We all need specific plans for our business to follow. To execute these plans, we prepare budgets. There can be different approaches and different methods for the smart allocation of resources. One of them is bottom-up budgeting.
Want to know what bottom-up budgeting is? What is the standard process for bottom-up budgeting? And in what conditions is bottom-up budgeting the most viable for you? If yes, read the full article for a clear and wider understanding of bottom-up budgeting.
What is Bottom-Up Budgeting?
Bottom-up budgeting is "a budgeting approach in which each department projects expenses and revenues for a specific period and then passes the numbers to senior management for approval." The definition is simple, but the procedure leading to a bottom-up budget is complex. It requires substantial time to prepare a budget using the bottom-up approach.
For example, you have different teams in your company. And you empower them to prepare a their own budgets. Your company's leadership then approves the budget for each team. The finance department will then prepare the company-wide budget by combining them all. They will soon come back with the costs they need in a year to keep your business up and running. Congrats, you just prepared a budget for the whole year using a bottom-up approach!
Bottom-up budgeting is also called "participative budgeting" because it allows each department to participate in the budgeting process.
Bottom-up budget process and techniques
There is a standard process that companies do follow when they have to prepare a budget for themselves using this bottom-up budgeting approach.
Identify all the stakeholders and departments.
The first step is to identify various departments within your corporation. Depending on your business, you may have sales, marketing, finance, customer service, production, etc. Analyze your business structure and break it down.
Instruct and sensitize them on your business strategies, aims, and goals
You have to instruct each department on your business strategies and goals you want to achieve in the year ahead. Ask them to prepare the budget accordingly. You may have some templates in place that you would like them to use when preparing departmental budgets.
For a comprehensive budget, the different departments need detailed instructions from senior management.
Review department budgets
The senior leadership then analyses and reviews the departmental budgets against their benchmarks. They review whether the budgets align with their aims and objectives. If all is right, the company's leadership passes the budgets at once and sends them to the finance department for final earmarking.
Set out a company-wide budget
The finance department is responsible for the company-wide budget. The finance team then adds up all the departmental budgets and prepares a final budget entailing all the revenue and expense estimations. Each department is notified that the budget has been approved.
Advantages and disadvantages of bottom-up budgeting
Bottom-up budgeting is an efficient method of budgeting for your corporation. However, there could be some cons. For a balanced study, we must weigh in pros and cons systematically.
Bottom-Up budgeting pros
- Bottom-up budgeting is more efficient in the sense that the individual departments have to stick to the budget constraints. It gives a sense of ownership among employees and department managers. They feel that they are not the outlanders in the organization. It motivates them to work hard to achieve those goals.
- The department managers more often know their needs and resources required for optimal performance better than the senior management. They also can think outside the box and take the initiatives that meet your organization's goals.
Bottom-up budgeting cons:
- The bottom-up budgeting process takes time. It takes time to prepare the company-wide budget when the procedure starts from the bottom. However, with the right benchmarks at your disposal, you can save time and energy.
- Sometimes, the department managers tend to be unmotivated. They don't have the capability to prepare the budget for themselves. Their predictions may also be way over budget.
- Bottom-up budgeting can often lead to overbudgeting if your organization blindly entertains the department's budget requests.
Bottom-up budgeting vs. top-down budgeting
The alternative budgeting approach to bottom-up budgeting is top-down budgeting. As the name suggests, the top-down budgeting process starts from the top. Unlike bottom-up budgeting, the senior management reviews the previous year's budget and then prepares the new budget, which may be adjusted to reflect internal and external changes. They will then notify the various sub-departments of the new budget.
Now that we have already detailed bottom-up budgeting pros and cons, it's time to study top-down budgeting pros and cons. You would then be able to decide on what approach is better for your organization.
Top-down budgeting pros
- The process is faster. The senior management does all the paperwork and notifies the departments of what funds have been earmarked for them.
- The senior management prepares a perfectly aligned budget. Perhaps, it is more in accordance with the business strategies. It focuses more on the organization's growth, aims, and objectives.
Top-down budgeting cons
- The budgeting fails to give a sense of ownership among department managers. They feel like outsiders in the organization.
- Top-down budgeting tends to ignore departments' concerns. The company's departments could be bitter strife as some would feel deprioritized.
- Fearing budgeting cuts for next year, the departments feel about spending all the funds allocated, which they will otherwise save.
Which one is better for your company?
Some questions don't have a plain 'yes' or 'no' answer. It is when things are dependent and interconnected. The approach you take for your corporate budgeting depends on the structure of your organization. It also depends on the capabilities of your departmental managers.
The ultimate aim of budgeting is to allocate resources intelligently for optimal use. The budgeting also needs to be aligned with your organization's strategic objectives. Whatever your approach is, bottom-up budgeting or top-down budgeting, this is the ultimate aim.
Bottom-up budgeting is efficient as it motivates your workers and employees and gives them a sense of ownership. The departments know the resources required by them more than senior management. They would set aside all the costs required for employees' salaries, maintenance, upgradation, new initiatives, and others. Surely, you have hired department managers capable enough to prepare budgets for themselves.
But the problem arises when you see that the bottom-up budget doesn't resonate with your organization's strategic objectives. The team leaders are unmotivated and do not have a strategic mind. You may, in this case, feel the need to prepare a company-wide budget by yourself and notify all the departments concerned.
You may employ a hybrid approach for your company. For example, you prepare a budget for a wider period. But you allow the departments to prepare their budgets for shorter terms within the constraints set by that original budget.
Bottom-up budgeting is a practical approach to corporate budgeting. The departments in your company prepare their budget by themselves, and the upper management approves each department's budget and will measure performance periodically. The finance team then prepares the budget for the entire organization by combining them all.