A process in which a company’s senior (top-level) management is involved in the preparation of a high-level budget is termed “Top-down budgeting”.
This type of budget is prepared based on the company’s objectives after which it passes on to 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 preparation of the budget however they are allowed to give their suggestions at senior management’s discretion regarding whether or not to use their contributions.
Since lower management does not get the opportunity to participate in the budgeting process, this type of budget may be viewed as dictatorial.
Due to this, such a budgeting process is also termed an “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 a 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 required in the budget preparation.
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 on 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 they will have to implement this budget once finalized so their point of view during 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.
- Managers of all departments then have to set their targets and develop their budgets, once the finance department assigns allocations to various departments.
- Each department within the company is then required to submit its budgets to the finance department for harmonization, first consolidating different departments’ budgets and then assessing them critically to ensure they are parallel to the company’s overall objectives.
- 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, suppose the manager of one department has made a good case for his cost allocation being insufficient for him to meet revenue goals. In that case, that department’s allocation may be adjusted with a corresponding decrease in other departments’ 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 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 every month.
Advantages of Top-down budgeting:
- Rather than wasting the time 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 its budget and then combine them later. Hence, it is less tedious since senior management formulates only one budget that 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 participate in the budget preparation 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 actuality they do not have any idea and are completely unaware of the expenses detail of each department, 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 staff feel demotivated and dejected as their input is not valued in the budget preparation. They may view it as being forcibly imposed on them to implement it.
- Directors and department heads who disagree 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.