Five Minutes for Finance - Budgeting
Budgeting for Nonprofit Organizations
Budgeting is an essential process for nonprofit organizations, serving as a roadmap to achieve their mission and goals while ensuring financial sustainability and accountability. Unlike for-profit entities, nonprofits must focus on both maximizing their impact and optimizing their financial outcomes, which makes effective budgeting even more crucial. This article outlines the key steps, challenges, and best practices for nonprofit budgeting.
One important note: Nonprofit budgets do not need to be “balanced” (i.e.income equal to expenses). Nonprofits are allowed to end the year with more revenue than expenses (i.e. a surplus), resulting in an increase in their net assets (known as equity in the for-profit sector). The build-up of annual surpluses over time creates a “reserve”, which a nonprofit can use when financial conditions are such that it can budget for and/or absorb an annual deficit (revenues less than expenses) and still maintain balance sheet solvency.
Importance of Budgeting in Nonprofits
Resource Allocation: Budgeting helps nonprofits allocate limited resources efficiently, ensuring that funds are directed toward programs and activities that align with their mission.
Financial Sustainability: A well-prepared budget allows organizations to forecast and monitor income and expenses in order to take advantage of opportunities and anticipate and prepare for challenges.
Transparency and Accountability: Budgets provide a clear financial plan, which can be shared with stakeholders, including donors, board members, staff, and regulatory authorities, to build trust and confidence.
Strategic Planning: Budgeting enables nonprofits to set priorities, plan for future growth, and respond to unforeseen challenges.
Key Steps in Nonprofit Budgeting
Assess Organizational Goals:
Begin by reviewing the organization's mission and strategic objectives.
Identify programs and initiatives that will require funding in the upcoming fiscal year.
Estimate Revenue:
Consider all sources of income, such as donations, grants, government contracts, membership fees, program fees, and fundraising events.
Be realistic and conservative in revenue projections to avoid overestimating available funds. This is especially important with donated revenue - projections should be based on realistic yields from planned activities and not just based on the organization’s need to have a balanced budget.
Estimate the timing of revenues. This will be important for cash flow projections.
Determine Expenses:
Categorize expenses into programmatic, administrative, and fundraising costs.
Include fixed costs (e.g., rent, utilities, salaries) and variable costs (e.g., event supplies, travel).
Estimate the timing of expenses - both when the expense is incurred as well as when the expense will be paid. Again, this will be important for cash flow projections.
Engage Stakeholders:
Collaborate with staff, board members, and key stakeholders to gather input and ensure alignment with organizational goals.
Create the Budget Document:
Use a spreadsheet or financial software to create a detailed budget that outlines revenue and expense categories. Although budgeting software may be costly and challenging to implement, it may reduce the workload of building and compiling the budget and the possibility of errors that exist in spreadsheet-based budgeting.
Include notes and assumptions for clarity. These notes and assumptions will be useful when analyzing budget variances during the year.
Review and Approve:
Present the draft budget to the board of directors for review and approval.
Make adjustments based on feedback and ensure alignment with strategic priorities.
Monitor and Adjust:
Regularly compare actual income and expenses to the budget to identify variances. Engage program directors and managers in analyzing variances so that they are versed in the financial implications of their programmatic decisions. Referring to the original budget assumptions can help to explain the reason for the variance.
Update the budget as needed to reflect changes in funding or priorities. Note that modifying the budget should be thoughtfully considered. One common practice is to establish a variance threshold for making a budget modification (e.g. plus or minus 5% variance from total income or expenses) and engage the Board in determining if a budget modification is appropriate.
As an alternative to updating the budget, consider maintaining a “working” budget that is separate from the “approved” budget, and updating the working budget on an ongoing basis as new information is obtained. This practice can help with forecasting year-end results.
Budgeting as Part of Comprehensive Planning
While budgeting is a critical component of nonprofit management, it is just one part of a broader planning process. Comprehensive planning ensures that all aspects of the organization are aligned and working toward its mission. Here are some additional elements to consider:
Strategic Planning:
Develop a long-term vision and set strategic goals that guide the organization's direction.
Ensure that the budget reflects and supports these strategic priorities.
Program Planning:
Define the scope, objectives, and expected outcomes of each program or initiative.
Align program budgets with overall organizational goals to maximize impact.
Operational Planning:
Outline day-to-day activities and processes needed to implement programs and achieve goals.
Coordinate operational plans with budgetary constraints and timelines.
Risk Management:
Identify potential risks, such as funding shortfalls or economic downturns, and develop mitigation strategies.
Include contingency plans in the budgeting process to address unexpected challenges.
Performance Evaluation:
Establish metrics and benchmarks to measure progress and effectiveness.
Use these evaluations to inform future planning and budgeting decisions.
By integrating budgeting into a holistic planning framework, nonprofits can ensure that their financial strategies are both sustainable and impactful.
Common Challenges in Nonprofit Budgeting
Unpredictable Revenue: Donations and grants can be inconsistent, making it difficult to forecast income accurately.
Restricted Funds: Many grants and donations come with restrictions on how they can be used, limiting financial flexibility.
Balancing Mission and Sustainability: Nonprofits must prioritize their mission while ensuring financial stability, which can lead to tough decisions.
Resource Constraints: Limited staff and financial expertise can hinder effective budgeting and financial management.
Accrual Basis Accounting: Most nonprofit organizations use the “accrual basis” of accounting, in which revenues and expenses are recognized in the period in which they were generated or incurred, not when the cash actually came into or out of the organization. Accrual accounting is a component of Generally Accepted Accounting Principles (GAAP). However, many people think of revenues and expenses on a cash basis - what came in this month and what went out this month in cash. Reconciling the two different approaches can be confusing and requires clear communication and systems to differentiate between the two to fully understand the financial situation.
Best Practices for Nonprofit Budgeting
Involve the Right People: Engage program managers, finance staff, and board members to create a comprehensive and realistic budget.
Use Technology: Leverage accounting and budgeting software tailored for nonprofits to streamline the process and reduce errors.
Plan for Contingencies: Include a reserve fund or contingency line item to address unexpected expenses or revenue shortfalls.
Focus on Transparency: Maintain clear documentation and communication about budget decisions and changes to build trust with stakeholders.
Evaluate and Improve: Conduct regular reviews of the budgeting process and outcomes to identify areas for improvement.
Conclusion
Effective budgeting is vital for nonprofit organizations to achieve their mission, maintain financial health, and uphold accountability. By following a structured budgeting process and adopting best practices, nonprofits can navigate financial challenges and maximize their impact on the communities they serve. Remember, a good budget is not just a financial tool; it’s a strategic asset that helps translate vision into action.
About this Series
Subsequent articles in this series will cover other topics related to nonprofit financial management. Here is a list of, with links to, previous articles:
About the Author
For over 30 years, Robert Pascual has been a leader in nonprofit financial management as a CFO, consultant, conference speaker and educator. He holds an MBA from the Haas School of Business at the University of California and is the founder and principal of Robert Pascual, MBA LLC. He has worked with small, mid-size, and large nonprofit organizations spanning the fields of education, workforce development, housing, health, philanthropy, social services, media, fiscal sponsorship, nature, and the environment. Each of these organizations has faced both unique and common challenges, some of which are probably similar to ones that you wrestle with.