Theoretically the budget process can be portrayed 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.
Organizational Structure Considerations
It is very important for managers at all levels to understand how information is transformed as it passes through an organization. Review the preceding graphics, this time noting how the top-down arrows change from yellow to pink as they pass through the middle-level leadership. Conversely, the arrows in the bottom-up approach morph from green to pink as they pass through the middle level managers. As budget information is transferred up and down an organization, the "message" will inevitably be influenced by the beliefs and preferences of the communicators. There is always a chance that information can be so transformed as to lose its original intent. Top management can lose touch with information originating on the front line, and front-line employees may not always get a clear picture of the goals and objectives originating with senior management.
Flattening the Organization Chart
There are staggering differences in the organization charts of different entities. Business growth is a natural incubator for expansion of the number of levels within an organization; as a result, great care must be taken to preserve the efficiency and effectiveness of growing entities. Sometimes the very attributes that contribute to growth can be undone by the growth itself. The charts of some entities consume many pages and involve potentially dozens of "levels." Other companies may have worked to "flatten" their organizational chart to minimize the number of links in the chain of command. While these endeavors are often seen as attempts to reduce the cost of middle-level management, the overriding issue is to allow top management more clear and direct access to vital information originating with front-line employees (and vice versa). In addition to focusing on revenues and costs, the budget process should also be taken as an opportunity for continuous monitoring of the organizational structure of an entity.
One thing is sure, no one can see the future. And, budgets clearly involve a good deal of forward looking prognostication. As a result, a certain amount of error is inevitable. Accordingly, it is easy to slip into a trap of becoming cavalier about the estimates that form the basis for a budget. This should be avoided. Budget estimates should be given careful consideration. They should have a basis in reason and logically be expected to occur. Haphazardness should be replaced by study and statistical evaluation of historical information, as this provides a good starting point for predictions. Changing economic conditions and trends need to be carefully evaluated.
Slack and Padding
Because budgets frequently form an important part of performance evaluation, human behavior suggests that participants in the budget process are going to try to create "breathing room" for themselves by overestimating expenses and underestimating sales. This deliberate effort to affect the budget is known as creating "budget slack" or "padding the budget." This is done in an attempt to create an environment where budgeted goals are met or exceeded. However, this does little to advance the goals of the organization.
When slack is introduced into a budget, employees may fail to maximize sales and minimize costs. For example, once it is clear that budgeted sales goals will be met, there may be a reduction in incentive to push ahead. In fact, there may be some concern about beating sales goals within a period for fear that a new higher benchmark will be established that must be exceeded in a subsequent period. This can result in a natural desire to push pending transactions to future periods. Likewise, padding the planned level of expenses can actually provide incentive to overspend, as managers fear losing money in subsequent budgets if they don't spend all of the currently budgeted funds. This has the undesirable consequence of encouraging waste.