What Is Bottom-Up Budgeting and Forecasting?

Definition & Examples of Bottom-Up Budgeting and Forecasting

Budget manager sitting at a desk
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Bottom-up budgeting and forecasting gathers estimates for each segment or department of a budget or forecast, then adds them up to reach the total. It's the opposite of top-down budgeting or forecasting, which begins with a total amount and distributes it among categories.

Learn more about the pros and cons of bottom-up budgeting and forecasting.

What Is Bottom-Up Budgeting and Forecasting?

Bottom-up budgeting and forecasting begin with detailed estimates for individual categories, then combine them, repeating the process for each level of hierarchy. For instance, with bottom-up budgeting, budget estimates are commissioned from every division, department, or business unit individually, then combined to arrive at the total budget amount for the whole organization.

Bottom-up methodologies may be used by economists, econometricians, management scientists, financial analysts, budget analysts, securities analysts, chief financial officers (CFOs), and controllers, among others.

  • Alternate names: Participative budgeting, participatory budgeting

How Does Bottom-Up Budgeting and Forecasting Work?

In the production of corporate expense budgets, revenue budgets, and capital budgets, a bottom-up approach would involve first setting them at the most detailed level of each management reporting line item for each unit or department within the management reporting hierarchy.

Under this approach, the aggregate budgets at each higher level of a hierarchy would be produced by adding the budgets at the level immediately below.

For example, a department's headcount budget would begin at the bottom of the hierarchy, determining precise salary and bonus forecasts for each individual projected to be on staff (allowing for exactly when new hires are expected to be added). Then they would drive employee benefits expense off these pay figures, and perhaps also occupancy charges, based on standard square footage assumptions per employee (while adjusting for differences in office space related to rank, job title, or salary grade).

The total would be calculated for each department. Then each department's headcount budget would be aggregated together to find the company's total budget for headcount.

With bottom-up budgeting, each department is responsible for assisting in the budgeting process. Budget allocations may be tied to business objectives or product life cycles as well.

Bottom-up processes often are used simultaneously with top-down processes, operating as checks upon each other.

Forecasting

A bottom-up approach to sales forecasting produces estimates for each specific product or component, and possibly also for other dimensions such as sales channel, geographic region, customer type, or specific customer.

The forecasts for broader classes of products or components, as well as for broader aggregates of sales channels, geographic regions, customer types, and customer categories, would be produced by combining the forecasts already made at more specific levels.

Pros and Cons of Bottom-Up Budgeting and Forecasting

Pros
  • Specific

  • Accurate

  • Can improve morale

Cons
  • Errors can compound

  • Can influence overspending

Pros Explained

  • Specific: A bottom-up approach forces attention to detail regarding expenditure, output, and revenue, which is necessary to plan and manage the activities of business units.
  • Accurate: Because the process is begun at the bottom, such a granular approach tends to be accurate regarding each department's needs.
  • Can improve morale: When departments are asked, not told, what the budget should be, it's clear that their opinions are taken into account, which can improve morale.

Cons Explained

  • Errors can compound: In some cases, projection errors made at more specific levels can compound during the process of adding up the more detailed forecasts and estimates. This is particularly true if the projection errors at the more detailed levels tend to go in one direction (that is, all towards over- or underestimates).
  • Can influence overspending: Some line managers may register needs for more resources than are necessary while committing to less revenue and profit generation than they should be able to produce. Such gamesmanship increases the odds that they will exceed goals and thus be rewarded accordingly. Likewise, in sales forecasting sales teams and product managers may enter lowball estimates for the same reasons.

Key Takeaways

  • Bottom-up budgeting and forecasting gathers estimates for each category or division of the budget or forecast and then totals them up to find the result.
  • The bottom-up approach emphasizes detailed analysis of each individual component before viewing the aggregate as a whole.
  • Bottom-up budgeting and forecasting can be combined with top-down methods to act as checks and balances on financial assumptions or judgments.

Article Sources

  1. Principles of Accounting. "Budget Processes and Human Behavior." Accessed Sept. 18, 2020.