Is Your Program Budget a Monster in the Making?

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In most nonprofit organizations, the forlorn wail, “We’re over budget,” is enough to send staff scurrying in all directions like so many villagers from the worst B-horror movie. Like Frankenstein’s creation, budgets are human-made and can become frightful monsters in their own right if misconstructed and not looked after properly.

Budgets are, at best, well-informed speculations based on a combination of historical records, anecdotal information, gut feelings and hopes. No matter how well thought out, how well planned and studied, budgets are still nothing much more than management’s best-guess working draft for the future.

Ask the largest, overall organizational planning questions, first: such as, “If we had our druthers, would we do something different than our revenue sources allow? Are we doing our best possible work, and, if not, can we address barriers through changes in our budget? Is the trend in the organization toward organizational growth or retrenchment—or is the organization stagnant and not investigating its possibilities? How is our infrastructure functioning (do we need a telephone system that works)?”

Questions on the expense side are, unavoidably, at the mercy of the questions on the revenue side. Forecasting revenues, especially major grant funding, is imprecise work, demanding full attention by everyone connected to fund development, including board members. A solid understanding of the organization’s historic revenue stream is necessary—are they trending upward or downward, and why? Often, especially in today’s uncertain economic environment, getting a handle on what grants will be coming in during the next 12 to 18 months is akin to predicting the sequence of numbers in next week’s lottery. Ask yourself some hard questions such as, “Should I no longer factor in the MegaBucks Foundation, since we are in our third consecutive year of seed money?” and “What do we do now that we’ve lost half our donors over the past two years while we were focusing on a foundation funded special project?” (Often, an organization’s very life depends upon continuing support from individual donors while foundations provide seed funding—but the seductiveness of those major chunks of cash will often cause us to lose sight of the importance of money that is more under our control.)

Predicting revenues is difficult and error-prone. Expenses, on the other hand, are usually the easiest predictions to make because most are well within management’s control and are reasonably consistent—adding a few percentage points to last year’s numbers will give a close estimate. The relationship between revenues and expenditures is a dependent one: more revenue enables more spending; less revenue means less spending. Sounds simple, right? Then why do so many organizations focus so much time on expenses during their budget processes? Probably because it is the one area of the budget that people can get their arms around.

Even with expenses, the budget process can go haywire because managers spend too much time on the minor incidentals and not nearly enough time on the major expense categories.

I would hazard a guess that in your own organization you spend most of your money on the line items of salaries and employee-related costs. Most nonprofits spend upward of 75 percent of their money on these categories. Focus on your salary and benefits structure, from top to bottom, and make it work within your financial resources.

If your organization is undergoing rapid expansion resulting from a capital campaign or major start-up funding for a new program, there needs to be special care in estimating the costs involved, as well as their effect on overall organizational administrative costs. You are inventing history; at this point, you have nothing in your own financial records to compare projections to. Be conservative with your estimates—meaning you should over-budget a bit for the odd surprise that new programs invariably bring. Remember, proponents of new programs tend to err on the side of optimism to get things off the ground.

Entity-level budgets are typically the budgets presented to the board, usually created from combining different program-level mini-budgets, including the administration and fundraising departments. The allocation of percentages for indirect costs need to be reviewed during the budget process and modified if necessary. The annual budget should then, if possible, be converted into a 12-month cash flow budget showing seasonality—revenues and expenses that occur only during certain times of the year. For example, grant and special events revenues tend to come in huge chunks, not evenly spread streams. It is important to understand this seasonality in order to plan your organization’s cash flows. Monthly numbers do not come from simply taking all the budget line items and dividing by 12.

You’ve gone through the work of preparing a budget, presenting it to financial and development committees, selling it to your staff, and entering it into the annals of board minutes as approved. Now what? Well, this is the time when a good budget can really shine. During the year, as interim financial statements are produced, budget-to-actual variance reports let management and board members know how your organization is actually doing with what was predicted. Variance reports should be your early warning system, like a canary in a coal mine.

These reports should not compel continuous revision of your annual budget; that can lead to embarrassment if you report to a funder based on the wrong budget or lose track of which budget you are working from. It is my belief that budgets should be amended just once, at the midyear point, and only after a series of discussions about any unanticipated new major funding and needed program cost modifications. More than a roadmap, a good budget is management’s best tool for instilling and maintaining fiscal responsibility and accountability.

Finally, make sure that program personnel have timely access to the all-important actual-to-budget numbers.
I have frequently heard program directors bemoan the fact that their initial input in the budget process rarely leads to program-specific variance reports during the year. This lapse of organizational foresight has the effect of disconnecting them from the important ongoing monitoring required for a properly managed organization. In order for a budget to have meaning it must be shared with key personnel. (See the articles on open-book management in the April 2001 Nonprofit Quarterly.)

A lack of foresight during Frankenstein’s construction, as well as misunderstanding and miscommunication between the creature and the villagers, ultimately led to the monster’s demise. Likewise, a lack of foresight, misunderstanding and miscommunication in developing and using a budget can be destructive to organizations’ fiscal well-being, making executive directors feel as if they are being pursued by an angry mob.

Jerry Soto is an auditor at Quigley & Miron, a Los Angeles-based public accounting firm specializing in the nonprofit sector. Previously, as chief financial officer at the California Association of Nonprofits, he provided financial technical assistance to organizations statewide. Mr. Soto serves on the finance committees of several organizations and participated in the national “Unified Chart of Accounts” project..