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.
- 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.
- 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.
- 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. It is generally helpful to do a mid-year deep review to include anticipated year end projection and forecast.
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.