What’s the best organizational approach to budgeting? Most executives would answer: the one that works best. There are three effective approaches to developing budgets.
Top-Down
In this approach, budgets are prepared by top management and imposed on the lower layers of the organization, generally without any consultation or involvement of the lower layers. Top-down budgets clearly express the corporate strategies and expectations of top management. These budgets, however, are often unrealistic because they do not incorporate the input of the very individuals who will be responsible for implementing them.
Bottom-Up
Most organizations use the bottom-up approach. In bottom-up budgeting, supervisors and middle managers are asked to prepare the budgets and then forward them up the chain of command for review and approval. Because middle managers and those first-line managers who report to them have a clear view of the organization and its financial performance, bottom-up budgets tend to be more accurate than top-down budgets.
Bottom-up budgets can also have a positive impact on employee morale, because employees assume an active role in the process.
Zero-Based Budgeting
In this process, each manager prepares estimates of proposed expenses for a period of time as though the plan was being performed for the first time. In other words, each activity starts from a budget base of zero. By starting from scratch at each budget cycle, managers are required to take a close look at all their expenses and justify them to top management, thereby minimizing unnecessary expenses.
The zero-based budget is based on the assumption that managers will spend money if allocated to them, whether it’s necessary or not.