Top-Down Budgeting: Definition, Process & Advantages
In top-down budgeting, a company's high-level targets and goals are defined by senior management, and then managers are given an allocation from those targets. In this lesson, we'll discuss why companies use this method and how the process works.
What Is Top-Down Budgeting?
Top-down budgeting is a budgeting method in which senior management develops a high-level budget for the company. Once the top-level numbers are created, amounts are allocated to individual functions or departments that must create a detailed budget with their allocation.
Process For Top-Down Budgeting
Let's say you are a manager in an organization that follows a top-down budgeting process. Here's how the process would work from your point of view:
- Senior management meets and determines high-level targets for the company for sales, expenses, and profits. You would not be included in this meeting; instead, only senior management would gather in a room and come up with the overall objectives for the year.
- Then the finance department takes the approved totals and allocates them out by department. They will likely use percentages from prior years to do this split - so if your department was responsible for 20% of the operating expenses last year, you will likely see a budget target of 20% of the total operating expenses approved for your department in the high-level budget.
- Next, each department manager is asked to take his or her allocation and develop a detailed budget to match it. This will be your job - taking the total revenue and cost figures you've received, and developing a detailed budget showing how your department will generate the revenues assigned and what you'll spend the cost dollars on to generate those revenues. This detailed budget will include specifics like the quantity of different products sold, the number and type of staff required, and detailed expenses by category (such as office supplies, equipment, and payroll).
- All of the detailed budgets are then submitted back to the finance department, which consolidates them to make sure the overall objectives have been met. You may receive your budget back for revision: for example, if another department manager made a good case for her cost allocation being insufficient for her to meet revenue goals, that department's allocation may be adjusted - with a corresponding decrease in your allowed expenses.
- Once all of the detailed budgets are finalized, the whole thing is loaded into the financial system, and monthly reports are generated comparing actual activity to the detailed budgets. You'll receive information each month showing your progress toward revenue goals and the amount of your allowed expenses you've utilized to date.
Advantages Of Top-Down Budgeting
The greatest advantage of top-down budgeting is that the overall business plan ties to senior management's objectives and that management determines that the appropriate resources are utilized to meet those objectives.
Top-down budgets also tend to focus management's attention on efficiency, since they receive a total and must figure out how to achieve their department's business objectives within that amount.
Disadvantages Of Top-Down Budgeting
Top-down budgeting has a downside as well. Since the budget is developed at a high level, the details necessary to implement the big picture are not addressed. When a manager receives his allocation, it may not be sufficient to provide the outputs needed toward the big company goals. Changing an allocation for one department will impact others as well, since the resources will have to come from another area for the total budget to tie in with the approved amounts.
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