Top-down budgeting is a crucial method of preparing a budget for an organization or a company. Under this method, the senior management prepares a high-level budget on the basis of the company’s objectives. The top management then allocates the amounts for the individual departments, who use those numbers to prepare their own budget.
For the top-down budget, the top management uses past experiences and the current market scenario, including margin pressure, competition, tax legislation, macroeconomic conditions and more.
Also, the management uses past years budget and financial statements as a reference for making an allocation to various departments. Additionally, senior management may also use input from lower-level managers. For instance, if any department accounted for 20% of the overall expenditure last year, then this year it would be allocated 20% of the funds. Any adjustments to these numbers will be based on the input from the managers or the current market scenario.
Process of TOP-DOWN BUDGETING
The top-level management will meet to decide on the targets for sales, expenses, and profits. Next, the finance department will allocate these targets to other business departments. After this, each department prepares its own budget.
Each department will then come up with a detailed budget, indicating how it will hit the revenue target and at what cost. For instance, the number of products they will sell, how much staff they will need, and more.
All such detailed budgets from the individual departments are then sent back to the finance department. The finance department then approves them if they are in-line with the overall objectives of the company. The finance department may also ask for some revisions if they believe the department’s budget is deviating from the set goals.
After the finance department finalizes all the things, the budgets are put in the system. Going forward, monthly reports are generated to compare the actual results from the planned ones.
- Such type of budget focuses on the overall growth of the organization.
- It makes departments aware of what the top management expects from them.
- It is a quick way of preparing a budget and helps to overcome interdepartmental issues.
- Saves time for lower management as well. Rather than preparing the budget from scratch, each department gets a set goal. This saves both time and resources.
- Under top-down budgeting, management creates only one budget, rather than allowing the department to create their own budget and combine them later. Hence, it is a less tedious approach.
- Since managers are not part of the budget-making process, they may not feel much motivation to ensure their success.
- Since senior managers are not much aware of the day-to-day operations of the departments, they may set unrealistic targets. This results in lower-level managers finding it difficult to meet the set numbers.
- Such type of budgeting may often lead to over or under allocation of resources.