As long as there has been budgeting there has been debate about whether Top down or Bottom up is the best approach. As consultants it is probably the most common conversation we have with our customers. Both have their pro’s and con’s, but, until now, they have also been mutually exclusive.
Defining top down
So, let’s be clear about each option. Top down budgeting is driven from the centre, and “dictates” to the business. The CFO and/or the CEO will decide what the high-level budget for the year should be. This will be based on an overall knowledge of the business, historic performance and, often crucially, the expectations of investors. If investors expect that a well performing business in this market should have an EDITDA of 7%, and turnover growth of 5%, then the CFO can build a high-level budget to achieve this. This can then be cascaded down to divisions and cost centres. The individual department budget is driven from the top, down to the lower levels – hence the name.
A Top down budget ensures that market and board expectations are clearly expressed and are the target for the business to hit. Of course, the downside is that for the managers who must meet this budget, the psychology is rather negative. They feel that the budget has been dictated to them and the will feel a very low level of ownership of the target. If the actual results fall short, they will quickly simply blame the unrealistic budget, rather than feel a commitment to deliver it.
The meaning of Bottom Up
Conversely, a Bottom up budget is build up from each department and division setting their budget, and the results being aggregated to give a high-level result. Department managers are intimately involved in setting the budget, and therefore have a high-level of ownership. Their willingness to meet the budget, to “keep their word” will be high. However, the high-level result may not meet the expectations of the Board and investors. Its human nature to build in a little slack when setting a target that must be met. Words like “sandbagging” or “low-balling” are common when allowing managers to set their own target, and not without good reason.
Of course, in a perfect world, a CFO would want the buy in and commitment of a bottom up approach but would go through a few budget iterations to weed out the slack and reach the expected high-level result. In the real world this is often not possible because the time it takes to create new iterations is prohibitive. Three months budget cycles are common – adding a couple more budget passes to that simply takes too long.
The best of both worlds
Until now this has been an insoluble issue. But we now have a solution – do both! We have built several models for customers who start with a high-level Top down budget as a guide. This is highly driver based, taking major market and business parameters to construct many different scenarios. Once the best of these is determined, the model then switches to a Bottom up approach, using the high-level result as a guideline to ensure an “honest” target is set.
This gives the best of both worlds. The CFO doesn’t spend weeks producing a budget that they know is unpalatable to investors. The managers are directly involved in setting their own numbers, against a backdrop of understanding the expectation. We’ve seen this work in customers as diverse as tech giant ARM and pharmaceutical wizards Immunocore.
Time on your hands
So why hasn’t this simple solution been tried before. The answer is simply time. Typically, business’ budget on Excel, and it isn’t possible to produce a budget versions fast enough in Excel. Using a modern cloud-based alternative, such as Adaptive Insights, the time to create a budget reduces dramatically. Our customers frequently report that it takes 80% less time or better. The budget becomes all about the content, not the logistical production. "What-if" scenarios can be planned in minutes not days and weeks.
Maybe it’s time for you to have the best of both worlds. Top down and bottom up, and all in less time than it takes you now. Budgets and Forecasts are too important to compromise.
WANT TO KNOW MORE?
Read the Christian Aid, case study and discover how the charity enabled the whole company to contribute in the budgeting process.