification from the budget stakeholders and the leadership’s decision making of what is best for the company.
Selecting Top-Down or Bottom-Up Budgeting
The top-down and bottom-up approaches aren’t the only approaches to budgeting, but they are among the most common. No matter what a company chooses, it should clearly communicate which method and why, starting from leadership down. They should also weigh the resources they have, the timeline of the process and what level of details they would like to see.
Leadership concerned with keeping a consistent top-level budget year over year may lean towards a top-down approach. However, if they want to be a little more strategic, are not afraid of making tough decisions and don’t mind seeing greater variance in budget numbers, they may consider a bottom-up approach.
Companies that decide to transition from one approach to another need to be clear in their communication ahead of time, so all members of the organization are prepared. Additionally, it is also helpful if the reasoning behind the transition taking place is also made explicit. (For example, the compelling force could be a change in leadership or a philosophical change brought about by market forces.)
If you want to make this sort of change internally, it can also be prudent to bring in outside support. 8020 Consulting has a team of 90+ finance and accounting consultants, who can drive key projects or serve in an interim management capacity, depending on your needs. We invite you to learn more about our financial planning & analysis services.
If you’d like to learn more about strategic planning, you can also download our resource below! It features a project timeline to help you build a five-year strategic financial plan:
Categorized in: Financial Planning & Analysis