For not-for-profit success, having a strong mission statement and popular programs are not enough. A thorough, thoughtful, and flexible annual budget will serve as a guide for planning, management, and decision-making, and is a significant tool for achieving financial stability. Effective budgeting will give a not-for-profit’s board and management more control over the organization’s finances and will help staff make and understand financial decisions.
By closely monitoring the budget throughout the year, a board and management team can respond to changes in its operations or circumstances. For example, funds may be reallocated to or from a program that is not meeting expectations, or developments in the local community might necessitate changing priorities and a subsequent shifting of dollars.
Seven Steps to Budgeting
The budgeting process should begin at least three months before the end of the fiscal year. This allows time for the budget to be approved by the board of directors before the start of the new year.
The following are useful steps for creating a not-for-profit organization budget:
1. Set goals. These include goals for the overall organization as well as specific programs. This will give you a starting point for determining how much revenue you’ll need to generate to reach these goals.
2. Assess your current financial situation. Review your current year income and expenses and compare them to last year’s budget. Analyze any variances so you understand them and can adjust going forward.
3. Make forecasts. Use last year’s budget as a starting point for your financial forecasts. Determine whether you expect income and expenses to rise, fall, or remain about the same in the upcoming year and plan for seasonal fluctuations in both income and expenses. Anticipate when you expect to receive major donations and incur large expenses.
4. Build in contingencies. Plan for the unexpected by building contingency amounts into your annual budget to cover unplanned events that may require funding. Also make sure you understand the true operating costs of your program services—including administrative expenses—and budget for these.
5. Develop and review a draft budget. Make sure the draft meets your organizational and program goals. Review and question all assumptions and adjust as needed to bring income and expenses into alignment.
6. Finalize the budget and obtain approval. The finance and audit committees should review the budget, and it should be separate from the budget committee to avoid conflicts of interest. Final budget approval should come from the board of directors.
7. Implement the budget. Document your assumptions and create a consolidated budget spreadsheet and file. Incorporate the budget into your accounting system, assign management financial responsibilities, and implement a system for monitoring the budget and make adjustments as needed. Note: Capital expenditures and fixed assets aren’t included in an annual budget. Therefore, it’s a good idea to prepare a separate capex budget to account for these large expenses so you have the capital needed when it’s time to purchase them.
Budgeting and Cash Reserves
Some not-for-profit organizations have less than three months of cash on hand while a minority of organizations have more than six months of cash reserves. As you work on your annual budget, also think about how much operating reserves your organization should have set aside.
An operating or cash reserve is a portion of net assets that is unrestricted and relatively liquid. Operating reserves for not-for-profits are usually built using unrestricted contributions or investment income—not endowments—temporarily restricted funds, or non-liquid fixed assets.
One rule of thumb is to maintain enough cash reserves to cover between three and six months of operating expenses. However, each organization must determine the right level of reserves based on the risks they face in terms of donor stability and unexpected large outlays. Given its fiduciary oversight role to ensure the organization’s financial sustainability, the board of directors usually determines the amount and purpose of cash reserves.
The board might establish an operating reserve to continue program services if a longtime corporate donor withdraws support. Other potential uses for cash reserves might be to develop an endowment, fund future construction projects, or simply have cash on hand in case of a “rainy day.” For example, healthy operating reserves allowed some not-for-profits to stay afloat even after donations dried up during the COVID-19 pandemic.
Your board might consider the following when adopting a policy for building and using an operating reserve:
• What is the minimum balance above which the reserve should be kept?
• What specific circumstances will warrant tapping the reserve?
• What process will be followed in determining when and if the reserves will be tapped?
• How (and how quickly) will reserves be replenished after they’ve been tapped?
• What kinds of restrictions or limitations (if any) should be placed on the use of reserve funds?
Cash reserve funds should be kept in a low-risk, highly liquid account so they can be accessed quickly and easily if needed, such as a bank or credit union savings account. Make sure your institution is an FDIC-insured bank or NCUA-insured credit union. The first $250,000 on deposit at these institutions will be insured against loss.
Don’t wait until the next year to develop your budget for the next year! Start planning well in advance by collecting financial information and documents. Begin talking about your goals for the coming year. Consider what changes might occur in your community, with your partners, or to your programs. Give your team plenty of time to develop an accurate and thoughtful budget.
The not-for-profit specialists at Dembo Jones have helped dozens of organizations develop budgets based on their unique missions and programs, with just the right amount of structure and flexibility. We’re ready to help you.