Should Financial Professional Analysts Look Top-Down or Bottom Up?

Should Financial Professional Analysts Look Top-Down or Bottom Up?

Brian Kalish 12/04/2018 FP&A 6

While “top-down” or “bottom-up” sound like some lively toasts you might hear in an English pub, they are also two of the most common ways to prepare a financial forecast. In that area, there is great debate as to which method is “better.” As with most questions in life, the initial answer is usually, “it depends,” so let’s look at the pros and cons of each approach. At the end of the day, there is no single answer. As a global FP&A professional, you will have to determine the best approach for your organization.

What is Top-Down Planning?

Top-down is a process based on estimating the cost of higher-level tasks first and using these estimates to constrain estimates for lower-level tasks. A crucial factor for successfully implementing this method for estimating is the experience and judgment of those involved in producing the overall estimate.

The major characteristics of the top-down approach include the following:

  • It usually takes less time to prepare
  • By definition, there is buy-in from upper-level management
  • It doesn’t require multi-level participation
  • Lower-level management usually has a better understanding of what upper-management expects
  • The results are presented down the chain of command

The Pros and Cons of a Top-Down Approach

There are many advantages to this methodology:

  • In the aggregate, it is quite accurate, even though some individual activities are subject to error
  • This process produces stability and high predictability
  • Low-cost activities don’t need to be identified early in this process; they are factored into the overall estimates
  • It can be accomplished in a relatively short time

As with everything in life, there are many perceived disadvantages to implementing a top-down approach.

  • Translating long-range estimates into short-range estimates can be challenging
  • Top management’s limited knowledge of scope and scale of downstream activities can lead to underestimation of costs
  • It can foster an unhealthy competition for funds among lower-level management trying to secure adequate funding for their operations
  • The process is a zero-sum game; one area’s gain is another area’s loss
  • Subordinate managers can often feel that they lack sufficient resources (time, people, money, technology) to achieve their assigned objectives

A Quick Definition of Bottom-up Methodology

The bottom-up methodology is sometimes referred to as zero-based budgeting (ZBB). We will be addressing ZBB in a future article in much greater detail. But to start, bottom-up begins with identifying all the constituent tasks that are involved in implementing a project and working out the resources (time, people, technology) and funding required by each. It provides the opportunity to create organization-level budgets by rolling up project budgets and creates centralized project-level budgets from their sub-project budgets. It also provides project managers with the flexibility to define the project budgets independently, and FP&A managers can centrally review the total project budget(s). The main characteristics of the bottom-up approach include the following:

  • It’s more time-consuming and involves the entire cross-section of the organization
  • The results are presented up the chain of command
  • It incorporates participation at all levels of the organization
  • It encourages commitment to the plan

The Pros and Cons of a Bottom-up Approach

The advantages of this methodology include the following:

  • You obtain a higher degree of accuracy
  • There is a clear flow of information
  • Use of detailed data available at the core level is the basic source of cost, schedule, and resource requirement information
  • With the higher level of participation, this process can lead to a higher degree of ownership and acceptance

Of course, there are a number of potential disadvantages to a bottom-up process, as well. For example:

  • Senior management has limited influence over the process
  • Business managers can overstate their resource needs because they believe upper management will reduce their requests
  • Politics and persuasiveness can have a disproportionate impact
  • A significant portion of budget-building is left in the hands of junior personnel
  • Critical activities can be missed and left unbudgeted

Budgeting can be a frustrating process, but both top-down and bottom-up processes can work well, without excessive effort. It should be an important resource allocation tool to help senior management prioritize the most important initiatives to invest in.

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  • Rafael Louise

    Top down is all about momentum and short-term gains.

  • James Derriman

    There is no single approach that’s right for all financial professionals and the decision between top-down or bottom-up is largely a matter of personal preference.

  • Paula Cameron

    I prefer the combinaison of both.

  • Mandi Lee

    The key to successfully using these techniques is identifying the correct criteria and analyzing them in a wider context.

  • Harry Walker

    There are many ways to combine the two approaches.

  • Sam Morgan

    It’s much harder to get huge projections with bottom-up forecasting.

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Brian Kalish

Finance Guru

Brian is Founder and Principal at Kalish Consulting. He is Former Executive Director – Global FP&A Practice at AFP. He has over 20 years of experience in Finance, FP&A, Treasury and Investor Relations. He previously held a number of treasury and finance positions with the FHLB, Washington Mutual/JP Morgan, NRUCFC, Fifth Third and Fannie Mae. He has spoken all over the world to audiences both large and small hosting FP&A Roundtable meetings in North America, Europe, Asia and soon South America. Brian attended Georgia Tech, in Atlanta, GA for his undergraduate studies in Business and the Pamplin College of Business at Virginia Tech for his graduate work. In 2014, Brian was awarded the Global Certified Corporate FP&A Professional designation.

   

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