Budget Processes, Mandated Approach or Participative Approach

What did you think of when you hear the word "budget"? A budget is a detailed and quantified financial plan for the future expectations or actions of individuals or organizations. It is usually relative to how an individual or organization uses their limited resources. Budgeting is probably the word we don't want to talk about because we don't want to be restricted financially. It makes us feel like we do not have the freedom to do something or to do what we want. However, it can prevent overestimation and understand we cannot do things beyond our control. Although the process of evaluating a budget may seem painful for most people and organizations, we still have to plan and make decisions largely on the basis of it. Moreover, it also provides benchmarks for organizations to evaluate the results of strategies and goals. If you are an investor, you desire to know how the companies in your portfolio manage their budgets since insufficient resources to sustain operation has been one of the top common reasons companies file bankruptcy.

Mandated Approach

In a nutshell, it is a top-down approach. The upper-level executives call the shots. The budget is prepared and processed mostly based on the top managers' decisions and they prepare the budget based on the objectives and goals. And then, passes it on to department managers for implementation. 

The obvious disadvantage is that just like most governments, their decisions often let their people down. By the way, that's also why digital and decentralized currencies such as Bitcoin are so popular recently. Those top managers do not truly know what the fronts need. As the expectation gaps get larger and larger, it will destroy the whole organization. Because, the top manager will lose their trust and credibility. In addition, those top executives are not involved in the day-to-day operations of individual departments and may tend to have realistic expectations of the expenses related to each department. Moreover, the lower-level managers may find it difficult to implement the budget because they are unaware of how the top management arrived at these unrealistic targets. 

However, this approach isn't always bad. This approach allows top executives to allocate resources with a comprehensive view. Just like a chess players, they care about the overall success and save time, rather than time-consuming discussion. This makes the budget process quicker than bottom-up budgeting. In addition, the top executives are also taking more risks and responsibilities for the company's operation. Therefore, their power is somewhat reasonable.

Participative Approach

Conversely, the participative approach is bottom-up budgeting. It starts at the lower level such as the department level and then moves up to the top management. Instead of calling them "lower levels", I call them the "front" lines. Those teams and managers are closer to the markets and customers. They prepare their budget based on present information and past experiences and present it to senior management for approval. 

Since it is a self-imposed approach, it improves employee morale and job satisfaction. Moreover, the top executives do not always have the accurate information and the best expertise to make every single decision. However, it is usually more time-consuming 

because it passes through more eyes and brains. In addition, I reckon that sometimes those front lines do not want to be stressed. They tend to increase the budgets up to ten or twenty percent higher than they need since those gaps give them more room for mistakes and inefficiency. 

Blended Approach

As we discussed above, theoretically, budgeting can be characterized as top-down or bottom-up. But, the reality is that most budgets are prepared with a blended approach where information is passed both ways. However, top management can lose touch with information originating on the front line as budget information is transferred up and down an organization, and front-line employees may not always get a clear picture of the goals and objectives originating with senior management. But, by doing this, companies can combine the benefits of the mandated approach and the participative approach, eliminating the disadvantages of the two. 

Which Approach Do You Think Is The Best?

I think there is not a perfect approach or one fits all approach. It depends on each different situation to consider. Rather than racking brains on it, I reckon that boosting communication efficiency and effectiveness is more important than working hard on trying to choose the right approach to prepare budgets. In addition, building trust is also a supremer.

Reference

Top-down budgeting. Corporate Finance Institute. (2022, March 6). Retrieved April 23, 2022, from https://corporatefinanceinstitute.com/resources/knowledge/finance/top-down-budgeting/