A process in which senior (top-level) management of a company is involved in the preparation of a high-level budget is termed “Top-down budgeting”.
This type of budget is prepared on the basis of the company’s objectives after which it passes on the managers of different individual departments or functions for its implementation.
Managers of the departments/functions are not invited to give their input during the process of preparation of budget however they are allowed to give their suggestions which are then at senior management’s discretion whether or not to use their contributions.
Since lower management does not get the opportunity to take a part in the budgeting process so this type of budget may be viewed as of dictatorial standard and owing to this, such budgeting process is also termed as “authoritative” or “non-participative” budget.
This type of budgeting process is useful for those organizations;
- which are newly formed,
- whose business is not spread at large scale,
- where the lower management themselves are not interested in the process of making a budget or who are not technically capable so that they are included in the budget preparation process? And,
- where only the senior management level has access to the information which is required in the preparation of budget.
Process of Top-down Budgeting:
- The top-down budgeting process begins with senior management meetings that come up with the objectives for the year. They decide high-level targets for the company in terms of sales, expenses, and profits.
- They use the previous year’s financial statements and budget as a benchmark for making allocations to different departments so if any department was responsible for 20% of the operating expenses last year, it will likely see a budget target of 20% of the total operating expenses approved for this department in the high-level budget for the current year as well.
- Senior management may take suggestions from lower-level managers of different departments because it is them who will have to implement this budget once finalized so their point of view during the preparation of the budget process must also be taken and considered.
- Prevailing economic conditions, amendments in tax laws, an increase/decrease in salary costs, and other internal and external factors must be considered during the budgeting process.
- The finance department then allocates the budget to different departments of the company. They may use the previous year’s figures to split the allocations.
- It is then the duty of managers of all departments to set their targets and develop their own budgets, once the finance department assigns allocations to various departments.
- Each department within the company is then required to submit their budgets to the finance department for harmonization who first consolidate different departments’ budgets and then assess them critically to make sure that they are parallel to the overall objectives of the company.
- If there are departments with less or excess budgets, the finance department may send the budgets back for alteration after assessment, and the allocations may then be adjusted. For example, if the manager of one department has made a good case for his cost allocation being insufficient for him to meet revenue goals, that department’s allocation may be adjusted with a corresponding decrease in other department’s allowed expenses.
- The newly prepared incremental budget is loaded onto the financial system to track monthly expenditures once the department budgets are finalized unanimously by both senior and low-level management.
- Information related to the progress towards revenue goals of each department is received along with the corresponding details of expenses they have utilized and how much they were allowed to utilize. All this information is received on a monthly basis.
Advantages of Top-down budgeting:
- Rather than wasting the time in creating a budget from the start, lower-level managers are given an already-formulated budget for implementation. Both time and resources can be saved that the managers would’ve had to use to prepare the budget. Top-down budgeting saves time for lower management.
- Under top-down budgeting, management creates a single budget, instead of allowing each department to create their own budget and then combine them later. Hence, it is a less tedious approach since senior management formulates only one budget which other departments have to follow. Hence top-down budgeting is a quicker and speedy process than bottom-up budgeting.
- Top-down budgeting helps to overcome interdepartmental issues since only senior management takes the overall responsibility of preparing the budget.
- Top-down budgeting focuses more on the overall growth of the organization.
- This budgeting process allows senior management to keep full financial control over the budget and resources.
Disadvantages of Top-down Budgeting:
- Managers who are made responsible for the implementation of this budget are not invited to give their opinion in the budget-making process hence the level of motivation of these lower managers decreases. The managers were not allowed to take part in the preparation of the budget and may, therefore, lack incentive to ensure its successful implementation.
- In the day-to-day operations of individual departments senior management is not involved, hence in actual they do not have any idea and are completely unaware of the expenses detail of each department and therefore, it becomes extremely difficult for the lower management in the implementation phase of the budget since they are completely oblivious what senior management has determined and on which basis, they have set the targets. There may also be the possibility that the budget prepared by the top-level management may not be based on logical calculations which may lead to over and under allocation of the resources.
- In this budgeting approach, most of the staff feel demotivated and dejected as their input is not valued in the process of preparation of the budget and they may view it as being forcibly imposed on them to implement it.
- Directors and department heads who are in disagreements with senior-level management over financial issues may cause a disturbance in the workplace which may lead to inefficiency and poor performance of the employees and subsequently expose the company to the risk of non-achievement of targets and objectives.