For organizations managing to a calendar year, January told you how effective you were as a financial forecaster. Did it bring good news or bad? Is it what you expected? Does one month even matter?
How organizations develop and use budgets has changed over the past decade and it’s essential that leadership reflect the new thinking toward financial strength.
Twelve Month Budgets Are Arbitrary
An annual budget is a necessity for almost every funding or financing request, whether it’s for a grant or a loan. On the other hand, experienced CFOs will tell you that creating a budget twelve months out and chaining your organization to those numbers is folly. In today’s environment, information on price inputs, societal trends and economic developments, to name but a few, are far easier to obtain and react to than decades ago. Therefore, it behooves an organization to reflect new information into the budget as soon as it’s known. As Russ Banham states in his May 1, 2011 article in CFO Magazine , “Let It Roll”, organizations found their annual budgets completely irrelevant during the Great Recession. As a result, sophisticated organizations are utilizing flexible, rolling quarterly budgets and event-driven planning.
Conventional wisdom says that nonprofit budgets should break-even. Jeanne Bell of Nonprofit Quarterly in her blog post “Nonprofit Budgets Have to Balance: False!“ says, “I’ve come to see that one of the reasons executives struggle to break the break-even habit is that foundation grants and government contracts are typically break-even contracts.” She advises that more important than a break-even budget is the organization’s financial objective. That ultimate objective should dictate the budget strategy. Consider her example scenarios below.
As we’ve advised in our articles here and here, organizations should be holding emergency reserves commensurate with its risk profile with three months of expenses being an absolute bare minimum. Organizations building a reserve from scratch or reinforcing an existing reserve should be generating more inflows than outflows to strengthen their financial standing.
The most common reason organizations adopt a deficit is if reducing expenses, particularly salaries or headcount, decrease revenue even more. This is a sign that an organization needs to rethink its programs and organizational structure to survive.
A less common reason for a planned deficit is when an organization diverts funds toward innovation, expansion and growth. This strategy presumes the investment will put the organization in a stronger position to deliver on the mission.
So when does a break-even budget make sense? It happens when projected outflows just about equal projected inflows. Leadership recognizes that any cuts to expenses, particularly fundraising costs, would reduce revenue significantly. But raising revenues isn’t feasible either, funds are insufficient to finance growth.
As financial outcomes become even harder to predict, despite the increased availability of information—or perhaps because of it—sticking to a budget is oh-so 20th century. Today budgets should be adaptable to a strategic outcome, not the other way around.
Talk to the financial experts at Fairlight Advisors to learn more about managing your nonprofit’s investments. Schedule a free consultation today!
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