Written by: Jon Osterburg
Reading Time: 7 minutes
The purpose of a nonprofit budget is to help you better plan your income and expenses in order to accomplish your goals. On an individual level, we may use this important tool to make sure all of our living expenses are covered while simultaneously saving for a big vacation. For nonprofits, you’ll use your budget to predict fundraising revenue and ensure those funds will cover all your program and administrative expenses.
Learning how to allocate funding to ensure a balanced budget is an important skill to acquire. And having an effective budget is key for your organization’s overall financial health—as long as you’re able to follow it throughout the year.
In this guide, we’ll help you develop that skill by outlining five important steps you need to take when you sit down to craft and analyze your budget, including:
- Define the types of budgets you need.
- Choose the best budgeting model for your nonprofit.
- Create the budget document.
- Present your budget to the board.
- Revisit your budgeted vs. actual revenue and expenses.
Whether this is your first time really looking into nonprofit budgeting or if you’re an old hat, there’s always something to be gained by reviewing best financial practices. Let’s get started!
1. Define the Types of Budgets You Need
When you create your personal budget, you probably use just one piece of paper or spreadsheet. However, due to the nature of nonprofit accounting, your organization may need to use several different budgets regularly.
These types of budgets include your:
- Operational budget. This is the day-to-day budget you’ll use at your organization. In it, you’ll allocate your program and overhead costs, as well as predict the revenue you expect to generate annually through fundraising.
- Capital budget. This is the budget that covers your long-term projects. For example, if you launch a multi-year capital campaign, this will be accounted for in your capital budget.
- Project budget. Project or program budgets cover the revenue necessary for specific initiatives. They’re incredibly important when you launch a new program or project to ensure you have spelled out all possible relevant expenses.
Jitasa’s guide to fund accounting explains that all funds provided for nonprofit organizations need to be recycled back into the organization rather than taken as profit, hence the name “nonprofit.” Therefore, if your organization brings in more funds than it needs, you need to have a plan to use those funds for the organization to grow. That’s the purpose of having several different budgets.
You’ll use your operational budget to ensure your organization has the funds necessary to cover annual expenses. Project budgets are especially important when you consider launching a new program. And your capital budget ensures you have room for multi-year growth.
Considering which budgets your organization needs (it might be all three!) is the first step to creating accurate financial plans for your nonprofit.
2. Choose the Best Budgeting Model for Your Nonprofit
The model you use to create your budget is essentially just your approach for ensuring that your budget is balanced. You’ll typically take one of two approaches to do so:
- Outline your revenue first and balance with expenses.
- Outline your expenses first and balance with revenue.
The first option involves outlining your fundraising revenue, earned revenue, and other sources of income and taking inventory of those funds. Then, you’ll line up your expenses with the amount of revenue you have, always starting with the most important expenses like programs, personnel costs, and rent. When you run out of predicted funds, you’ll start cutting expenses to ensure a balanced budget.
The second option is simply the opposite approach. You’ll outline all of your expenses first, ensuring you’ve included everything you need to reach your nonprofit’s annual goals. Then, you’ll line up all of your revenue sources to ensure you’ll have enough to cover those goals. When using this model, you may need to go back and forth between cutting expenses and finding new revenue sources to ensure a balanced budget.
No matter which approach you choose, an accurate nonprofit budget should always be balanced. Without a balanced budget, your organization could go into the red, a very unsustainable financial position.
3. Create the Budget Document
When you know which types of budgets you’re creating and your approach to creating them, it’s time to start making your own! Your budgeting document will have a section for your organization’s revenue and another section for expenses.
When it comes to recording your predicted revenue, use your past fundraising successes to determine what you expect to earn this year. Consider each of your fundraising campaigns, grants, and earned revenue sources, then use one of these two forecasting methods to predict the coming year’s revenue:
- Discount method. Using this method, your organization will predict the amount of revenue you’ll receive from each revenue source and multiply each source by the chances you have of actually receiving that funding. For example, if you have a 70% chance of winning a grant and an 80% chance of earning a major gift, you’d multiply your grant by .7 and your major gift by .8, and then incorporate the resulting calculations into your budget.
- Cutoff method. The cutoff method is similar to the discount method, except that you’ll consider your entire fundraising revenue and your chances of receiving that entire amount. If you have a 75% chance of raising $1,000,000 this year, you’d calculate your revenue at $750,000.
These two forecasting methods will help you create a more accurate forecast for your fundraising revenue. Accurate forecasting will ensure you not only have the funding to cover expenses, but also have the ability to grow.
The expense part of your budget should be broken down into general categories, including your administrative, fundraising, and program expenses. However, you should also be sure to break them down further, getting as granular as you can with your data to ensure all expenses are covered. For example, within your administrative expenses, you’ll have costs associated with rent, employee compensation, and office supplies.
Again, review your past to predict the future. Look through your previous expense reports in order to determine your expected expenses for the upcoming year. Take also into consideration the new programs and projects you expect to take on during that time.
4. Present Your Budget to the Board
After you’ve crafted your budget, you’ll present the final product to your nonprofit’s board of directors. They have to approve your prepared budget before you can move forward with it.
Make sure you’re prepared to answer any questions they may have about the numbers as you present. The trick to this is to make sure all of your data is clean and hygienic. According to Accudata’s data hygiene guide, unclean data costs about $3.1 trillion a year in the U.S. alone. One of these costs is unclear predictions in your budget. If your data is not clean, you will be more likely to misrepresent it in your budget.
Ensure your financial data is accurate and hygienic. Then, when your board asks questions about your budget, you’ll have concrete figures to point them back to so you can answer all of their questions.
The next step is to predict the types of questions your board members may ask. Prepare to discuss why you’ve predicted certain amounts of revenue and where your expenses will be directed. Put yourself in their shoes and proactively provide the information they need to make a good and sound decision about your budget.
5. Revisit Your Projected vs. Actual Budget
Crafting your budget is more than just an item that can be marked off your annual to-do list and then shoved in a drawer. Instead, you should reference and re-reference the budget document throughout the year as a financial guide for your organization.
On a monthly or quarterly basis, pull reports such as your statement of activities and your statement of cash flows. These provide financial data that you can compare to the numbers featured in your budget. This will help you ensure you’re on the right track throughout the year.
More than that, you can use the numbers in these reports to calculate helpful financial ratios. These allow you to discover additional insights into your organization’s finances that will help you craft future budgets. For example, if your nonprofit operating margin ratio is positive, you might be able to prepare a capital budget that incorporates a multi-year expansion plan for your nonprofit to grow.
Crafting and using your nonprofit’s budget throughout the year can be challenging, but these steps outline how to create a strong financial plan. If you encounter challenges creating your budget, you can always consult a nonprofit accountant who will help you craft your budget and make an effective plan to stick to that budget for sustainable growth.
About the Author:
Jon Osterburg has spent the last nine years helping more than 100 nonprofits around the world with their finances as a leader at Jitasa, an accounting firm that offers bookkeeping and accounting services to not for profit organizations.