Five Minutes for Finance - Cash Flow Forecasting
Cash Flow Forecasting for Nonprofit Organizations
In our previous article, we introduced the concept of budgeting - creating an annual financial plan for the organization. As noted in the article, most nonprofits use the accrual basis of accounting, which can make understanding the cash flows more difficult.
Cash flow forecasting is a critical financial management tool for all types of organizations, but it is particularly important for nonprofits, which often operate under tighter financial constraints and rely on fluctuating funding sources. Effective cash flow forecasting helps nonprofit organizations plan for the future, allocate resources wisely, and ensure they can meet their financial obligations and sustain their mission.
It is important to remember that cash flow forecasting does not adhere to accrual accounting standards. In effect, it translates the accrual-based budget into a cash-basis financial forecast. For many managers and nonprofit leaders, it is easier to understand cash-basis accounting.
What is Cash Flow Forecasting?
Cash flow forecasting is the process of estimating an organization’s future financial position by predicting cash inflows and outflows over a given period. For nonprofits, this involves projecting revenue sources like donations, grants, contract payments, and fundraising events, as well as anticipated expenses such as program costs, staff salaries, and administrative expenses.
A well-crafted forecast helps nonprofits avoid cash shortfalls, make informed decisions, and maintain operational stability. Unlike budgeting, which typically focuses on overall financial planning, cash flow forecasting provides a more detailed, time-specific outlook of the nonprofit's liquidity and financial health.
Why is Cash Flow Forecasting Crucial for Nonprofits?
Managing Unpredictable Income: Nonprofits often rely on a combination of individual donations, government grants and contracts, earned income, corporate sponsorships, and fundraising activities. These revenue streams can be irregular or unpredictable, making it difficult to plan for expenses without careful monitoring. By forecasting cash flow, nonprofits can predict when funds will be received and ensure they have the necessary liquidity to cover costs during lean periods.
Ensuring Liquidity: Even when a nonprofit’s overall income is high, cash flow issues can arise if there is a timing mismatch between when expenses are due and when income is received. For example, a nonprofit may have significant funds tied up in receivables or delayed grant payments, making it challenging to pay staff or vendors on time. Forecasting helps identify these potential gaps and allows organizations to plan accordingly.
Supporting Program Planning: Nonprofits often operate on tight margins, and their ability to deliver on their mission depends on effectively managing resources. Cash flow forecasting ensures that enough funds are available to carry out programs, pay for overhead, and cover any unexpected costs. If the forecast indicates a shortfall, it gives the organization a heads-up, allowing for adjustments or the pursuit of additional funding.
Improving Financial Decision-Making: With accurate cash flow data, nonprofit leaders can make more informed decisions about expansion, program adjustments, and fundraising strategies. Whether it’s scaling a program, launching a new initiative, or increasing the fundraising budget, understanding when cash is available for these endeavors is crucial.
Enhancing Stakeholder Confidence: Donors, board members, and other stakeholders are more likely to trust a nonprofit that demonstrates strong financial management. Regular cash flow forecasting can provide transparency into the organization’s financial health, helping build confidence in the nonprofit's ability to manage funds responsibly.
How to Create a Cash Flow Forecast for a Nonprofit
Creating a cash flow forecast involves projecting both cash inflows and outflows over a set period (typically monthly, quarterly, or annually). Here’s a step-by-step guide to building an effective forecast. The key to this process is regular and transparent communication among the various parts of the organization with visibility into the receipt (fundraising, program fees, contract and grant payments) and disbursement (accounts payable, credit cards, petty cash) of cash:
1. Identify Cash Inflows
Nonprofits should consider all potential sources of revenue when forecasting cash inflows:
Donations and Pledges: Estimate monthly contributions from individual donors, foundations, or corporate sponsors.
Grants and Contracts: Project when grant funding is expected to arrive, including the timing of restricted and unrestricted funds.
Fundraising Events: Include expected income from events such as galas, auctions, or crowdfunding campaigns.
Program Fees: Estimate income from fees related to service delivery, educational programs, performances, and the like.
Other Income: Include any other sources, such as rental income, or investment income.
2. Identify Cash Outflows
Outflows include all the expenses necessary to run the nonprofit’s programs and administrative functions:
Staff Salaries and Benefits: Include wages, healthcare, and other employee-related costs.
Program Expenses: Budget for program-related costs like materials, supplies, and personnel.
Operating Expenses: These include rent, utilities, office supplies, and other overhead costs.
Debt Payments: If applicable, forecast loan repayments or other financial obligations.
Capital Expenditures: Consider any larger investments in infrastructure, technology, or equipment.
3. Create a Cash Flow Projection
Using the inflows and outflows, project cash balances on a monthly basis. This can be done by starting with the current cash balance and adding expected inflows, then subtracting anticipated outflows for each month. The goal is to create a running balance that shows whether the nonprofit will have enough cash to meet its obligations.
4. Monitor and Adjust Regularly
Cash flow forecasts should be dynamic documents. It’s essential to monitor actual performance against forecasted amounts and make adjustments as necessary. If income is lower than expected, the organization may need to cut back on discretionary spending or seek additional funding. Conversely, higher-than-expected income may allow for more program investment or savings.
5. Use Software Tools
While simple spreadsheets can work for small nonprofits, more complex organizations may benefit from financial management software that offers cash flow forecasting as a feature. Many nonprofit-specific accounting applications integrate budgeting, forecasting, and reporting features, making it easier to keep track of both revenue and expenditures.
Challenges in Cash Flow Forecasting for Nonprofits
Unpredictable Donor Behavior: Donations can vary widely depending on the economic climate, donor sentiment, or unforeseen events. Nonprofits may struggle to predict the timing or amount of contributions.
Seasonal Variability: Some nonprofits experience peak funding periods around certain holidays or events (e.g., end-of-year giving), while others may face low income in off-seasons.
Restricted Funds: Grants or donations with restrictions can complicate cash flow forecasting, as funds may only be used for specific purposes or at certain times.
Cash Flow Gaps: Even if a nonprofit is financially stable overall, temporary gaps in cash flow can still occur, especially if income is tied to specific payment schedules or milestones.
Best Practices for Cash Flow Forecasting
Be Conservative with Estimates: It's better to overestimate expenses and underestimate revenue. This creates a buffer against unexpected shortfalls.
Plan for the Long Term: Cash flow forecasting should be part of a broader strategic financial plan. Nonprofits should ensure that their forecasts align with their long-term goals and sustainability plans.
Monitor Trends: Over time, nonprofits can track trends in cash flow forecasting and make adjustments based on past performance. This historical data can improve accuracy and help organizations anticipate future needs.
Build Reserves: Whenever possible, nonprofits should aim to create financial reserves or rainy-day funds to cushion the impact of unexpected cash flow disruptions.
Conclusion
For nonprofit organizations, cash flow forecasting isn’t just a financial tool—it’s a necessity for operational success and sustainability. By forecasting cash flow, nonprofits can better plan for the future, ensure they have the liquidity to fulfill their missions, and demonstrate fiscal responsibility to donors, board members, and other stakeholders. With careful planning and ongoing monitoring, nonprofits can mitigate financial risks and thrive, even in uncertain economic climates.
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.