Imposed budgeting, also known as top-down budgeting, is the process wherein the top management of a company prepares a budget and then imposes it on lower-level managers for implementation. It starts at the top, where the budget is prepared by senior management according to the goals that the company wants to achieve in the next financial period.
While the lower-level managers may be allowed to make suggestions in the budgeting process, the top management has the discretion to decide whether or not to include the suggestions in the budget preparation. Once the budget is ready, it is passed down to the individual departments, where the departmental managers are required to prepare their departmental budgets so that they fit within the allocations made by management.
The Imposed Budgeting Process
The following is the basic process that companies follow when preparing an imposed budget:
1. Target setting by top management
Setting up an imposed budget starts with the top management formulating the overall objectives for the year. Top-level executives determine the targets that the company wants to achieve in terms of revenues, profits, and expenses.
The management sets the targets based on previous trends, past performance, economic conditions, salary increase/decrease, changes in legislation, etc. Management may seek input from the department managers, but the suggestions given may or may not be considered when preparing the budget.
2. Finance department approval
The draft budget proposal is then sent to the finance department for making allocations to the different departments. The finance manager uses past records of expenditures to make allocations to individual departments.
For example, if the marketing department received 15% of the total operating budget in the past year, the finance manager will allocate an expense budget of 15% out of the total operating expenses budget determined by the top management.
3. Allocations to departments and preparation of departmental budgets
After the finance department has made allocations to the departments, the departmental managers are required to prepare detailed budgets within the allocation limits. The lower-level managers are required to show how their departments will generate the budgeted revenues and the amount of expenses they will incur to generate the revenues.
The expenses should not exceed the finance department’s allocation for that specific department. The department-level budget will include the expected sales in terms of quantities, staff needs, as well as the projected expenses like equipment purchases, payroll, and office supplies.
4. Review of departmental budgets by the finance department
After the departmental managers have completed preparing their budgets, they submit them back to the finance department for review. The finance manager is interested in knowing if the departmental budgets are aligned with the overall objective of the company. If a department includes operating expenses that are deemed not necessary, the finance manager will return the budget for revision.
Sometimes, a department’s budget exceeds its allocation. If it has a good case for doing so, the finance manager may increase the budget allocation for that department while decreasing other departments’ budgets to balance the overall budget.
5. Actual allocation of the budget
Once the finance manager is convinced that the budget is ready for implementation, the budget is loaded into the company’s financial system for easy tracking. The actual monthly revenues and expenses for each department are compared with the budgeted revenues and expenses.
Afterward, reports are generated showing any discrepancies or agreements with the budget. The top management uses these reports to determine which departments are performing well and which ones are slow in achieving the set targets.
Benefits of Imposed Budgeting
Below are some of the benefits of using the imposed budgeting process over other forms of budgeting:
1. Greater efficiency
One of the benefits of using imposed budgeting is the efficiency that an organization achieves. When a department is given an allocation by the finance department, it must figure out how it will use that budget to achieve the set targets and objectives of that department. The departmental heads will be prudent in how they use the money. The prudent approach will help reduce wastages and allocations to unnecessary expenditures.
2. Faster and less costly process
Imposed budgeting takes less time than bottom-up budgeting because it only allows the input of key decision-makers. In the case of bottom-up budgeting, the lower-level staff is required to contribute towards the budget preparation at the department level. It will take a lot of time and effort before the final budget is ready.
Imposed budgeting only allows input from a few people who have access to key information on the company’s performance and, therefore, are better placed to make suggestions.
3. Better financial control
Imposed budgeting gives management better control over the company’s financials. Management starts by evaluating the company’s financial needs and the expense budget required to meet its needs and generate revenues. It gives them better control in determining how much of the total budget goes to specific departments, depending on past performance and revenue projections.
Limitations of Imposed Budgeting
The following are some of the limitations of using imposed budgeting:
1. Lack of motivation
When lower-level staff is not involved in the budget preparation process, they will feel demotivated because their input is not required. This may result in tension and loss of productivity.
2. Decline in performance
Imposed budgeting requires departments to prepare their budgets within the limits of the amounts allocated to them. This means that a department that requires additional funding to finance its activities will need to work with the funds allocated from the top management. Lower-level managers may even use it as an excuse for failing to meet the revenue targets imposed by the management.
Learn accounting fundamentals and how to read financial statements with CFI’s free online accounting classes.
These courses will give the confidence you need to perform world-class financial analyst work. Start now!
Building confidence in your accounting skills is easy with CFI courses! Enroll now for FREE to start advancing your career!