Bottom-up budgeting, also known as participative budgeting, is a process that involves management from every department within a company. The collaborative effort makes use of the specialized knowledge held by departmental employees to construct a detailed and meaningful company financial budget. This directly contrasts with top-down budgeting, in which senior management creates a higher-level budget and enforces it from above the department level.
Bottom-Up Budgeting Defined
A bottom-up budget is typically constructed in the format of an income statement, and it's an estimate of the current year's business targets for revenue (where applicable) and expenses based on averages of last year's performance or current amounts, such as current building rent. The bottom-up part means a budget that's been developed at a granular level by each department within a company.
Each department formulates its own projections of sales revenue and expenses. Alternatively, some companies may develop a bottom-up budget based on each project the business chooses to take on for the year. Upon completion, each detailed departmental budget is consolidated into a master budget for the entire company. Some firms may also assemble a top-down budget as a check, compare this to their bottom-up budget and make adjustments so that the budgets meet in the middle.
Advantages of the Bottom-Up Method
Bottom-up budgets are typically very accurate because each department uses its specialized knowledge to create the individual line items of its budget. This type of budgeting process improves company morale and employee motivation since the whole team gets involved in formulating the budget and takes more ownership over achieving budgeted targets.
Some departments have budgets that depend partially on activities in another part of the company, and communication often improves as teams work together to set their interrelated targets. The budgeting process also helps management gain a deeper understanding and commitment to the business goals.
Departments can become guilty of over-budgeting, getting too buried in detail and trying to budget for every single staple and pencil. As each department manager formulates their own budget, there's a tendency to add a little bit of cushion in case the group has any trouble hitting its budget numbers. If every department pads its budget, the cumulative effect can have a significant and negative effect on the consolidated budget.
Additionally, a department may set budget targets that are too easily achievable, and inexperienced managers could make poor decisions when estimating and calculating budget numbers. The budgeting process may also take significantly longer because of all the people and departments involved.
Aside from any disadvantages, a bottom-up budget typically has much higher-quality information than a top-down budget because the employees who work with the data every day are the same ones creating the numbers. The employees share what they know best while giving senior management the freedom to focus on higher-level business planning and strategy for the company.