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Budgeting must be more flexible in uncertain times

By Jim Simpson, CPA and Director, Financial Technologies & Management

A strong budget is an essential element for any nonprofit organization to achieve financial leadership. Superior budgets, though, have written plans about the core activities to include strategic, organizational, and program goals and how they will be financed.  A superior budget must be monitored and managed in light of the political and economic realities and the increased uncertainties we are all facing.

Most financial leaders focus too much time on budget variance analysis and not enough time on anticipating or planning for the future. By anticipating or planning, organizations can focus on what’s upcoming regardless of its budget cycle or fiscal year-end. A budget can be complemented with rolling forecasts to better anticipate upcoming financial results.

Budgets also need to include cash flow projections, which maybe outside of the finance departments capacity or capabilities. Financial leaders must have a direct role in developing useful cash flow projections and assumptions with frequent, detailed analysis.

Financial sustainability can only be achieved with a well-prepared and continuously monitored budget. Conversely, a poorly developed budget can diminish mission focused activities opportunities and threaten long-term success.

It is important that each of the following budget process practices is used to develop the budget.

  • Draft revenue and expense budget to attain strategic, organizational and program goals. It is important to break expenses into variable expenses, fixed expenses, incremental expenses and indirect expenses for administration and facilities.  It is important that any new initiatives are approved and deadlines established before they are undertaken.
  • Modify budget with budget team input to ensure everyone understands and approves the revised draft budget.
  • Implement budget to communicate budget, assign management responsibilities, implement in accounting system, monitor and respond to changes to the budget. It is important that you document budget decisions including writing down all budget assumptions.
  • A budget should be implemented with monthly distributions to anticipate the changes to monthly revenues and expenses based on timing and seasonal program activities.
  • A budget may need to be broken out for donors without restrictions and donors with restrictions to insure that there are sufficient resources to actually fulfill the donor restrictions.
  • A budget should add a contingency or cushion to take into consideration the unknown.   The less predictable your budget it, the more contingency you may need to have.    A contingency of 5% of your non-personnel costs is typical and may need to increase if your funding or costs are not predictable.

Any unfavorable budget deficits need to be evaluated to determine if it is just a timing difference or an actual deficit. Shortfalls created by deficits need to be solved by budget adjustments or strategic choices to absorb a shortfall. An organization can determine timing or actual deficits by reviewing the budget to see if it had planned for or not.

Your budget deficits should consider what funding may become available, whether to utilize reserves, utilize unrestricted funding, or reduce expenses.  If funding is disappearing, can we replace the funding, should we reduce or eliminate an ineffective program, or can we reinvest into more effective or sustainable programs.  You should create various budget scenarios so you have various options about how to meet budget deficits.

In contrast to traditional budgets, a flexible budget may include a range of scenarios or a shorter time frame, or both. Three scenarios at a minimum should be prepared: best, worst and expected cases.

A bare bones worst-case budget will show you exactly which expenses are crucial to your organization.  Prepare your flexible budget in shorter or longer time increments from the annual budget cycle.

It is important the you strike the right balance in your development of flexible budgets.

  1. Worst-case budget – It will include realistic income and your core expenses.  The realistic income is committed funds and conservative fundraising estimates.  The core expenses would include essential expenses with no expansion of services.
  2. Expected-case budget – It will include optimistic income and incremental expenses.  The optimistic income will include uncertain funding estimates.   The incremental expenses would be the additional expenses to be incurred if new funds are secured.
  3. Best-case budget – It will include the fundraising goal revenue and projected expenses.  The fundraising goal revenue includes the combination of the realistic and optimistic income.  The projected expenses includes the combination of he core and incremental expenses.

It is important that an accompanying cash flow projection be developed to accompany the accrual based budget.  A cash flow projection will help to foresee cash flow problems a plan for solutions even if an organization has a balanced or surplus budget.

Flexible budgets and Cash Flow Projections will provide you with additional tools to help ensure your organization remains financial stable despite an uncertain future.

Key Goals for Financial Stability

  • Diversify Revenue so you are no too dependent on any one funding source and look for ways to accelerate cash flows
  • Allocate indirect costs to programs to insure all program costs are covered
  • Develop Staff versatility and adaptability to work in different program areas
  • Develop and maintain an Endowment to support financial operations
  • Maintain one to three months reserves to allow for program growth and cover short-term deficits
  • Keep track of financial results and how you are doing to keep organization financially stable
  • Monitor cash flow projection at least monthly to determine how long the organization can survive without additional funding

Let us know how we can help your organization develop the financial tools it needs to grow and remain financially stable.

5 Tips for Nonprofit Internal Financial Reports

When it comes time to present internal reports to the board, more likely than not we have grown to expect a few yawns, complimented by blank stares. This article has the ability to engage, enhance, and provide useful information to the board during these internal report presentations.

A not-for-profit should consider the following best practices to ensure that internal financial reports prepared for its board of directors and other governance committees are accurate, timely, and decision-useful.

The following 5 Tips are provided to make your Nonprofit Internal Financial Reports more effective and useful.

Make it easy to read. Internal financial statements that include management’s discussion and analysis of the results presented can be helpful to board members as they carry out their oversight responsibilities. A brief overview of the period presented and highlights of the results that are meaningful to the organization will assist the governing bodies in their decision-making processes. The analysis should be easy to read, avoiding overly technical language while conveying the organization’s financial story. In addition, the accompanying financial statements should include, at a minimum, comparative statements of financial position (balance sheet), statements of activities (income statement), and budget-to-actual report.

Describe profit and loss by program. Not-for-profits operating multiple programs (especially those relying on governmental funding) should also consider, as a best practice, producing a profit and loss statement for each program on at least a quarterly basis. The surplus or loss on each program should be compared with the surplus or loss of the corresponding period in the previous year with significant variances explained. As an additional best practice, on an annual basis, a reconciliation should be prepared between the budgeted surplus (or loss) to the surplus (or loss) from the audited financial statements. If a program is regularly operating at a loss, management and the board can evaluate whether the organization should continue to subsidize the program.

Use ratio analysis. Ratio analysis is an effective tool for assessing an organization’s financial viability. When produced on at least a semiannual basis, internal reports on key ratios can help organizations monitor their liquidity, performance, activity, and leverage. The ratios can also be used for benchmarking purposes. Each organization should identify which key ratios and metrics are the most meaningful to their business model.

Present cash flow and liquidity data. Periodically throughout the year, organizations should assess their liquidity and availability of resources to meet their cash flow needs for a specified time. These assessments should be shared with the board on a quarterly or semiannual basis. For organizations struggling with cash flow or liquidity issues, reporting may need to be more frequent.

Keep it simple. Avoid lengthy reporting and choose a format that is easy to follow. Provide training to board and senior staff members on how to read and understand the reports so they can ask appropriate questions and make effective decisions. In some cases, dashboard reporting, using visuals to highlight key metrics and indicators, is very effective. Having accounting software that can produce internal financial statements with minimal edits outside of the system is important, providing data integrity while maximizing efficiency.

Source: “Tips for NFP Internal Reports”. Journal of Accountancy. November 2018.