Most of us are familiar with the word “budgeting”. More likely we have done budgeting in some ways in our business or personal life. It can be as simple as making a plan of your next holiday trip. Or make a plan based on your personal income and expense level to see whether you can afford to start a business.
However, as the Business grows, the streams of income and expenses grow over time, the process of budgeting can prove to be daunting. When business grows, it is an evolving process from simple operation into multi-regional, multi-departmental collaboration. It is this multi-dimensional aspect, which makes the budgeting process more complex and challenging for larger operations. Being a blog for a lot of start up audience here. We will introduce some of the basic concepts about budgeting in three blogs.
In short, the budget is the financial plan made by the management considering internal and external factors of an organisation, which intends to figure out expected operations revenue and expenses of an organization for a future time period. With a view to control the cost and maximise the profit.
There are two types of Budget Approach: Top Down and Bottom Up
Top Down Approach:
Top Executive Management usually prepares the budget initially according to the companies’ goals and objectives and then pass the budget with other relevant instructions to the operational managers for implementation. Often, the Top Management will seek the opinions and suggestions from Department Managers before the budget finalisation.
This approach to budget is considered more driven by company’s long-term goals as the Management is responsible to decide how much revenues and profits they are looking for. Hence, they can give a clearer view on how much marketing and selling needs to be done. It is ideally quicker to finalise since there are less department managers involved in the decision making.
The downside is the divisional and department managers may lack motivation while taking this budget forward, if they feel the budget is with too optimistic, the goal is too difficult to achieve.
Bottom Up Approach:
The Divisional Managers are given the opportunity to prepare business unit or department wise budgets. They will fill up some provided templates that includes their need for resources and what is possible in terms of the revenues to support the business goals. Finance Department then consolidates divisional budgets into a group or company wide budget. HR department will usually provide headcounts for each division in order to support the next period growth. Then Financial team will perform the budget modelling and submit that for Management’s approval. Then this is passed onto top executive to approve before finalisation. The middle level managers often have better knowledge than the top executives on detailed operation, which equip them with the right insight to identify irregularities and seasonal variations where applicable. And could lead to a more accurate achievable target.
One of the major benefits of a bottom up approach is that it involves divisional managers into decision making, which is an important element of employee empowerment. This gives the managers a sense of ownership, in turn they may work harder to motivate their respective team members to achieve the goal. The downside of bottom up approach is that this may take up more resources from the operational team.
Top Down vs Bottom Up, which one is better?
Both approaches here have its merits and shortcomings. Which one to be used really depends on the business situation.
For example, in a smaller organisation, where departmental managers may have multiple hats across different departments, they may see a bottom up budget as an added burden to their very busy schedule. So, they would more be inclined to come up with a shortcut to save their time. Also arguably, the top executives in a small firm often have the best knowledge on all aspects of the business, a top down approach can well serve the business, and with benefits of timesaving comparing to a bottom up approach.
And if we flip the coin, in a larger organisation, it may be beneficial to introduce the bottom up approach for the facts listed earlier. In addition, this also creates an opportunity to coach and nourish the middle managers with the essential skills to become the possible successors of more senior executives. However, if you have a fast growing business with relatively young inexperienced middle management team, a bottom up approach may not be feasible.
Find hard to decide? A professional business consultant can here to help you make the right assessment, review your current business operation and team competence, and design the budget process best fit for your organisation.