Top-Down Budgeting

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Last Updated:November 30, 2023

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What is Top-Down Budgeting?

The process of planning the organization's future is the cycle of mapping out the direction to meet the goals. To match the industry's strengths and opportunities, a strategy is laid out to achieve short and long-term goals.

A budget provides the foundation steps for planning a successful budget that is created by a process of aligning the company's resources with its strategy.

A budget is an operational plan and a control tool that identifies resources and their commitments required to achieve goals and objectives. A budget is quantitative and qualitative.

Where budgeting is the process and steps involved in preparing a budget, it facilitates clear communication of organizational goals. An ideal budgeting process budgetary controls.

Budgetary control is a formal system of control. It's a management process to help ensure that a budget is achieved by

instituting a systematic budget approval process
coordination of all the parties involved
variances analysis, and providing feedback to the parties involved

The type of budgeting will depend upon the size of the organization or the type of management the organization would like to assume.

Methods of budget preparation differ among companies, but all come under the category of authoritative or participative. The top-down budgeting starts from the top/senior management. The authority to decide on matters vests in the hands of the top management.

The Participative budget (also known as a bottom-up budget or self-imposed budget) is the type of budget where managers at all levels and certain key employees are expected to set budgets for their areas. The final approval is usually done by the top management.

Understanding Top-Down Budgeting

Top-down budgeting, also known as authoritative budgeting, involves the top management setting everything from strategic goals down to the individual items of the budget for each department.

It's the budgeting method where the senior management prepares the high-level budget. The company's senior management prepares the budget based on the objectives. Later, passes these instructions and objectives to department managers for application.

The managers of business units and departments may recommend suggestions, and these suggestions may be accepted or rejected. This is dependent upon the management's discretion.

Management makes specific capital and human resource allocations to different departments. Then these business departments should make their budgets based on the allocations.

Top management incorporates the strategic goals into the budgets. The preparation of strategic goals and budgets are activities that are well executed and coordinated from the top.

In the top-down approach, the managers are authoritative and dictate instead of communicating, which may make employees resentful and uninterested in achieving corporate goals and objectives.

Dictating can negatively impact the employees, especially at the lower levels, since they weren't consulted before setting the budget, and now they must be working more than they should meet the budgetary standards making them feel unmotivated and uninvolved.

Stringent budgets may not be strictly followed at lower levels since they are dictated. Even in some scenarios, we can expect the word not to be pushed to the lower levels, where the groundwork happens.

Although authoritative budgeting is strict and rigid, managers have better control over decision-making. We can say better decision-making is ensured.

Since a few personnel are involved in setting targets, making decisions over them can be executed effectively and efficiently.

Authoritative budgeting is not recommended for large corporations because that could sabotage the operations and cause miscommunication or no communication at all. And, since the power is not distributed at different levels, this could result in weak monitoring.

The Top-Down Budgeting Process

Let's understand the process below:

Decision targets are set: The first step begins with setting targets and the preparation of the budget by the top management. The top management assesses the company's performance to decide the critical goals and objectives. The top management may seek suggestions from the middle and lower management, although these considerations will be taken or may not.
Allocation of targets to the departments: The department heads receive their portion of the allocation of resources from the respective departments to meet the targets set. This leads to department-level discussions. Depending upon each department's requirements, the top management and finance department may allocate the budget according to the prior year's numbers.
Departmental budgets' submission to the top management: The budgets show how the departments intend to expend their resources. The department managers prepare their budgets based on departmental requirements. The figures are used and forecasted, ensuring they are aligned with organizational goals and objectives.
Approval: Any insufficient or excess budgets will be required revision. Managers will rework the budgets. This rework will lead to a reallocation of resources.
Feedback is collected, and the budget is revised until they are feasible. Then they are moved up to the hierarchy for approval.
Execution: Once the budgets are finalized, the finance department records the projections in the company’s system for tracking the progress or points of concern. Tracking the budgeted numbers will help management assign resources in line with budgetary targets. Each quarter, department heads get a report on how much money they earn and spend. A lot goes into top-down budgeting. As a business owner, you might not have time to do everything yourself.

Advantages of Top-Down Budgeting

Whether it be advantages or disadvantages, they are part and parcel of the approach taken by the management. If the management is certain to take a particular approach to the budget, they should be very well-versed with the merits and demerits involved.

Advantages are:

Synchronization and coordination: One of the first, but not the least, benefits of the top-down approach is the synchronization and coordination of activities. The authoritative approach encourages companies to synchronize their business targets across all departments.The comprehensive view adopted by the executives helps them unlock this benefit.
Time-saving: As mentioned earlier in the article, the top-down approach is better in the case of the small organization since it's easier to control the activities of the personnel involved. It works for small businesses mainly due to the limited setting. The departments are limited and won't be time-consuming since the budgets won't have to be built from scratch. This will be taken care of by the top management.
Growth Oriented Approach: Growth-oriented strategies are adopted by the senior management. The department managers are responsible for the execution and are also held responsible for the results. The top-down budgeting process starts with the executive input, which makes it easier for the middle management to align with the strategies set by top management.

Disadvantages of Top-Down Budgeting

Disadvantages are:

Lack of accuracy: Accuracy is affected since the top management dictates the budget. The budgets that are prepared by department managers and heads have a higher chance of accuracy and diligent implementation. These department managers have a better understanding of the operational and capital needs of the departments. Only holistic thinking can't lead to better planning and its execution. The top-down approach could lead to departments getting too much or too little money.
Biases: Lack of view and perspective could lead top management to make subjective and biased decisions. Hampering the achievement of organizational goals and needs. This bias can be a reason for the over/under-allocation of resources. Affects the performance of business units and departments.
Over-or under-allocation of resources: Unrealistic allocations to departments can obstruct operations in the affected departments. Resulting in middle managers might blame underfunding for the poor performance of departments. The opposite could happen in lower levels, where they are overfunded. Deploying funds where it is not needed at all. This leads to under-allocation and ineffective utilization of resources.

Top-Down Budgeting vs. Bottom-Up Budgeting

Let's understand the difference by taking a look at the table below:

Topic	Top-Down Budgeting	Bottom-Up Budgeting
Approach	Authoritative approach to budgeting	Participative approach to the budgeting
Strategic goals	Incorporates the strategic goals and planning into the budgeting. Places emphasis on the organizational strategy and the achievement of organizational goals since inception.	Has no consideration for the organizational strategy and strategic plans. The focus of the Bottom-up approach is the incorporation of different levels of management in the budgeting process. This leads to the concentration of business units on their own performance and productivity.
Communication	The top-management dictates instead of communicating.	This approach helps in capturing the lower levels of management’s perspective in the budgeting
Employees	Employees at lower levels in the authoritative approach are uninvolved in the budgeting process. Making them resentful and unmotivated.	The middle and lower levels of management are heavily involved in the budgeting process. The employees here are motivated, appreciated, and happy.
Budgets	The budgets prepared under the top-down budgeting approach are strict and stringent. There is a possibility that they won’t be followed at lower levels.	The budgets prepared under participative budgets are by managers and employees themselves. The numbers and the targets set are easily attainable. Chances of loose budgets being prepared.
Recommendation	Not a recommended approach for an organization with big sizes and a large number of departments. The presence of large numbers of departments makes the communication of goals and objectives difficult. Also, the problem may arise in controlling departments at different levels. Best for a small organization.	Usually recommended for the organizations that have responsibility centers with highly variable situations and managers have perfect information and best data available.