The Real Value of Your Budget
The annual budget presents a nonprofit’s financial plan for of an uncertain future by setting both limits and goals. The limits in a budget are expressed as authorized expenses. The goals show up as income lines as projections of what amounts of revenue are hoped for from different revenue streams. The combination is essential but confusing, which is one reason many nonprofits are not able to maximize the value of their budgets.
Many small and mid-size organizations* struggle because they take the numbers in their budgets too seriously—or not seriously enough. Nonprofit leaders may feel enormous pressure to match actual expenses to those projected in their budgets. They may simply disregard the budgets as unanticipated events make those forecasts seem less and less relevant. Neither of these approaches serve the higher potential of the budget—establishing alignment around the direction a nonprofit is heading in the year to come.
Authorizing Expenses.
A mainstay of nonprofit governance is that the Board of Directors will exercise its fiduciary duty through the annual budget review and approval process. Upon approval the organization has a formal plan for its financial activities in the coming fiscal year.
For all the time and energy spent by staff preparing the budget by staff, the thoughtfulness and diligence of the Board in reviewing it, the authority actually conveyed is remarkably vague. Three primary factors contribute to this:
Income Shortfalls. The expense authorization is not much good if the money isn’t available.
Stuff happens. The budget is a plan grounded in an array of assumptions about what will or will not occur in the future. Foundations will support certain programs, highly skilled staff won’t leave, a program won’t be shown to be ineffective, the economy won’t tank. When underlying assumptions prove mistaken, the budget has little to say about what the organization should do.
The authorization itself is not well defined.
Are expenses dependent on revenue or does the budget allow spending from reserves?
If needed, can funds be moved from one line item to another?
Is staff allowed to pitch unanticipated, new work? What is the approval process for this?
What are the consequences for going over budget?
Setting Goals.
Budget goals speak to multiple audiences. It will be important for prospective foundation funders to see that specific work they’re being asked to support has been incorporated. Organizations that rely on Board members to contribute or raise funds will be wary of setting goals too low for fear of demotivating donors. Set goals too low and accept the likelihood of unrealized potential. Set goals too high and they won’t be reached. Too low means that the organization will not have the impact that it could. Too high may mean trouble making payroll.
As with expense authorization, the income goals in the budget generally contains an enormous amount of ambiguity:
How much risk has been incorporated into the income goals? The greater the risks, the less realistic the goal.
What parts of the income goals consist of restricted funding and what are the implications for projected expenses?
Do income aspirations take into account multi-year contributions that are accrued during one budget cycle and yet spent over several?
Accountability for the projections may be difficult to establish. When goals are not met is the fault in the aspiration or in the performance? More significantly, does future success rest on improving performance or projecting more carefully?
The budget’s ambiguities around authorizing expenses and setting goals suggest that these cannot be the most important aspects of the budget. For that, we have to think about the budget’s value as a common starting point.
Establishing Alignment.
At the moment the annual budget is approved, it embodies a shared understanding—an alignment—of intent. The organization has collectively signed on to expectations about what will happen in the coming year. That alignment rests on three pillars:
The discipline of creating a budget requires that choices are made explicit. The expense lines in the budget are the price tags of a set of decisions. Not everyone will agree with all of these decisions, but they will know what they are.
The Board’s role in approving the budget elevates the significance of the choices being made. Through its approval, the Board designates the budget as the organization’s financial direction for the coming year.
The budget provides a critical starting point for ongoing alignment. Because it is written down, because it’s official, and because it embodied alignment, the budget provides a shared reference point when the organization encounters opportunities and difficulties. Sustaining that alignment over time requires additional tools, but the budget is the indispensable origin of that future alignment.
From the perspective of alignment, some challenging aspects of the budget become more manageable:
The budget is simply a plan, and shouldn’t be a straitjacket on future opportunity. The extent to which the plan continues to make sense will evolve as better information becomes available, risks are better appreciated and unforeseen opportunities are considered.
Adherence to the budget is only as wise as the continued accuracy of the assumptions and expectations that informed it. Of course spending should be reconsidered if income is substantially lower OR higher than anticipated. Staying the course doesn’t really make sense if you’re heading into a hurricane OR if you see a preferable destination sharp to port.
Rather than being treated as objects of power struggle or territoriality, Board authorization of unbudgeted expenses can be viewed as opportunities to strengthen alignment.
Plans are incredibly valuable, but they have their limits. Passage of the budget does not foretell an organization’s financial status fifteen or more months down the road. Rather it sets the organization on a specific path. But to make sound financial choices on an ongoing basis, the organization will need additional financial tools. Tune in next month. . .
* The issues discussed in this article will be less applicable to larger organizations that tend to have more stable income streams and relatively modest changes in expenses from year to year. Nonprofits with multi-level budget responsibilities are also likely to enforce greater conformity with the budget to provide clarity to more junior decision makers.