Often overlooked, avoided, or not utilized effectively, a budget is a valuable, even critical financial tool for a nonprofit. Budgets can be time consuming and may feel restrictive, but when used properly, they help create financial stability for an organization.
For nonprofits, budgets are essential to improve efficiency and properly utilize resources. However, in order to be useful and effective, they must be created properly. This article will offer tips on developing an effective, meaningful budget that will meet the specific needs of your organization.
The Importance of Budgeting
Budgeting is a particularly important practice for nonprofits because they typically have limited funding resources. For many nonprofits, funding sources can be unpredictable. For example, consider donations from the public: Will the donor contribute again? If so, when? And how much? If funding is not received, what can be done to raise additional money? Such uncertainty can be stressful for management, creating doubts about their ability to fulfill their organization’s mission.
Budgets identify the monetary needs of the organization to cover program costs and general and administrative expenses. Once these are identified, the organization must determine how they will obtain the needed funding, which could come from such sources as program fees or charges, general contributions from the public, government grants, grants from charitable organizations, fundraising events, retail sales, rental income, investment income, and so on.
Once the budget is created, it is used monthly to compare actual results to budgeted amounts. Any variances are investigated, and, if necessary, additional action may be required. If revenue received is less than budgeted, the organization needs to either find another source of revenue or reduce spending in order to avoid operating at a deficit. Although it is unlikely that operating at a small deficit for a year or two would significantly impact the organization, eventually the organization will have to find additional resources or cut costs in order to remain a going concern.
Budgets enable the leaders of the organization to prioritize programs in accordance with the organization’s mission; they discourage wasting resources by concentrating on organizational needs versus wants. As well, nonprofits require bids for large purchases and budgeting for those purchases helps them ensure the prices they pay are appropriate. Budgets are also used to help organizations maintain and improve capital items as necessary.
Many grantors require a budget in order to provide and continue funding because a budget demonstrates the organization’s accountability to donors and the general public.
Tips for Creating an Effective Budget
If budgets are not created properly, they are ineffective and add no value to the organization. The following are tips for preparing an effective budget:
- The budget should include a surplus. A common misconception about a nonprofit budget is that it should be prepared assuming a breakeven, that is, no surplus or deficit. However, a budget should operate at a surplus in order to contribute to the financial stability of the organization by enabling it to set aside funds as an operating reserve.
It is typically recommended that a nonprofit organization should maintain three-to-six months of operating expenses in reserve. Operating at a surplus also allows the organization to pay back debt, invest in information technology and other capital improvements, grow program activity, and take other actions necessary for its success.
- The budget should be prepared before the start of the year and amended only if there are significant changes to the operations of the organization. Another common misunderstanding regarding the preparation of a budget is the belief that it should be updated monthly, when actual revenue and expenses are known. Although there are situations that warrant an amended budget, small changes should be avoided. If the budget is amended to accommodate actual results, monthly variance analyses, which provide valuable insights on those results, cannot be performed. For example, if repairs and maintenance exceed the budget by $7,000 during the month and are explained by a furnace repair that was not budgeted, it could indicate a new furnace should be considered. On the contrary, if the budget is revised, it is likely the same repair will be in the budget next year, which might not be appropriate.
On the other hand, consider amending the budget if there are significant operating changes, such as the addition or discontinuance of a program, the addition of a new location, or significant increases or decreases in funding.
- A budget should be detailed. If possible, create a budget for each program: fundraising expenses, general and administrative expenses, each special event, etc. If the organization has more than one location, consider a budget for each location. Separate budgets can be combined to provide the overall budget for the organization.
A budget should include a line item for each type of revenue source and for each expense by natural classification. The budget should also contain a line item for capital additions, including improvements, equipment, and furniture.
- If operations vary month to month, consider monthly budgets versus an annual budget. If operations are seasonal, an annual budget divided by 12 months will not provide a good basis for analysis of actual-to-budget variances. Although a monthly budget may take more time to prepare, it will provide for more meaningful analysis.
- Start with last year’s actual results and budget. In order to save time, start with last year’s actual results and budget analysis and consider changes expected in the upcoming year, such as the impact of inflation, new grant revenue, increases in program revenue fees, lost funding, annual payroll raises, or additional personnel.
- Add 10-to-15 percent of total expenses as a contingency for unexpected costs. There are always unplanned expenses; a contingency for unexpected costs will alleviate the burden of finding additional revenue or reducing expenses for some of these items.
- Consider a long-term budget, one-to-five years, for capital expenditures. A long-term budget for these items will let you spread out costs and avoid substantial budget increases in any one year. In addition, consider requesting grant monies to pay for capital expenditures.
- Consider adding a budget line for the creation of an endowment fund. An endowment fund will help the organization achieve financial stability.
- Consider recommended guidelines provided by The Better Business Bureau:
- Executive compensation should be less than 10 percent of the entire budget.
- At least 65 percent of revenue should be spent on program costs.
- Create the budget with input from management, program leaders, and the board of directors. These individuals understand your operations and are aware of potential changes that could occur, so ask for their assistance. The board of directors should officially approve the budget.
- Analyze and investigate monthly. Once approved, the budget should be compared to actual results on a monthly basis and any significant variances investigated and documented.
Budgets can be an effective instrument for nonprofit organizations striving to plan for the future success of their organization. However, they must be used properly to be effective. Employing the tips above will help you ensure your nonprofit gets the most out of this powerful financial tool.
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