Budget Development Tips: Blending Top-down & Bottom-up Processes

With today’s ever-changing financial environment and external market pressures, you may find your company is under pressure to create a new budget quickly. There are two general budgeting approaches your company can take: top-down and bottom-up. 

As experts in helping businesses drive successful financial and operational transformations, we’ve outlined the pros and cons of top-down and bottom-up budgeting to help your company make the right decision, plus some tips for creating an effective budget process. 

What is top-down budgeting? 

Top-down budgeting is a process that starts with senior management creating a budget for the entire organization and allocating budgets to departments.

Department managers are then required to create their budgets based on senior managements’ allocation.  

Pros to a top-down budget:

• Takes less time than other budget processes (such as bottom-up budgeting). 
• Less obsession into the details with a focus on the overall growth of the company, leading to saved time for middle and executive leadership.

Cons to a top-down budget:

• Less accurate as department heads are not involved. 
• Decreased motivation/engagement from department managers. 

What is bottom-up budgeting? 

The bottom-up budgeting process begins with each department identifying goals and projects that are aligned with organization’s strategy.

The department head then determines the estimated costs by activity and aggregates the data into a budget spreadsheet/template. 

Pros to a bottom-up budget:

• More accuracy, as these budgets are typically built from the ground up.  
• Increased engagement and motivation by budget holders due to their involvement with the decision-making process. 

Cons to a bottom-up budget:

• Requires substantial time and effort from both budget holders and the FP&A function. 
• The tendency for departments to over-budget to ensure they receive sufficient funding for their goals.  

8 Steps to Building a More Effective Annual Budget by Blending Top-down and Bottom-up Processes

1. Define organizational strategy and objectives
2. Establish high-level budget targets  
3. Distribute targets to budget owners
4. Outline requirements 
5. Perform gap analysis 
6. Outline and prepare budget plan revisions 
7. Communicate budget revisions to senior management 
8. Prepare budget presentations for relevant stakeholders 

1. Define organizational strategy and objectives 

The most important element to an annual budget process is defining the organization’s strategy and objectives for next 3 to 5 years.

Senior management should then cascade this information down across the entire organization to ensure everyone is aligned.

2. Establish high-level budget targets 

CFOs should then establish a “strawman model” (re: a draft budget proposal that is intended to generate an informed discussion with the Board or key investors) with the CEO to identify high-level budget targets for revenue growth, gross margin percentage profile, absolute profit (EBITDA) numbers, capital expenditures growth and working capital metrics.

These high-level targets should then be shared and agreed upon with your Board or key investors.

Note: Operating expenses were deliberately left out of target settings because it’s a variable that’s solved for based on revenue, gross margin and profit (EBITDA) targets. 

3. Distribute targets to budget owners 

CFOs together with their FP&A teams must set targets by department and distribute those targets to budget owners.

The differentiation from the top-down approach is that these targets are viewed as guidelines to follow rather than explicit orders that must be achieved, which enables greater flexibility and ownership over individual budgets.  

4. Outline requirements 

The FP&A team must outline and clearly communicate the requirements needed to drive a smooth budget process. Some of these requirements include: 

• Mandates: All spend must align with the organization’s strategy and objections. In other words, there needs to be linkage between the high-level company goals and the day-to-day activities needed to achieve them.
• Two-way department spend views: 1) aggregated by activity/project and 2) aggregated by general ledger accounts. 
• Using FP&A predefined spreadsheets/templates to populate data: These templates are usually created by the FP&A function and are standardized across departments to make data collections more efficient.
• Calendarization: Developing a timeline with deadlines. 
• Management meeting cadence: Series of meetings (in-person ideally) that includes your CEO, CFO, FP&A team, and select management personnel where each department owner presents and defends their budget. 

5. Perform gap analysis 

The FP&A team must then consolidate all departmental budgets and perform a gap analysis (re: the process of comparing current performance with desired outcomes).

In this circumstance, we are comparing the initial draft budget from various individual department templates.   

6. Outline and prepare budget plan revisions 

At this point, the FP&A team has met with all department owners to understand their goals/strategy. 

The next phase requires the CFO in conjunction with their FP&A team to outline and provide recommended revisions by department that can then be reviewed with the CEO.

Next, the CEO and CFO must meet to align on any recommended revisions. 

7. Communicate budget revisions to senior management 

CFOs (with their CEO’s full support) must communicate budget revisions to senior management and align on expectations.

Budget holders are expected to work with their FP&A team at this stage to make changes and finalize the budgets as quickly as possible. 

8. Prepare budget presentations for relevant stakeholders 

Finally, prepare a comprehensive budget presentation for your board or key investors.

Presentations should run smoothly, as any new or controversial items were likely previously discussed in step 2 with budget approval essentially guaranteed at this stage.  

Final Thoughts on Blending Top-down and Bottom-up Budgeting Processes 

Though combining elements of two budgeting processes may seem tedious, with upfront calendar planning and effective communication, a thorough budget plan can be realized and provide an organization with the tool it needs to transform its strategy into action.  

Important Note: Budgets are NOT intended to be finance-only exercises. If the organization’s mindset to an annual budget process is “it’s something we do annually” or “it’s a way to set bonuses,” then the intended purpose of budgeting is likely not achieved.  

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