Top Down Bottom Up Financial Projections

Prepare using bottom up and check using top down…

Top down bottom up refers to the two methods which a business can use to prepare financial projections, forecasts and budgets.

Top Down Financial Projections

Top down financial projections start, as the name implies, with the broadest set of parameters relating to the business and then work the financial projection numbers down from there. For example, if you were planning on opening a coffee shop, you could (but not recommended) discover the value of the worldwide market for coffee consumption, assume you will be able to get a tiny percentage of that market into your coffee shop, and generate a sales forecast by multiplying the two numbers together. You might be a bit more sophisticated in the approach by narrowing down the coffee consumption to a particular country, area or perhaps town, but either way, you are starting with a broad-brush, industry related, parameter and assuming you will be able to obtain a certain percentage of that market.

This top down approach enables the financial projections to be produced quickly and without too much effort, you only have to find the worldwide market for coffee consumption, decide on a percentage and the sale forecast is ready. From this you can generate the rest of the financial projections.

While not a particularly useful or recommended approach to preparing detailed financial projections, the top down method is a useful tool for checking that the projections produced using the bottom up approach (discussed below) are reasonable.

Bottom Up Financial Projections

Bottom up financial projections require a lot more time, effort and detail. The business needs to understand what is driving demand for their product. In the case of the coffee shop, the passing footfall will determine the potential demand, and other factors such a quality and price, will determine what percentage of the passing footfall will choose to enter the coffee shop and make a purchase. Each individual parameter needs to be considered in preparing the bottom up financial projections.

Bottom up financial projections tend to be more accurate than top down financial projections, and as they are built using a number of individual assumptions such as price and quantity, they can be amended to show the impact of changes to the assumptions with relative ease.

Top Down Bottom Up Financial Projections Example

To show the differences in approach between top down bottom up financial projections, we will use the coffee shop business as an example.

Bottom Up Financial Projections

To produce bottom up financial projections, the business, having decided on a location for the shop, can monitor the passing footfall for a period of time and establish an accurate estimate of the number of people who pass the proposed shop each day. Based on other shops in the area it can find a value for the percentage of passing footfall who are likely to enter the shop and make a purchase. Looking at the prices of the competition in the area, the business can establish the amount it can charge each customer.

The business can then forecast its annual sales

Annual sales = Passing footfall x Percentage who enter shop x Average price x 365

Suppose for example the passing footfall is estimated at 10,000, the percentage who enter the shop at 2%, and the average price at 4.00, then the initial guess at the annual sales forecast for coffee is 10,000 x 2% x 4.00 x 365 = 292,000.

As the projections were built from the bottom up, questions such as, what is the impact of increasing the price?, what is the effect of closing at weekends?, how does seasonality affect the footfall? can be answered. Clearly each parameter needs to be considered and, as more and more information is gathered the financial projections can be refined.

The bottom up method of producing financial projections is used in our Coffee Shop Revenue Projection template, which is available for download.

Top Down Financial Projections

Now consider what happens with the top down financial projections. In this case, perhaps the business is able to ascertain that the retail value of coffee consumption demand in the country is 5 billion, and estimating that it might get 1/100th of a percent of that market, guesses that the coffee shop sales will be 500,000. The top down financial projections are entirely reliant on the accuracy of the coffee consumption demand figure and the percentage of market estimate. There is no way of building into the forecast the type of ‘what if’ questions asked and answered by the bottom up financial projections.

Reasonableness Check Using Top Down Financial Projections

Providing accurate market information can be obtained, the top down financial projections are useful as a check to see how reasonable the bottom up financial projections are.

Suppose in our example we have accurate information to show that the retail value of coffee consumption from coffee shops in the area is 6 million. Using our bottom up projection of 292,000 we can see that the business is anticipating getting 292,000/6,000,000 = 4.9% of the total market in the area. This is clearly too high based on the number of coffee shops in the area, and shows that the bottom up forecast needs to be reviewed to see which of the individual assumptions (footfall, price. percentage entering the shop) needs to be amended.

Last modified September 27th, 2019 by Michael Brown

About the Author

Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.

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