Preparing for Financial Uncertainty in 2021
Financial planning always involves some level of uncertainty, but 2021 shows every indication of taking that uncertainty to an absurd level. The pandemic, recession, stock market volatility, government shortfalls, election and evolving foundation and donor priorities are combining to create as unpredictable a funding environment as we’ve ever seen.
With budget season now upon us, it’s tempting to approach income uncertainty primarily as a major budgeting challenge. But this current problem only distracts the longer term issue: how to maintain both organizational capacity and sustainability through this period of uncertainty? Trying to plan in this environment may even be counterproductive. Instead, reduce the emphasis on planning and concentrate on preparing for whatever may be ahead. Focus on the bigger picture, adjust the relationship between Boards of Directors and Executive Directors and adapt different tools to prepare your nonprofit for our unpredictable future.
The Budget.
The annual budget isolates the coming year from the rest of the organizational timeline. This enables the organization to establish a shared set of expectations over a finite period of time, allowing the Board to cleanly delegate responsibility to the Executive Director, and facilitating reporting and accountability.
Budgets generally seek to match income and expenses during the coming year, keeping any imbalance to a minimum. Since the organization controls expenses, the budget can reliably predict these. Income is harder. Whatever the methodology used to validate income estimates, the unavoidable fact is that future income depends on the future decisions of donors, funders, clients and even governments. When these are in flux as they are now, the budget’s central purpose is undermined—if you can’t anticipate income, how can you match it to expenses? How can this be a plan?
Nonprofits nevertheless determined to maintain the role of the budget as a plan have two options:
Proactively cut expenses to increase the likelihood that income will be sufficient.
Hope for the best, budgeting for sufficient income to appear.
Sadly, the result is likely to be a bad plan.
The whole point of even having a plan is to facilitate the longer term goals of maximizing organizational capacity and sustainability. But imposing and then implementing a plan in a chaotic environment is unlikely to end well. Better to prepare for a more dynamic year by embracing ways of thinking, internal processes and financial tools better adapted to the challenges ahead.
The Bigger Picture.
Income and expenses are essential concepts for budgeting (and financial reporting), but they have a more limited role to play in maintaining organizational capacity and sustainability over the longer term. Predicted income during the coming year is only one element of organizational resources. Expenses are meaningful to the extent they contribute to capacity, the organization’s ability to accomplish its mission and sustain itself over time.
Resources includes four components:
Predicted Income. Funds to be raised during the budget year.
Reserves. Accumulated funds from prior years.
Restricted funds. Funds already received that are designated for budget year expenses.
Year-end fundraising. Amounts to be received prior to the beginning of the budget year.
As much as possible, resources, not just predicted income, should be the primary factor in financial decision making. The greater the availability of resources that are not predicted income, the less disruptive income uncertainty has to be. On the other hand, in the absence of other resources, predicted income will be more critical and uncertainty around that income will be harder to navigate.
Capacity. From the perspective of the budget, an expenses is what something costs. Taking a broader perspective means valuing an expense as its contribution to organizational capacity. In assessing the value of an expense consider:
Is the expense necessary to meet commitments to donors, constituents and other stakeholders?
Is the expense an investment in the longer term success of the organization? For example, outstanding staff are not just valuable for the work they do in the budget year, but for the benefit to the organization and its mission that they will provide in the future.
Is the expense sustainable? Resources to cover the expense may be available even without predicted income, but for how long?
Expenses that do not contribute significant value may be eliminated without damaging the organization. These should be cut immediately, even if current income is sufficient. Those cuts increase the resources available to fund expenses more tightly bound with capacity.
Finally, nonprofits that are most dependent on staff expertise and relationships create significant risks by not taking a longer term approach to income uncertainty. Balancing costs against capacity reduces the likelihood that jobs will be cut unnecessarily solely to satisfy budgeting requirements.
Board and ED.
Enabling a clear demarcation of the roles of Board and ED is an essential function of the annual budget. The Board exercises its fiduciary responsibility by approving a budget and then delegating its implementation to the ED, who becomes responsible for the success of that implementation. Income uncertainty—and the urgency of prioritizing bigger picture concerns, undermine the ability of the budget to play this role. Resources and capacity considerations require financial decisions beyond the annual scope of a budget. These decisions are not appropriately delegable by the Board.
The Board and ED can mitigate the absence of a clear financial plan by adapting their working relationship to improve their ability to collaborate and engage in collective decision-making. A best case scenario would have the ED and Board prepare for income uncertainty by finding consensus on:
The highest priority capacities to be maintained.
The current level of resources available to support those capacities.
The scope and nature of the income risks in the coming year.
An annual budget that captures current aspirations for the coming year.
A short term budget plan, perhaps for the first quarter, that provides authorization for expenditures in the near term.
A monthly schedule, to review the latest Cash Flow Projection (discussed below).
A very short list of financial indicators (for example, total resources falling below a certain point) that will trigger decision-making.
Create a team. Effective collaboration won’t happen just because it should. Engage only willing Board members with the skills, temperament, and relationship with the ED to facilitate a strong working relationship. That’s unlikely to be all Board members. Far better to engage a small team. If that team happens to include Officers—Chair or Treasurer, for example—so much the better; this can ease their relationship with the rest of the Board. If no Board members are appropriate for this team, consider other stakeholders—former Board members, advisors, etc.—to whom the Board can delegate its participation.
Start now. Preparing for the financial uncertainty ahead requires developing and learning to use new tools, new rules of engagement between the Board and the ED, and new ways of thinking about finances that prioritize the longer term over the coming budget year. All of this will take time and energy, and maybe a false start or two.
The Right Tools.
The annual budget is so fundamental to nonprofit financial management, it’s easy to forget that it’s just a tool. The uncertainty ahead means that a fixed definitive plan, as embodied in the budget, will not have the value it normally does. A Cash Flow Projection is a far more flexible tool, appropriate for these more volatile times. The Cash Flow Projection considers available resources as a starting point and then shows the impact of anticipated income and expenses on those resources. As new information becomes available it is incorporated into the projections. Most importantly, the Cash Flow Projection facilitates ongoing financial decision-making and reduces the inclination to rely on outdated plans. More about the Cash Flow Projection can be found here and you can download a Model Cash Flow Projection here.
Even though the annual budget will not be able to fulfill many of its critical functions, including planning, delegation, and accountability, it remains extremely valuable. Most helpfully, it embodies shared organizational aspirations for the coming year. Staff, the Board and funders can align around these aspirations, which can guide decision-making and communicate priorities, even absent the emphasis on accountability.
Other tools can address some functions normally embodied in the annual budget. A quarterly budget, for example, can provide authorization for agreed upon spending. Some organizations may start with an aspirational annual budget and then use periodic amendments to reflect changes in expectations.
No tool is available to take over two of the annual budget’s core functions—delegation of financial responsibility to the ED and providing a framework for the accountability of the ED to the Board. As discussed above, addressing these requires adjustments in the relationship between ED and Board.
Additional Preparations.
It’s one thing to see the benefit of approaching income uncertainty with a longer term orientation, but the obstacles to doing so may be overwhelming. The Board may be too set in its ways, the ED may not be settled in their role or fiscally adept enough to champion change, the détente between Board and ED may seem too fragile, the politics too complicated. Perhaps most critically, the ability to look further down the road requires having at least some resources available beyond projected income—not everyone does.
With this in mind, some relatively minor steps may be more achievable:
Identify potential financial advisors and build relationships so that they can be called upon when the need arises.
Review policies, particularly around separation payments. These may influence decisions around staff departures so adjust as necessary to optimize those decisions.
Increase and improve communication with Board, staff and other stakeholders so that poor or miscommunication doesn’t unnecessarily compound the challenge.
Explore borrowing and other financing options that may help mitigate shortfalls.
None of this is ideal—or easy. Budgeting requires making financial decisions in advance, before adequate information is available. Without that information, those decisions are not likely to be very good. Emphasizing planning when it simply cannot be done well is not a good use of anyone’s time and energy. Instead, put that effort into preparing, so that when the time does come to make those decisions, your nonprofit is as ready as possible. If you would like to discuss any of the ideas here or you have any questions please don’t hesitate to reach out.