Does your nonprofit eagerly look forward to preparing a budget for the new year? Do you see this as an opportunity to imagine a better future for your organization?
Or do you look at the calendar with trepidation as you realize that it’s time for the dreaded budgeting process?
This article will give you renewed incentive to tackle this all-important annual endeavor, whether you embrace budgeting or procrastinate as long as you can.
The budgeting process actually begins with your strategic plan, which will identify your annual goals. The budget is simply your plan for funding the organization’s annual goals.
The National Council of Nonprofits offers an excellent perspective in its timely article. Be sure to read this entire article because it has some very helpful links.
“A key component of financial sustainability is the commitment of board and staff to financial management that includes timely review of financial reports and advance planning. One way that board and staff plan for income and expenses in the future is by creating a budget. Approval of the annual budget is one of the fundamental building blocks of sound financial management.”
For nonprofits fortunate enough to have employees with financial responsibilities, creating the annual budget usually begins with them, along with the executive director.
Once a draft budget is prepared, it is usually presented to the board finance committee for input. Depending on the situation, it may require multiple meetings with this committee before they are ready to present a proposed budget to the full board for approval.
Once the board approves the budget, it is important to remember that the purpose of this document is to serve as a guide for financial activity in the months ahead.
Budgets are not necessarily written in stone because many factors may change during the coming year. Rather, a budget can be a guide to help your nonprofit plan for the future as well as assess its current financial health.
However, some nonprofits like to retain the original budget and add a forecast column to the financial reports. This way the budget does not need to change and yet you have an accurate idea of what your financial situation will be at the end of the year.
Remember that your budget may be requested by parties involved in financial transactions with your nonprofit, such as banks, or by donors/grantmakers considering a gift to your nonprofit.
Diane Wondolowski, CFO of the Santa Barbara Museum of Natural History, explains, “The museum starts planning for the next calendar year in July, turning those plans into numbers in August, presenting the first round of the budget to the finance committee in September for, culminating hopefully, with approval by the board in November.”
Steps in the budgeting process
When you decide it’s time to roll up your sleeves and craft your budget for the coming year, follow these steps to ensure your budget aligns with your goals and priorities while also ensuring financial sustainability.
1. Review your Previous Year’s Budget. This will provide insight into your organization’s spending patterns, revenue sources, and financial performance. Use this information to inform the upcoming budget.
2. Set Goals and Priorities. Identify your nonprofit’s goals and priorities for the upcoming year. This may include fundraising targets, program expansion or changes, capital improvements, and other initiatives. Consider the financial resources required to achieve these goals.
3. Estimate Revenue. Estimate your nonprofit’s revenue for the upcoming year. This may include donations, grants, membership fees, fundraising events, and other sources of income. Be conservative in your estimates to avoid overestimating revenue.
4. Project Expenses. Project your nonprofit’s expenses for the coming year. This may include personnel costs, program expenses, facility expenses, fundraising costs, and administrative expenses. Use historical data and industry benchmarks to inform your projections.
5. Create a Draft Budget. Using the estimated revenue and projected expenses, create a draft budget for the upcoming year. Make sure the budget aligns with your nonprofit’s goals and priorities.
6. Review and Revise. Review the draft budget with your nonprofit’s leadership team before you present it to the finance committee. Make revisions as needed based on feedback from committee members.
7. Approve the Budget. Once the budget has been reviewed and revised, the finance committee presents the budget to the full board for approval.
8. Monitor Actual Performance. Throughout the year, monitor your nonprofit’s actual performance against the budget. Adjust the budget as needed to address any significant deviations from the budget. Consider including a column for the forecast.
Additional budgeting issues to consider
How much should your nonprofit have in Operating Cash Reserves?
According to Nonprofit Quarterly, “Every nonprofit needs to have adequate cash balances available to support the timing of payroll and other expenses, as well as to pay for unanticipated costs or increases. It’s a myth however, that a single standard applies for all nonprofits.
Each nonprofit needs to determine the appropriate level of cash reserves for its own operations. No standard policy will be an exact fit for your organization.
Developing a cash reserves policy is a highly recommended practice for nonprofit boards.
When developing an appropriate policy for your nonprofit, consider including guidance on how much money the nonprofit will set aside at all times, defining the types of circumstances that will result in assets in reserve being used, the process the nonprofit will go through to make the determination whether or not to dip into reserves, the process and timeframe for repayment into the reserve account, and whether there should be any directions, restrictions, or limitations on what the money held in reserve may be used for.
How important is it for your budget to be balanced?
There are three main ways to approach the design of your budget, depending on your organization’s financial situation and goals for the coming year.
1. The surplus budget: If your nonprofit needs to increase reserves or pay down debt, consider adopting a surplus budget.
When the organization’s leaders decide that its cash and other reserves are lower than ideal, the organization can plan to generate more income than expenses, creating surplus funds that can be used in future years.
A surplus may also be needed to provide funds for paying down debt or for easing cash flow.
The board should direct staff to develop the draft budget by determining realistic income targets that nonetheless outpace expenses. If the organization can deliver on a surplus budget, it will have higher net assets (net worth) at the end of the year and enjoy a stronger financial position.
2. The break-even budget: You will use a break-even budget when your organization doesn’t want to gain ground now but doesn’t want to lose ground either. Typically, organizations choose break-even budgets by default and the skin of their teeth.
A first cut on the budget shows expenses much higher than revenue, so the staff then tries to figure out how to increase the revenue number (but still stay close to reality) and decrease the expenses (but not damage programs).
The staff and the finance committee tack their way towards a break-even budget, and hope their cautiously optimistic projections work out.
3. The deficit budget: There are three typical reasons for adopting deficit budgets. First and rarest, the organization’s leadership decides that its cash and other reserves are more than sufficient, and so spending some of those reserves in the coming 12 months is a good idea.
They may choose to make one-time purchases or expenditures, or to give the staff one-year, non-permanent raises. At the end of the year, they will have more expenses than income for the year, and thus a deficit for the year.
A second reason for a deficit budget is a decision to invest. For example, the organization may invest funds in strengthening its fundraising capacity, or in new programming.
Leadership believes that resources from previous surplus years can be risked as investments in future programmatic or financial paybacks.
An all-too-common third reason for adopting a deficit budget is a decision that ending the year in a worse financial situation is the lesser evil. For some organizations, simply cutting costs may not be the right financial decision.
For example, in an organization that relies on earned income, cutting staff will result in lowering income.
In this case, the leadership will need to re-work the way its services are structured. Or an organization may be in executive transition, and the board believes that the dip in revenue is due to the absence of an executive director and expects that income will go up again. They decide simply to “bite the bullet” this year–and they believe they can afford it.
At the end of a deficit budget year – assuming reality matches the budget – there will be a lower net worth and the organization will appear to be in a financially weaker position. However, a planned loss may, in fact, be a sound, strategic fiduciary decision by a board.
For example, investing in a new website may mean a deficit this year, but could reap substantial gains in fundraising in coming years.
The core issue is intentionality. An unplanned deficit reflects an error in planning and/or execution, while a planned deficit is an investment of accumulated reserves for the benefit of the organization and its constituents.