Top-down budgeting explained

If you’re looking to change the way you budget, there’s lots of different methods to choose from – top-down, bottom-up, operational, activity-based, static, flexible, and more.

But finding the right approach for your business depends on the benefits and limitations of each, and your business needs. Today, we’ll explore top-down budgeting, including:

What is top-down budgeting?

Top-down budgeting is the practice of having senior leadership prepare a budget for the organization, based on corporate objectives and goals for the next year and beyond.

This method of budgeting takes a high-level approach that begins with the “top” of the organization – e.g., senior leadership.

During top-down budgeting, executives evaluate the effect of past performance and market conditions on the business, as well as profitability and personnel costs. The companies’ objectives are usually categorized around three key areas: sales, expenses, and profits.

Top-down budget vs. bottom-up budget

Unlike bottom-up budgeting, top-down budgets begin with senior leadership (i.e., the “top” of the business), rather than individual departments (i.e., the “bottom” of the business).

Instead of having each team put together a request for resources, the leadership team allocates available funds to each department. Each team then uses that allotment to create their own budget.

Both top-down and bottom-up budgets evaluate the impact of past performance and current market conditions. The difference lies in who is identifying the impact of these trends differs in each approach. External and internal factors are identified by leadership in top-down budgeting, and departments in bottom-up budgeting.

Top-down budget vs. operating budget

An operating budget estimates a company’s revenue and expenses over 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 often updated monthly or quarterly.

Operating budgets traditionally employ a top-down method. This means that it primarily focuses on revenue and expenses, with high-level input from leadership shaping the overall budget. Thus, the top-down approach in budgeting should not be confused with an operating budget; instead, it's a method used in the formation of such budgets.

How does top-down budgeting work?

Let's look at how top-down budgeting works within an organization.

Budget allocations to departments

To start the top-down budgeting process, senior leadership meets to discuss and identify corporate objectives for the year ahead – with a focus on sales, expenses, and profits.

Then, based on past performance as well as anticipated future trends and market conditions, the leadership team allocates a budget to each department.

Departmental allocations can be based on the team’s contribution to the organization in the previous year, as well as anticipated contributions. This comprehensive approach ensures that departmental budgets align with both past performance and future expectations, optimizing resource allocation across the organization.

Department-level budgets

After budget allocations have been shared with each team, departments are responsible for creating their own budget. Each department must consider their goals and how they align with the corporate objectives identified by leadership and allocate their resources accordingly.

In the top-down budgeting process, departments generally operate independently to create their budgets. This ensures that each department is focused on achieving its individual targets while contributing to overall organizational success.

Alignment of department-level budgets

The final step in the top-down budgeting process is the alignment of department-level budgets. After each department has had a chance to prepare their budget, they are shared back with the finance team to ensure they align with the budget structure set by senior leadership.

Once finance has approved each department budget, the top-down budget is finalized. This comprehensive review ensures financial alignment across the organization, so that all departments are working towards the company's broader financial objectives. 

What are the advantages of top-down budgeting?

There are plenty of reasons why a company might want to take a top-down budgeting approach.

Top-down budgets are functional

Top-down budgets align with the company's strategic objectives. This alignment not only makes them functional but also ensures that they serve as effective tools for financial planning.

Through this approach, management can strategically allocate budgets to departments that have a significant impact on growth. This strategic allocation can amplify efficiency and productivity, solidifying the advantages of the top-down budgeting approach.

Top-down budgets save time

Since top-down budgets are prepared by management, often without input from department leaders, this can save a significant amount of time for middle managers.

Rather than create a budget from scratch, team leaders can use the top-down budget to set their targets for the year.

This makes the process substantially more efficient and quicker compared to the bottom-up approach, enhancing productivity and allowing for a more streamlined budgeting process.

Top-down budgets streamline budgeting

While other corporate budgeting methods require each department to assemble their own budget for further review and consolidation by the finance team, top-down budgeting operates differently. This approach empowers team leaders with pre-determined resource allocations.

This method significantly reduces the back-and-forth usually involved in budget creation and approval processes. As a result, top-down budgeting streamlines the process, making it more efficient and less time-consuming.

What are the disadvantages of top-down budgeting?

There are limitations and drawbacks to top-down budgeting too. Let’s take a look at a few.

Top-down budgets are not collaborative

Top-down budgeting relies primarily on input from executives, rather than managers and individual contributors. As a result, departments can feel like they have little say in the resources they’ve been allocated or the targets they’re held to, which can decrease the incentive to participate in the process.

Top-down budgets may not be realistic

Since top-down budgets are prepared by leadership, they can be removed from the day-to-day operations of the business. It may be difficult for department managers to effectively implement a top-down budget, especially if they don’t understand how the targets were determined.

Top-down budgets are high-level

Another downside of top-down budgets is that they may lack the necessary details to action the budget. Since top-down budgets are traditionally focused on company goals, rather than department targets, it can be hard to translate these high-level objectives into actionable items for team leaders. This lack of granularity can make it difficult for teams to align their actions with the broader company objectives.

An 8-step top-down budgeting process

Do you want to know what it takes to create a top-down budget? We’ve outlined it in 8 steps:

1. Set objectives: Senior leadership establishes the overall goals and objectives for the upcoming budget period. .
   
2. Budget formulation: Executives or senior management develop a high-level budget that aligns with the company's strategic goals..
   
3. Allocation to departments: The high-level budget is broken down, and resources are allocated to each department based on the company's priorities and objectives..
   
4. Departmental review: Department heads review the allocated budget and plan how to use these resources to achieve their departmental goals..
   
5. Feedback and adjustments: Departmental leaders provide feedback to senior management about the allocated budget. If necessary, adjustments are made to better align with departmental realities..
   
6. Finalization: The adjusted budgets are finalized and consolidated into one master budget..
   
7. Approval: The master budget is reviewed and approved by the board of directors or senior leadership.
   
8. Implementation and monitoring: The approved budget is communicated back to the departments for implementation. Throughout the budget period, actual results are compared with the budget estimates, and adjustments are made as necessary.

The role of top-down budgeting in modern FP&A teams

Top-down budgeting can be incredibly beneficial for modern FP&A teams who are looking to align departmental activities with broader strategic goals, streamline decision-making processes, and ensure resource allocation is in line with overall business objectives.

Modern FP&A teams can champion top-down budgeting by working closely with senior management, communicating high-level targets to departments, and creating feedback loops to ensure alignment.

This top-down approach strengthens the link between strategic planning and operational activities, enhancing the role of the FP&A team as effective strategic partners. It also provides a level of control and consistency in budgeting, allowing for an organization-wide perspective instead of fragmented departmental views - a crucial aspect in today's complex and interconnected business environment.

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

Conclusion: Effective top-down budgeting with Prophix 

Top-down budgeting is a strategic approach that aligns departmental activities with overarching business objectives. It's a method that can streamline decision-making processes and ensure efficient resource allocation. Despite its potential disadvantages, with effective implementation using a platform like Prophix, and by embracing a culture of communication and feedback, it can significantly enhance the role of FP&A teams as key drivers in an organization's financial planning strategy.

Want to see how top-down budgeting measures up to other approaches? Read Bottom-up budgeting: everything you need to know.