Individuals, small companies and corporations mainly use one of two budgeting techniques – bottom-up or top-down budgeting. Bottom-up budgeting starts from the lowest level in an organization and works its way up to formulate a budget. The top-down budgeting process starts from management and works down to lower-level units. Advantages and disadvantages exist for both top-down and bottom-up budgeting processes.
Appropriately named, the bottom-up budgeting process starts with the smallest components of an organization, usually lower-level individual projects, to collectively create a budget for the organization. To begin the bottom-up budgeting process, you must look at the steps needed to carry out an individual project and associate a cost to each step. You may need to perform market research to determine costs if you haven’t previously completed a similar project within your organization.
Next, you will need to add up the cost for each project to come up with the total. You must do this for every level of the organization. You will need the input of managers on each level, so that you are aware of the cost of the projects under their supervision. To come up with an annual budget, you simply add up all of the monthly budgets for the year.
An advantage of using the bottom-up budgeting technique is that you can accurately plan every phase of a project. Bottom-up budgeting typically involves individuals of multiple levels within an organization, which is an advantage for most companies because it builds employee morale. A disadvantage of bottom-up budgeting is that it is easy to over-budget, which means that lower-level participants may ask management for more money than is actually needed. Another disadvantage of bottom-up budgeting is that it’s easy to miss a step in the process, which can cause you to miscalculate your budget requirements.
Although bottom-up budgeting is more common, some companies and governmental agencies are abandoning traditional budgeting methods to implement the top-down process. Top-down budgeting starts the process by estimating the cost of higher-level tasks within an organization. The budgets are prepared by management, and lower-level staff do not have much input in the process. Management sets the guidelines for the budgeting process, and guidelines are potentially based on projected sales or expenditure levels.
An advantage of the top-down budgeting process is that it can establish organizational principles. For example, if management has budgeted for a certain amount of sales, it will encourage the employees to perform in a way that goals are met. A disadvantage of the top-down budgeting process is that lower-level employees are usually excluded from the process, which can make them feel like a budget is imposed upon them against their will. This has the potential to weaken employee morale.