Considerations in Budgeting for Nonprofits
Guest post by Cherian Koshy
Budgeting in nonprofits can often seem like it’s a daunting task, but for many at this time of year, the pressures of fiscal year end are upon us and the annual budget is on everyone’s mind. In this month’s guest post, Cherian Koshy, CFRE, CAP, demystifies the process and points out some very useful ideas to make the most of your budgeting process.
This post includes personal budgeting metaphors but there are not many good analogies between individuals and nonprofits. As with all things, please make sure that you are connecting any advice to the conditions and circumstances of your nonprofit and seek out qualified, trusted counsel to assist.
What is a Budget?
We all intuitively know what a budget is but how we think about budgets impacts our organization’s inner workings significantly. Creating a budget means that you begin with identifying your sources of income. For you, personally, this means how much you expect to make this year. If, after taxes, your take home salary is $3,000 a month, that means two things:
a. You can’t spend more than $3,000 a month and,
b. You can’t spend more than $36,000 a year
With your month and year limit, you can now get to work giving each dollar a job. For individuals, there are various expenses that go into creating their own budget. Items like housing are costs that need to be paid in the same amount every month. For nonprofits, items like rent and staffing are fixed expenses. Then for individuals there are variable costs such as food. These are expenses that can be minimized but not eliminated. Finally, there are discretionary costs. These are costs that are value-based. For example, individuals might choose to give to charity, go on vacation, or contribute to retirement.
Many organizations overlook conducting an assessment that identifies whether your resource allocation matches your values. For example, our family values philanthropy but we quickly noticed that our charitable dollars were at the bottom of our list, not at the top. This meant that everything from Netflix to tacos decreased our charitable giving even though that wasn’t our intention.
What is Zero-Based-Budgeting and Is It Right for Our Nonprofit?
How many times have we heard, ‘that’s not in the budget’ or ‘we don’t have the budget for it.’ When I hear this from boards I counsel, my immediate question is ‘why?’ If this is something we should be resourcing, then we need to reconsider the budgeting process. For nonprofits, it might be investment in new staff, or new systems, or help jump starting a particular program or activity. Unfortunately, many times resources don’t align with the needs. Likewise, any organization that has, thus far, weathered the pandemic and economic conditions and shifted their practices, should consider a review of their budget process.
There’s a philosophy in budgeting called Zero-Based Budgeting and while this approach would not be recommended for every nonprofit every year, it is an excellent exercise on a periodic basis for some.
The nonprofit begins with an exercise in goal setting and values identification. It then builds a budget from scratch with no requirement to allocate resources from a previous year’s budget. As you deliberate over expense items, you are required to justify the needs and costs as well as alignment to your values. If there’s disagreement on the need, the allocation of the resource, or on values, it’s placed lower on the priority list until everything is accounted for. Then whatever meets some criteria gets what’s left over, while those that don’t match up on need or value, get deferred to a future when they can be justified.
In the end, you should have a budget that accurately reflects your needs and values and can be updated for several years without having to revert to ZBB each year.
Budget Warning Signs
Not every organization is going to go through the process of ZBB or some other exercise on budgeting. That’s why there are three warning signs that any board members or staff should be on the lookout for in any budget:
First, does the budget present expenses greater than revenues? Put another way, are you spending more than you are making? The obvious concern here is that there is a high likelihood of running out of cash, depending on a savings account or line of credit, or expecting that your donors will foot the bill for a misallocation of resources. While there are exceptions to any rule, this is generally the first clue that an organization has a problem. The simple solution to this problem is to write a balanced budget where expenses equal revenues and present a budget amendment if additional revenues occur.
Remember, your budget is a roadmap for how your resources will be allocated. They prevent you from spending more than you had planned to ensure that resources are available to do all that you planned for each year. As everyone knows, you can go out to eat and spend your entire monthly budget on food in one night. By setting up a budget you are constraining your future organizational self from a financial mistake.
Second, does the budget predict revenue increase against fixed expenses year over year? Put another way, are you looking to get more money by spending less? This is a red flag because expenses always increase. It’s more expensive to print, mail, cater an event, or conduct programs each year. Any budget should reflect this fact and revenues increase in proportion to the expense budget.
Many nonprofits don’t calculate the cost to raise a dollar. This is a mistake and causes considerable heartburn come budget season.
Here’s a simple formula:
___________________ = cost to raise a dollar
For example, $2,000 is spent on a fundraising event where $6,000 is raised, the cost to raise a dollar is $2,000/$6,000 = .33 or 33 cents. While there are benchmarks about standard costs to raise various donor dollars, my recommendation is to begin by making sure your calculation is correct. Many fail to allocate expenses by not including staff time and other costs into the top number. For example, an event that has $2,000 in direct event related costs might take a month of planning (160 hours of staff and volunteer time) to execute. At even $15 an hour, the expense line more than doubles to $4,400 and the cost to raise a dollar is now 73 cents, well above nearly every industry average.
Boards and staff can quickly identify a faulty budget when they see that expenses don’t increase in correlation to anticipated revenue that is some function of the cost to raise a dollar. If, for example, last year’s event truly had $2,000 in expenses, then a revenue goal of $10,000 would require at least $3,300 in expenses. The same is true of direct mail or major gifts where either hard costs or staff time would need to increase in relation to the overall revenue goal.
Finally, and perhaps most importantly, does the budget require gap fundraising? Put another way, has the budget determined expenses first and donor dollars will need to fill in the gap? Run – do not walk – away from such a budget. An expense side budget fundamentally misunderstands how nonprofits function and how fundraising occurs. Nonprofit budgets cannot be made whole by wishful thinking, fairy dust, and unicorn wings. Nor should any fundraiser or staff be made to think that they have failed because they were required to do the unimaginable.
Inherent in any fundraising data set are the keys to understanding what goal amount is likely and what is a stretch amount. By looking at factors such as:
- Average gift size
- Donor retention rate
- Donor acquisition rate
- Cost to raise a dollar
- Available fundraising budget
Any nonprofit can identify what their next fiscal year fundraising goal should be. For example, if you have 100 donors at a $100 average gift size and a retention rate of 60% and a reacquisition and acquisition rate of 10% and a cost to raise a dollar of 40 cents and an increased budget of $1000, you can be relatively sure of the following:
- Next year’s revenue from previous donors will be $6,000 vs $10,000
- You’ll get $1,000 in recaptured donors and $1,000 in new donors
Your previous year budget will get you about $8,000 in donor revenue.
- To get back to even, you’ll need to spend $800 of your increased budget
- Your remaining $200 of budget will get you to an extra $800
Could you set your next fiscal year goal at $11,000 (a 10% increase)? Yes, but this is a deviation higher than what the data indicates. At those small numbers, most boards would be comfortable passing that budget. At $100,000 or $1M or more, my personal comfortability wanes. While I’ve focused on fundraising in this specific example, it can be applied to programming or earned revenue with modification.
Budgeting need not feel like it is out of reach for any nonprofit staff member. With the right tools, anyone can build a budget or use a common sense approach to identifying problems with a budget. As you get more familiar with budgets, you’ll be able to identify additional sources of tension.
Cherian Koshy is a Certified Fundraising Executive (CFRE), Chartered Advisor in Philanthropy (CAP), & AFP Master Trainer. Cherian is the Chief Development Officer and principal at Endowment Partners, an investment management firm that solely focuses on nonprofits and foundations. He currently serves on the global board of the Association of Fundraising Professionals and is the Chair of the Iowa Commission on Volunteer Service (Volunteer Iowa) as well as eight other boards and commissions. As a coach and consultant, he helps organizations to scale their revenue growth and build stronger teams. The nonprofits he works with design strategies that give them back time and develop predictable success.
Stay Up-to-date on Fundraising News and Resources