1. Methodology and Example
2. Differences Between Top-Down and Bottom-Up Budgeting
3. The Pros and Cons of Bottom-Up Budgeting

The bottom-up budgeting definition describes it as a budgeting method in which each department within an organization makes a list of things it needs and projects that it plans to embark on, then proceeds to estimate the cost of each individual project. When all projects in all departments are listed, the costs are added together, and the result is the company budget.

It is used by many economists, analysts, and managers and relies on the idea that the best way to correctly estimate a large budget is by calculating the individual cost of every necessary component, then adding them all up for the grand total.

Methodology and Example

When forecasting the budget for capital, corporate expenses, or revenue, this form of budgeting implies first calculating the budget figures for the lower hierarchies, then adding them up and therefore estimating the necessary budget numbers for the level immediately above, and so on.

A good example of how bottom-up budgeting works is in calculating future sales estimates for a specific period of time. Doing it from the bottom up implies first calculating the individual estimate for each product and component. Then you can jump to the next level by calculating sales forecasts for a specific region, sales channel, or a section based on the type of people or companies you intend to advertise your products to.

This approach basically would mean starting from the individual product estimate and then working your way up, depending on the approach. If, for example, you are using a geographic region, you can calculate the budget for smaller regions by adding up the estimated revenues from the products that would be sold there, then adding more subregions to reach the budget for one large region.

Differences Between Top-Down and Bottom-Up Budgeting

Top-down and bottom-up budgeting are the main ways to calculate a budget and are basically opposite approaches. They are often done simultaneously in order to check each other for accuracy. Here are the areas where they're most applied:

  • Budgeting – The top-down approach when it comes to corporate budgeting means first estimating the overall budget for the entire company, then working your way down. The bottom-up approach implies that each department creates spending estimates, listing each individual forecasted expense. Then they are added up and all of them are put together to form the company budget. Usually, the bottom- up method produces a higher estimated budget, and a compromise is reached to keep the budget as low as possible without affecting vital purchases.
  • Setting company goals – Similar to budgeting, the top-down method means setting overall company goals, while the bottom-up method implies setting individual goals for each department. Similarly, a compromise must be reached, because the bottom-up method usually overestimates the necessary budget and number of employees necessary to reach the company's goals.
  • Sales forecasting – Using a top-down method, sales are forecast by first analyzing large categories of products or services, and then gradually breaking them into various categories, all the way to individual components. The bottom-up approach first estimates the individual cost and then works its way up, depending on the desired approach (geographical, based on customer type, etc.)
  • Macroeconomic forecasting – At the state/national level, top-down methodology implies projecting a broad indicator, such as the GDP, and gradually going down the ladder, while the bottom-up approach means starting with individual people or business and gradually reaching a GDP estimate.

The Pros and Cons of Bottom-Up Budgeting

The main advantages of bottom-up budgeting are accuracy and accountability. That means that being calculated from basic levels, it is very likely to result in a number that's as close to reality as possible. It also means that, given that everyone in the company participates, tracking ownership of each figure is a realistic endeavor.

On the other hand, this type of calculation usually results in department managers overestimating what they need, out of fear they won't be able to meet their objectives. Other downsides are an increased pressure on employees to deliver results based on their own projection, but also the high chance of human error, or the overall speed of the entire process.

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