Bottom-up budgeting: everything you need to know 

Whether you're a seasoned finance professional or new to budgeting, this blog will demystify the concept of bottom-up budgeting.

We'll explore how it works, its pros and cons, practical examples, and its role in modern FP&A teams. 

Let's dive into the world of bottom-up budgeting and unlock its potential for effective financial planning.

What is bottom-up budgeting? 

Bottom-up budgeting is the practice of having each department submit their targets and requested budget for the year, which is then reviewed by the finance team for alignment with corporate goals. This method of budgeting takes a granular approach that begins at the “bottom” of the organization – e.g., departments. 

Bottom-up budget vs. top-down budget 

In contrast to bottom-up budgeting, top-down budgeting requires the finance team to put together targets and allocate funds to each department. Top-down budgets are usually reviewed and approved by management before being communicated to individual teams.

Instead of starting at the “bottom” of the organization, top-down budgeting begins with the “top” or leadership, and resources are allocated based on the company’s strategic initiatives for the next year, as well as each department’s past performance and market conditions. After the plan is circulated with the broader team, departments can begin to put together a budget based on the funds they’ve been allocated.  

Bottom-up budget vs operating budget 

An operating budget estimates a company’s revenue and expenses over a period of time. Operating budgets provide a high-level overview of business performance and a way to monitor revenue, variable costs, fixed costs, non-cash expenses, and non-operating expenses.

Operating budgets are usually updated monthly or quarterly. While these budgets can be assembled using a bottom-up approach, they primarily focus on revenue and expenses and are often compiled using a top-down method that solicits input from leadership.

Note that, like any budget, even those created through a bottom-up approach can be updated periodically as needed, and don't necessarily reflect only one point in time (e.g., the beginning of the year).  

Bottom-up budget vs. capital budget 

Companies use capital budgets to evaluate the feasibility of new projects and investments. This process usually involves examining the cash flow of a project over time to determine if the project would meet the company’s benchmarks and offer a return on their investment.

Like operating budgets, capital budgets are a type of budget, not a method of budgeting. Both capital and operating budgets can be assembled using either a top-down or bottom-up approach, depending on the company's management style and structure. While some companies may prefer a top-down approach that uses feedback from leadership to evaluate projects or investments, others may use a bottom-up approach that values inputs from employees closer to the day-to-day operations.

How does bottom-up budgeting work? 

Let’s look at the three major steps of putting together a bottom-up budget.

Departmental cost analysis 

The first step in bottom-up budgeting is to have each department put together a projection of their anticipated costs and expenses for the year. This should include employee expenses, planned projects, and equipment and administrative costs.  

Creating the department budget 

After evaluating their anticipated needs for the year, each department adds up their costs to form their budget. These departmental budgets are then compiled and added up to from the company’s overall budget.

Balancing departmental needs with top-level company wants 

Once the company budget is established it is reviewed by the leadership team to see if it aligns with the organization’s strategic goals by asking questions such as: have resources been allocated to the right projects? Are there enough funds to cover new projects or investments? Will departments have the resources they need to meet revenue targets?

If the budget is well positioned to meet the company’s goals and objectives, it is then passed to the finance team who will validate the entries and finalize the bottom-up budget.

What are the advantages of bottom-up budgeting? 

There are several advantages to bottom-up budgeting, including improved accuracy, accountability, and employee morale.  

Precision in budgeting

Bottom-up budgeting is more accurate than many other methods because it solicits feedback from employees who are involved in the day-to-day operations of the company.

Individual contributors often have a better understanding of recurring expenses and departmental plans than leadership teams, and so bottom-up budgeting is an ideal way to compile a granular overview of organizational needs.  

Fostering stewardship among department leaders

In the bottom-up budgeting process, department leads play a crucial role in not just creating, but also adhering to their budgets. Since they are responsible for assembling and projecting their anticipated costs, they inherently develop a sense of ownership over their budgets. This stewardship typically results in them committing to the budgetary constraints they've set, leading to better financial discipline within their departments.

However, this process works best when there's clear communication from upper management regarding the company's overarching strategic objectives and financial guidelines.

Boosting employee morale

Bottom-up budgeting is a great way to boost morale among individual contributors. By involving each department in the process, your employees feel like their input matters and that their department’s plans are a priority for the business. 

What are the disadvantages of bottom-up budgeting? 

While bottom-up budgeting has many advantages, there are several disadvantages too, including the risk of over-budgeting, the amount of time it requires, and misalignment with strategic objectives.  

The risk of overspending

One disadvantage of bottom-up budgeting is that it can lead to over-budgeting. When department leaders oversee their budgets, they may allocate extra funds to account for unexpected costs, which can lead to over-estimating their needs. If every department tries to allocate themselves additional resources, this can lead to over-budgeting at the company level, and more funds being spent than necessary.  

Time-consuming processes

For many organizations, bottom-up budgeting can quickly become a time-consuming process. Without a standardized approach in place, it can be difficult to coordinate and collaborate with all the necessary departments and understand the rationale behind their choices. It also takes time for each department to evaluate their costs and compile their plan for the year.  

Potential misalignment with organizational goals

When departments put together their budgets for the year, chances are they’re most concerned with their ability to meet their targets and goals. A bottom-up approach to budgeting can miss the big picture because teams are focused on what they want to achieve, rather than on what the company aims to accomplish.

Upper-level management also has limited involvement in the initial steps of bottom-up budgeting, which can limit visibility into the overall strategic alignment of individual department budgets. Bottom-up budgeting can also lead to missed opportunities for cross-departmental collaboration and optimization of resources.

A sample 8-step bottom-up budgeting process 

Create a bottom-up budget in eight straightforward steps, as outlined below:

1. Set objectives: Establish the goals and objectives for the upcoming budget period.
2. Departmental budgets: Each department estimates their own expenses and revenues based on their objectives.
3. Budget submission: All departments submit their proposed budgets to the budget committee or management.
4. Review and adjustments: The budget committee or management reviews each department's proposal, asks for clarifications if needed, and adjusts.
5. Consolidation: All department budgets are consolidated into one master budget.
6. Approval: The consolidated budget is reviewed and approved by top management or the board of directors.
7. Implementation: The approved budget is distributed back to the departments and implemented.
8. Monitor and control: Throughout the budget period, actual results are compared with the budget estimates, and adjustments are made, as necessary. 

The role of bottom-up budgeting in the modern FP&A team 

Bottom-up budgeting can be incredibly beneficial for modern FP&A teams who are looking to improve employee involvement, create more detail-oriented plans, and identify operational inefficiencies. Modern FP&A teams can champion bottom-up budgeting by working closely with every department, validating inputs, and communicating changes to upper management, positioning themselves as a strategic contributor and fostering a culture of collaboration.

The bottom-up budgeting process fosters stronger relationships across departments, enhancing their role as effective business partners. It also paves the way for improved agility, allowing for swift adjustments at the departmental level without disrupting the entire budget - a critical aspect in today's rapidly changing business environment.

Lastly, modern FP&A teams leveraging advanced budgeting technologies can manage the bottom-up budgeting process more efficiently, with real-time updates, better visibility, and streamlined communication. This approach not only empowers FP&A teams but also positions them as key players in the organization's financial planning strategy. 

Conclusion: Effective bottom-up budgeting with Prophix 

In conclusion, effective bottom-up budgeting, when managed well, can be a game-changer for FP&A teams. Despite its challenges, Prophix's Financial Performance Platform can make the process seamless and efficient. From detailed forecasting to fostering inter-departmental collaboration, bottom-up budgeting with Prophix is your key to strategic financial planning.

Explore the best budgeting solutions for bottom-up budgeting in 21 best business budgeting software for CFOs (in 2024).