Annual Budget Planning

Each month, Nonprofits Assistance Fund hosts the Financial Management Network.  These free, informal gatherings are opportunities for members of the nonprofit community to get together to discuss different financial topics and network with peers. Key takeaways from these discussions will be posted and form an archive to help promote healthy financial practices.

Notes from Annual Budget planning (September 24, 2008)

We try to schedule this network in the fall, which is budget season for nonprofits whose fiscal year matches up with the calendar.  Obviously many nonprofits, including Nonprofits Assistance Fund, have a different fiscal year.

What is a budget?

A budget is a planning tool that is realistic and based on sound assumptions. Above all, budgets should be realistic, flexible, and consistent

  • Realistic - based on sound and reasonable assumptions for income and expenses.
  • Flexible - able to adapt if there are significant changes in revenue or expenses. Remember, a budget is a planning documents, and things don't always go according to plan (especially over a longer timetable).
  • Consistent - in line with the organization's mission, strategic plan, and yearly goals.

For some history and background on the word:

Different kinds of budgets

  • Annual budget (for the entire organization)
  • Project budgets
  • Program budgets
  • Operating budget (overhead)
  • Capital budget
    • This is important if you own a building
    • They are also used for separate capital purchases
  • Grant budgets
    • Pay particular attention to restricted grants
  • Fundraising
  • Communications
  • Technology

Budgeting steps

  • Mission, strategic plan, annual goals must be approved by the board in advance of crafting a budget. The budget needs to be based on the organization's direction and established priorities.
    • This helps establish both a long-term and immediate priorities.
  • Establish a timetable for the budget. Work backwards from when you'll need to have the budget approved to ensure you have enough time.
    • It takes more time than you may expect. Some large corporations begin their budgeting process 14 months out, so allot more than a month to get this important work done.
  • We recommend at least 2 board meetings with the board/finance committee
    • One to approve parameters for budget
    • The second to approve the actual budget
  • Look at what you did last year - the budget and, more importantly, the actual numbers.
    • This provides a historical perspective that helps you plan for the future.
For more budgeting steps, check out our 10 Step Annual Budgeting Checklist.

Budget assumptions

Budget assumptions are very important.  They are the foundation of a sound budget and, often, a fiscally healthy organization.

  • Budget assumptions are drafted and then approved by the board.
  • Establish basic parameters with the board before crafting the budgets, and have these written down and disseminated, it's easier to get board approval when you're already on the same page.
  • Set aside time at a board meeting to discuss/agree on these parameters - this is the plan for the year, these are goals (serve a set number of clients, etc) - they should tie back to the mission and strategic plan.
  • If a budget does fail, you can look at the assumptions to try and find the weak points and be more prepared for the following year.
  • Budget assumptions help staff understand the budget.  They are especially critical if there is turnover in the finance and/or operations area. Clear assumptions can help new staff get up to speed and make sense of the budget more quickly.
  • Make sure there is a budget narrative that outlines and unpacks the numbers. It should be written in a way that helps board members and other staff understand the budget and the assumptions that underpin it.
  • The budget assumptions should link the overall budget to the strategic plan and the stated goals for each program. A successful financial year may not mean a successful program year, however at a truly successful organization these two are in sync. A well crafted budget will provide the resources necessary to get the work of the organization done.

Allocations

You can either divide income/expenses by 12 months or try to project each month individually.

  • Even if you choose to divide by 12 for budgeting purposes, revenue rarely flows evenly. There will be some ebb and flow, some good and some lean months. Some expenses (such as rent and payroll) are consistent and must be paid out each month.
  • We suggest doing a 12 month cash flow projection. Remember, this is a cash projection and should not include restricted funds or non-cash transactions. This complements your budget and more accurately reflects the reality of your financial position.
    • Past history can be helpful in projecting cash flow. Look at your revenue and expenses from previous years to help benchmark and anticipate where you should be.
    • Download our cash flow template.

Craft alternative budgets

We suggest developing three different budgets for different scenarios:

  • Good year (or what you expect)
  • Great year (woo hoo!) - 10-15% budget surplus
  • Bad year  (bare bones) - 10-15% budget deficit

Planning for these scenarios during the budgeting process helps you make strategic decisions about what to do with higher/lower revenue and/or expenses.

Budgeting for a surplus

A balanced budget is good, but budgeting for a surplus is better.
  • Going into the budgeting process, we believe that every organization should aim to have a budget surplus. We recognize the importance of putting as many resources as possible towards your mission; however that is not a model for a sustainable organization. If you want to make an impact and reach long-term organizational goals, it is important to be proactive and plan for your financial future. For more, read Why Nonprofits Should Think About Profit.
  • It is unrealistic to assume you will be "profitable" every year. It takes time to build up a cash reserve (or rainy day fund), so we suggest aiming for a budget surplus every year. 
    • This reserve will help you be prepared for leaner times. 
    • Budgeting for a surplus also can help with budget cuts - there is some added flexibility already built into the budget in case of a shortfall.
  • Trying to build in a surplus is a strategic way to build the capacity and stability of an organization during good times. There is no standard amount or percentage to set aside for building a reserve. Discuss with the board how much you want to have available and then draft a plan to reach your goal (perhaps aim for a 5% surplus). Remember, it will take a number of years to build up this financial cushion. Some organizations create a line item on the budget for operating reserves.
  • How much should you have on hand for cash reserves? 
    • Depends on the organization - at a minimum, you need to be able to cover your cash needs (payroll, withholding, other expenses).
    • Read Kate's take on the "Cash Reserves Myth".
    • Some organizations may want to have a building reserve fund for unanticipated capital expenses.
    • Other factors to take into account when considering reserves - how liquid are your assets (do you have a lot of restricted funds or assets tied to a building), how much cash on hand do you need to be able to sleep well at night?
  • How do funders perceive cash reserves?
    • Most funders view cash reserves as the mark of a fiscally sound, responsible, and well managed organization. They indicate sustainability.
    • However, there is concern in instances of hoarding - having such a large reserve that the funds could be better spent on programs or service delivery. The Charities Review Council has a standard that is a useful benchmark: "Unrestricted net assets available for current use are not more than twice the current or next year’s budgeted operating expenses."

Identify and monitor risks in your budget closely

You need to intimately know your budget to identify the risks. Are there any plugged numbers? (According to Peter Bernstein, "risk means not having cash when you need it.")

  • What percentage unsecured dollars are you comfortable with in a budget?
  • What is the likelihood of receiving those funds?
    • What is this likelihood based on? Such as:
      • Your history of receiving these funds
      • Relationships with funders/donors
      • New fundraising plan
    • If you are unsure of receiving a grant, it's better not to include that income in your budget.
  • Even with previous performance or great planning, there are no assurances of success. Keep in touch with funders for indications about the status of grants or government contracts. Monitor these funds to see if your projections are on track and give the board regular updates.
  • If donations or grant dollars are less than expected, is this a one-time aberration or do you need to make adjustments?
  • Remember, a budget is a flexible planning document, there are times when you need to make adjustments to your plan to take into the realities of actual revenue and/or expenses.

Working with the board

Communicate regularly with the board about your financial condition, especially about anything that could significantly impact the budget - not receiving an expected grant (or receiving a much smaller grant), fundraising challenges, unanticipated large expenses, or receiving unexpected major gifts. It's very important to be open and transparent with the board about what is happening. Withholding information will damage your relationship and prevent them from fulfilling their fiduciary duty to the organization.

  • Regularly show the board the budget and the actual revenue/expense. Explain why there are differences between the budgeted numbers and the actuals, especially in the case of significant swings.
  • Previous year's financials can be a helpful benchmark. Some organizations provide the previous year's budget, as well as the current budget and actuals to board members at each meeting.

How often should you adjust your budget?

  • Modifications may be required throughout the year - things don't always go according to plan, especially over a 12 month time span.
    • The economy may impact revenue and/or expenses.
    • Charter schools - state contracts are based on enrollment numbers.
  • Unanticipated events can require unbudgeted expenses and adjustments to your budget.
  • Clearly document any changes to the budget.
  • Some organizations maintain that you should not make changes to a board approved budget. However, even in these instances, the budget is a planning and forecasting tool - it gives the organization some idea where they will be at year-end. For these organizations the forecast may change even if the budget document is fixed.
  • Every organization should formally review their budget and budget assumptions at least once a year. 
    • Are things going as planned?
    • What will our year-end look like?

Why do budgets fail?

  • Unrealistic numbers or goals.
    • Individual giving, grants, corporate giving, earned income were set at unreasonable levels.
    • Expenses were set, and the projected income did not match up. Rather than trimming expenses, large numbers were plugged in to balance the budget and people hoped to be able to generate that amount of community support and/or earned income. Some people call this "faith-based budgeting."
      • When you have a plugged number, you need to be aware of it and set a realistic plan to fill the hole.
      • You don't want to have to implement a plan that is not based in reality.
  • Changes in government contracts.
    • Changes in federal, state, and municipal budgets can impact government contracts, affecting your budget.
    • Regular dialogue with your funders - foundation officers, government employees, significant donors - is important for maintaining that relationship, but also can give you an indication of impending changes.
      • In this climate, government contracts are more tenuous than usual, and maintaining a dialogue is especially important.
      • Even in examples of large and surprising cuts, there are usually some signs if your funding is in danger. If you have good, long standing relationship with your grant manager, you are more likely to receive notice about possible changes and cuts. It's important to listen to those hints and take them seriously.
  • Individuals donors may move or pass away.
  • Foundations may change their funding priorities.
  • Expense projections may be way off.
    • For example, gas and utility prices this year.
    • You may have unanticipated building, technology, or program expenses.
    • Disconnect between revenue and expenses.
      • For example, if you set a high fundraising goal, but forget to budget for fundraising costs.
      • Remember, you have to spend money to make money.
  • Grants can create cash flow challenges.
    • You may have money in the bank that is restricted, so you are unable to use it to pay operating expenses.
    • The timing of grant disbursements may create a cash flow challenge.
    • Some grants and government contracts are based on reimbursements, so you spend the money and then send an invoice for payment - a recurring cash flow problem.

What can you do during budget challenges?

  • Management should address "hoarders" - people who ensure that they purchase or use supplies for their program, rather than thinking about what makes sense for the entire organization.
  • Have a conversation with staff about the situation. For example, just because certain items were in the budget for this year, it doesn't mean these purchases can be made at any time. Sometimes you may need to ask them to hold the line on expenses. 
    • Use these conversations as a way to bring staff into the process. There can be a lot of tension around an organization's finances, especially during challenging times. Explain why some things are being cut or delayed, the rationale behind those decisions.

Who has a say in budget decisions?

  • For the overall organizational budget, most of the work will be done by the Executive Director and other operational staff, who then submit the budget to the board for approval.
  • For program budgets, we recommend working with program staff.
    • It may be more efficient if one person does the budget, but it may not produce the best results.
    • Program managers must be able to implement the budget and work plan. Often, they have a better idea of the resources needed for their program. Having their input is valuable when crafting a realistic and reasonable budget. This conversation can help reinforce the goals and priorities of the organization and generate buy-in around the budget.
  • Define expenses and priorities for the organization at the outset. Staff can feel that there is never enough money for their program, but putting everything in perspective at the beginning can help frame the conversation. It's one piece of a larger pie and a delicate balancing act.
  • One way to structure the conversation is to share only relevant line items with program staff - excluding salary and overhead expenses that are part of the program budget but not at the discretion of staff.
  • Discuss the program assumptions, especially if they seem off base, excessive, or not aligned with the mission and goals of the overall organization. If there are large shifts in projected revenue or expenses, check the underlying assumptions. Use the previous year's budget and actual income/expenses as a baseline, as you would for other budget conversations. 
    • Educate program staff on budgets - what is expected, how to craft them, etc

Do programs need to make a profit?

  • What is the true cost of each program?
    • Are your programs self-sustaining, or do they require a subsidy in the form of grants and/or donations?
    • Does your program contribute to the overhead and administrative costs of the organization?
    • For more information, you can attend Calculating True Program Cost.
  • Do you have a cash cow program? This strategy where one program generates a lot of earned income that helps financially supports the organization. It's a way to ensure you are able to achieve other core mission goals.
    • Subsidizes other programs that are essential to your mission and may be expensive to operate.
    • Contributes to overhead costs - this is a useful strategy since general operating funds can be difficult to come by.

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