Budget planning is an ever-changing process that requires constant review and adaptation. And one thing is for sure: managing it effectively is the key to producing successful outputs across every department.
As a finance leader, there are two popular approaches you should know about: top-down and bottom-up budgeting processes. Both of them come with great perks. However, getting a good understanding of each budget planning strategy will help you make an informed decision and adopt one that actually works for you.
In this article, we'll cover:
- Top-down and bottom-up budgeting advantages & disadvantages
- Top-down budgeting and bottom-up budgeting use cases
- Why a hybrid budgeting process might be the best choice
But first, let’s share the basics.
What is a top-down budgeting process?
In a top-down budgeting approach, the decision-making authority rests with senior management at the highest level and trickles down from there. That’s why it’s called “top-down.”
The budgeting process steps might look like this:
- Top management establishes company-wide targets and budgets, based on the previous year’s budget and financial statements, department heads' feedback, current market conditions, and changes in the business model.
- They communicate this general budget to departmental managers and their teams.
- Each department's manager implements a budget that is in alignment with the targets set for them.
Overall, all budget decisions go through multiple layers of management before being shared with the larger teams.
What is a bottom-up budgeting process?
Bottom-up budgeting has a more decentralized approach than top-down budgeting.
Why? Basically, bottom-up budgeting begins at the lowest department level and moves up to senior management.
So, bottom-up budgeting process steps might look like this:
- Each department level identifies business goals that will require funding and calculates the estimated costs.
- The budget will be determined based on the estimates provided by each department.
- The final budget is submitted to senior management for approval and forwarded to finance for its specific allocation.
All in all, each company sector creates its own budget based on its specific goals. Then, these budgets are consolidated and sent up to higher levels of management. Lastly, the CFO reviews and approves the budgets or suggests necessary adjustments.
The bottom-up approach is best suited for growing companies that want to:
- Leverage department-level knowledge for more accurate budget allocations.
- Give employees and management ownership over their goals and how they achieve them.
Whether you want to implement a top-down or bottom-up budgeting process, knowing the benefits and drawbacks of both is key. In the next section, we’ll dive into them.
Top-down vs. bottom-up budgeting process: Advantages and disadvantages
With a better understanding of what top-down and bottom-up budgeting mean, let's look at their pros and cons.
Top-down budgeting pros
Among the advantages of top-down budgeting are:
- Faster approval. Usually, top-down budgets don’t need to go over multiple revision levels.
- Clearly defined organizational goals. Top management executives are closer to the board and the main shareholders, so they have a better understanding of the company's strategic goals and resources.
- It’s designed with profit in mind. Expense estimates are used to demonstrate how revenue will be achieved in each department.
- Smart team growth. By setting ambitious goals, upper management can accelerate team growth in a smart and efficient way.
- It saves time and resources by relieving lower management from creating their own budgets.
Top-down budgeting cons
Despite our best efforts, budgeting processes aren't flawless. In fact, top-down budgeting has some disadvantages, including:
- It may lead to a lack of employee participation and involvement. If targets seem nearly impossible to achieve, employees might feel excluded and less motivated, as the goals may not feel aligned with their first-hand experience.
- It can result in inaccuracies in budget allocations. Sometimes senior management lacks a complete understanding of each department's needs and challenges. Consequently, they may under- or overestimate the headcount and resources required to fulfill the set goals.
- It can lead to flexibility issues. It may be difficult to implement changes to a budget based on strategic goals.
- It can lead to internal conflicts and competition. As a result of the top-down approach, employees do not understand the big picture of budgeting. Thus, there may be conflicts between the goals and vision of different departments.
Bottom-up budgeting pros
There are several pros to bottom-up budgeting, including:
- It leads to more accurate budget allocations. Departmental employees are better acquainted with the area’s strategic goals and needs.
- It can provide more accurate headcount inputs. Departmental employees usually have a better understanding of the roles needed to achieve specific business goals.
- It allows greater flexibility. Budgets can be adjusted according to departmental needs and challenges.
- It boosts management morale and employee ownership. In addition to feeling valued, managers and team members feel their opinions are listened to and truly considered.
Bottom-up budgeting cons
And what about bottom-up budgeting cons? The main bottom-up budgeting cons include:
- It’s not as accurate as it could be. As the budget is developed at a department level, it can lead to a lack of alignment with the company's overall strategy and goals. Plus, team members could be a bit conservative and avoid including the total expenses in order to get their plans approved.
- It can lead to a lack of consistency. Each company’s department may develop its budget using different assumptions and methodologies. However, that could turn into a problem when it comes to merging those budgets.
- It can be time-consuming. Each department must develop its target, and everybody needs to review the numbers to see what expenses are necessary to cut or improve. In this way, this process can be time-consuming due to back-and-forth communication and could result in overspending.
Top-down vs. bottom-up budgeting: Which one should you adopt in your scaling startup?
Once you have set the basics, it’s time to outline which of the two budgeting processes is the best fit for your business needs and unique characteristics.
First up, we suggest you ask yourself:
- Would it be better if teams came up with their own ideas?
- Could your team benefit from leadership's suggestions on the best course of action?
- Do you have a new organizational design in mind? What could be the functions, roles, and responsibilities of your team?
- Are there area directors in each department? Do they all identify key metrics? Can they access historical budgeting and year-to-date actuals?
- Does your entire team receive training on this topic? Can individual contributors efficiently participate in the process?
- In what ways does your organization promote transparency in its objectives and strategies? Would it be possible to pivot and reallocate resources more quickly?
It's important to note that there is no magic formula. Your choice will greatly depend on your company's type, how it operates, and your financial goals. However, this section will provide you with everything you need to get started.
We'll explain when it is better to:
- Choose the top-down budgeting process
- Choose the bottom-up budgeting process
- Choose a hybrid budgeting process
When to use top-down budgeting
It is better to adopt a top-down budgeting approach if:
- Only senior management is qualified to keep expenses under control
- You are the founder of a small company of fewer than 150 employees, so it's likely that you have a complete overview of all operations
- Your organization is hierarchically structured and managers are better at making budget decisions
When to use bottom-up budgeting
Bottom-up budgeting is better if:
- You're part of a big company with complex hierarchies, and department leaders are well-qualified to track budgets.
- You want to improve upper management's co-working and connections with specific departments. Here, bottom-up budgeting is a good fit, since senior management can usually offer you the resources needed. Nevertheless, in this situation, many tend to lean towards a hybrid approach as well.
When to do a hybrid budgeting process
Comparing top-down vs. bottom-up budgeting isn't just about choosing one methodology over the other. Many companies choose a hybrid methodology. So, why choose between two options when you can have the best of both?
A hybrid budgeting approach combines elements of top-down and bottom-up budgeting. They aim to strike a balance between centralized decision-making and employee inclusion, and accurate resource allocation.
As part of a hybrid budgeting approach, senior management sets the overall budgetary goals, while department-level employees input their resource requirements and challenges. That way, hybrid budgeting approaches present the following advantages:
- Balance: Employee participation is balanced with centralized decision-making.
- An informed approach: As well as aligning with the company's overall strategy and goals, it also considers departmental needs and challenges.
- Accuracy: As department-level employees provide input, it results in more accurate budget allocations.
At this point, you may be wondering: how does the hybrid approach work? Well, the process might look like this:
- Leadership and department leads set goals, and create an effective org design
- Leadership determines which resource requests and objectives will be met
- Work with finance to create a budget that works for everyone
Leadership and department leads set goals & create an effective org design
Leadership and department leads set the company's goals and desired outcomes. Then, they create an efficient organizational design to achieve them. But what does the ideal organizational design entail? Essentially, you should first think about what functionalities are needed to reach your goals, and then think about headcount and resources.
Thus, you'll gain a better understanding of different departments in terms of:
Moreover, the organizational design should be tailored not only to fit the company's current needs but also to short-term and long-term projects. This way, you'll take into account how your business may evolve over time and what's required now.
Leadership determines which resource requests and objectives will be met
After identifying the desired outcomes and the necessary functions to achieve them, it’s time to figure out the required headcount and resources.
To do this, leadership should pay attention to requests and prioritize them according to:
- Departmental priorities
- Leadership priorities
This is an excellent opportunity to get insights, share opinions, and most importantly, learn from one another. Thus, leadership can strategize and negotiate which headcount and resource requests get filled and what objectives are most important. In fact, using a headcount planning solution can help streamline these discussions and come up with forecasts.
Work with finance to create a budget that works for everyone
Once your budget goals have been discussed and established, you should triangulate your plan according to what finance is willing to support. Although finance sets the final budget, keep in mind that leaders have the ability to influence it by:
- Bringing strategic insights
- Presenting multiple case scenarios
In fact, in order to strengthen your position when negotiating with finance, you may want to consider presenting:
- A high-case budget (largest budget)
- A middle-case budget (average budget)
- A low-case budget (smallest budget)
Ultimately, the best part about the hybrid budgeting process is that it's influenced by multiple department levels and driven by functionality and strategy. As a result, this increases the likelihood of getting approval.
How to centralize your company’s budgeting process with TeamOhana
It's evident that adopting a hybrid budgeting methodology is a smart decision for companies of all sizes and industries. However, besides its many pros, a hybrid approach also involves significant back-and-forth communication between managers and leaders. This may lead to:
Luckily, you can tackle these challenges and make hybrid budgeting transparent and collaborative. TeamOhana can help here.
TeamOhana is a people planning software that provides a single source of truth with real-time data, so you can forecast headcount spending accurately.
With TeamOhana, you can plan your headcount based on:
- Forecasts- Have an exclusive current & future headcount spending source-of-truth
- Analytics- Improve decision-making by tracking relevant KPIs
- Case scenarios - Get real-time headcount insights, predictive analytics, and past business strategies to plan for future scenarios and adjust your budget accordingly
- Collaborative work and complete visibility- You can seamlessly work with the Finance, HR, Talent, and Hiring Manager teams in a single platform.
- and more
Curious? Book a TeamOhana demo today →