Nonprofit Budgets Have to Balance: False!

As nonprofits serving people and communities in these difficult financial times, we don't expect things to turn around for our communities in the near future. Many of us are wondering: how can we achieve a balanced budget in these times? When is it okay not to have a balanced budget?

A potentially harmful habit practiced in many community nonprofits is presuming that a break-even budget is mandatory. Board members and staff may be under the influence of the false but persistent ‘nonprofits can't make money' myth as they develop the year's income and expense plan. Like other conventional wisdom, the balanced budget is based on sound concepts, but can become unnecessarily constricting. Instead of "How can we make the budget balance?" the annual budgeting cycle should begin with the question, "What financial outcome does our organization want or need this year?" Different scenarios lead to different decisions about what the budget's bottom line should look like:

1. We need to increase reserves or pay down debt: adopting a surplus budget. When the organization's leaders decide that its cash and other reserves are lower than ideal, the organization can plan to generate more income than expenses, creating surplus funds that can be used in future years. A surplus may also be needed to provide funds for paying down debt or for easing cash flow. The board should direct staff to develop the draft budget by determining realistic income targets that nonetheless outpace expenses. If the organization can deliver on a surplus budget, it will have higher net assets (net worth) at the end of the year, and enjoy a stronger financial position.

2. We can't gain ground now, but we can't lose ground either: the break-even budget. Typically, organizations choose break-even budgets by default and the skin of their teeth. A first cut on the budget shows expenses much higher than revenue, so the staff then tries to figure out how to increase the revenue number (but still stay close to reality) and decrease the expenses (but not damage programs). The staff and the Finance Committee tack their way towards a break-even budget, and hope that their cautiously optimistic projections work out.

3. There are three typical reasons for adopting deficit budgets. First and rarest, the organization's leadership decides that its cash and other reserves are more than sufficient, and so spending some of those reserves in the coming 12 months is a good idea. They may choose to make one-time purchases or expenditures, or to give the staff one-year, non-permanent raises. At the end of the year they will have more expenses than income for the year, and thus a deficit for the year.

A second reason for a deficit budget is a decision to invest. For example, the organization may invest funds in strengthening its fundraising capacity, or in new programming. Leadership believes that resources from previous surplus years can be risked as investments in future programmatic or financial paybacks.

An all-too-common third reason for adopting a deficit budget is a decision that ending the year in a worse financial situation is the lesser evil. For some organizations, simply cutting costs may not be the right financial decision. For example, in an organization that relies on earned income, cutting staff will result in lowering income. The leadership will need to re-work the way its services are structured--perhaps too complicated to do in just a month or two. Or an organization may be in executive transition, and the board believes that the dip in revenue is due to the absence of an executive director, and expects that income will go up again. They decide simply to "bite the bullet" this year--and they believe they can afford it.

At the end of a deficit budget year--assuming that reality matches the budget--there wil be a lower net worth and the organization will be in a financially weaker position. But "weaker" should be in quotes because a planned loss may, in fact, be a sound, strategic fiduciary decision by a board. For example, investing in a new website may mean a deficit this year, but could reap substantial gains in fundraising in coming years.

The core issue is intentionality. An unplanned deficit reflects an error in planning and/or execution, while a planned deficit is an investment of accumulated reserves for the benefit of the organization and its constituents.

Consulting to nonprofits, 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. We must prove that we spent exactly what we raised. But while grants and contracts are designed to break even, organizations are not. Healthy organizations require cash reserves, which means they must generate excess cash in at least some of the years.

The majority of community nonprofits with whom I work need to build reserves. But especially as we head into recession--which classically means fewer resources and higher demand for nonprofit services---developing a credible surplus budget may prove impossible. We may have to settle for break-even because we don't see opportunities for income growth or expense cuts. But we'll be settling for break-even, not aspiring to it.

 

Jeanne Bell, MNA, is CEO of CompassPoint Nonprofit Services, and consults to nonprofits in business planning, financial systems, and sustainability. She co-authored Financial Leadership for Nonprofit Executives (Fieldstone).

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Comments

Question about budgets/fundraising:
We ended last year with a significant surplus due to a large individual donation one month before our fiscal year end. Thus our P&L shows a net income of $32,000. We know we'll need these funds to operate existing programs that are in growth phases and our ED's salary, which is the most difficult to raise through grantwriting.

On paper, it appears we are in great shape, and we're not hurting, however, we're coming to year's end again and we've used up that surplus and are awaiting several pending grants. Individual and business donations are down.

How do we make the argument to potential funders that we're not flush, nor are we squandering our surplus from last year?

Your question on how to justify your surplus to funders relates to the point Jeanne made about intentionality and how to communicate the story of your organization. It sounds like your surplus was, in fact, intentional in that you were going to use the donation to fund expenses over the following 12-month period (although it didn't happen to coincide with your fiscal year). This is the narrative and plan you could be communicating to your funders -- hopefully they will appreciate your foresight and financial management skills!

Yes, adding to Rob's excellent response, it's also valuable to contextualize your year-end surplus ($32,000) in terms of 'months of reserve.' That is, how many months of spending in the coming months does the $32,000 represent? Divide your 2008-09 budget by 12 to determine one month. It is good practice to have 2-6 months reserve depending on your situation. If you get there, you can describe it as good finacial practice and a board mandate as opposed to being 'flush.'

We all have wish lists. For some groups, these are well defined and approved capital expansion/acquisition plans. Surpluses enable organizations to implement non funded or under funded plans that strengthen its programs and services. As a donor, I appreciate it when the charities I support can tell me immediately how they can use surprise gifts! What really works for me is when they can articulate how many more individuals can be served!

I previously worked for an organization that put money in "deferred maintenance" every year. The money in deferred maintenance was used to buy a new HVAC unit, put on a new roof, etc. We also designated large donations like that into the next fiscal year budget. They called it deferred funding. They deferred it into the next fiscal year.

You are absolutely correct! Not-for-profits should try to achieve a surplus every year. While success is measured by more and better service, money is required to produce those services. Too many boards (and staff) don't realize there is no legal prohibition against their organizations earning a profit. If you lose money, you won't be able to produce any services.

Jeanne: Thank you for the good article. A completely agree on the need for reserves. One thing my organization is struggling with is figuring out a rational basis for answering the question "How much of a reserve should be maintain?" Hint: This would be a good topic for another article!

We are also interested in this same question: "how much of a reserve should be maintain?" Please write an article on this topic soon...

Our goal is to have one year of operating expenses in reserve funding. Our nonprofit agency has been in existence for 10 years. We have a small staff of 5 people and an operationg budget of $325,000 a year. We are $24,000 short of having one year of operating expenses in reserve funding. We are currently in a donated facility. When we meet that goal and the recession is over we plan to begin a capital campaign to build a new facility.

Thank you for this great article! I found it by doing a google search of "non profit budget reserves" and it proves to be very timely to my organization.

We will end our fiscal year with a net worth that will allow us to establish the beginning of a reserve fund. We'd also like to use a portion to boost our promotions budget in the next fiscal year. Would this mean that, all else being equal, that our budget for 0809 should be a deficit budget? Knowing that we will intentially spend reserves to pay for our planned increase in promotions spending? Do I understand that correctly?

As I've been working on the budget -- I have been struggling with how to account for using reserve funds and have it be reflected in the budget.

Your guidance is greatly appreciated!

Wendy

Building nonprofit reserves is critical to your organization's health. Having a surplus budget this year does not mean you have to have a deficit budget next year - plan for growth. The reserve funds are an asset on your balance sheet, and do not have to be "spent" the following year. This is how your organization can grow and become financially stable even in unstable times.Our budget this year has actual reserve targets - we want to put away 5% in operating reserves, 5% in facility reserves (we own two building complexes), and 5% in venture reserves. These venture reserves will build a fund from which we can plan our growth in other areas or strengthen some of our programming. This is unrestricted money that we can use for future health.My real point is that we can plan not to be broke every year!Dana

Great response, Dana. Wendy, from a presentation standpoint in the near term, your annual budget as presented to your board of directors for approval can have a notes column on the far right highlighting notable things in each row. For instance, on the bottom line deficit rown, the note could read: "Intentional deficit funded by reserves." You might also consider putting at the botton of the page a box that lists "Opening Cash Reserves" with the corresponding dolllar value you expect to begin the year with and another row called, "Ending Cash Reserves" with the corresponding depleted reserve projection your budget would yield. This way Board Members can assess whether they are comfortable with the extent of deficit spending you are proposing.

This is a great article, with lots of good comments from readers. I find this especially important for small nonprofits, because those are the ones more likely not to have depth of financial and accounting expertise on their board or staff, and the ones struggling with deficits.

But regardless how much you vacillate between surplus and deficit, you must continue to focus on growing your budget (and by extension your charity). It took five years for our nonprofit to achieve a budget surplus, and I’d even venture to say that was purely by chance. But despite living hand-to-mouth during our formative years (and chewing on a lot of antacids), our budget actually grew by some 25% to 30% in each of those years; it just never broke even. Financial supporters will not write checks to a stagnating cause, so if you can accept the fact that budgets do not have to balance, you can still grow a successful nonprofit, even in successive periods of deficit. You just don’t want to do that forever.

Last month or two of has really hit our non-profit hard- and for the first time in many years (I'm founding/exec director of 22 years) I am looking at the need for significant cost reductions-- the overhead/program expenses are a piece of cake compared with staff trimming-

Any thoughts on the most effective and fair means of cutting staff costs-
this is painful stuff!-

I do think we'd gotten a bit 'comfortable' with having enough staff to cover our programmatic needs-- but this also means, for once we had attracted and kept a good group of people for our needs.

I'd welcome any feedback!

Thx.

Unfortunately, there's really no cookie-cutter "fair" way to make staff cuts & reductions. Every situation is unique, and some of your decisions may have to be driven by personnel policies, longevity, labor agreements, etc.
That being said, I would encourage you to review the core functions of your agency and compare that to the staff you consider most productive/most valuable. Some folks will insist that you not consider individuals in your decision-making process for staff cutbacks, but I think that's a mistake. It's important to keep your most productive and dedicated employees in place, both from a morale standpoint and from a productivity standpoint.
The bottom line is that there's no simple solution to painful cuts. Asking staff for their ideas about how to streamline operations is helpful, but you've got to accept the leadership role and make the ultimate decisions.
One final suggestion - many agencies cut back on travel and training while they're reducing staff to show how they're cutting corners and tightening belts. I do the opposite; if you have less staff, it's more important than ever to make sure those staff are well-trained and appreciated. The morale boost from an offsite training will be far more valuable than the additional 15 or 20 minutes per week that not going to the training would produce.

Bill, these are such important questions. We're working on it. Be on the lookout for our February 1 issue, "The Layoff Issue."  Jan

I'm developing a Nonprofit and expect to have a surplus the first year. What is the best way to handle this money, from the donors point of view? This surplus will be our reserve,or emergency fund, but can donors live with that? Any suggestions?
SarahB.

It is not only reasonable but responsible of you to have an operating reserve and will give comfort to your board. It's SOP and you won't need to explain it to your donors.

An acceptable loss is all relative to how much in reserves an organization has.
Having said that, is there an 'acceptable loss' standard?
A simple math example for my question.
The operating budget for this organization is $1,000,000.
They have an endowement of $2,000,000.
They bring in $850,000 in donations/fundraising annually.
Thus, they lose $150,000 a year and this has been happening for many years, obviously not an ideal situation.
The need for this organizations programs are great and the simple solution is to shrink programs to match donations/fundraising.
Is there a base answer as to how long the above sample numbers should continue before somebody cuts the programs?

I always suggest to my non-profits to make the budget balance to zero by earmarking most those excess profits for a cause, like if they are trying to pay down debt. Since a budget is a guess and a lot of my non-profits receive their money for individual contributors or businesses if they show a "profit" the contributors are less open to giving a contribution. Especially if they are a school organization and the economy has been so tight. Is this how you would handle it?

Negative. Said organization hasn't received a 'profit' in 9 years. Quite the opposite, it's been a six figure loss for the past 5. I think it's a matter of us having too much staff and the community is not responding to our financial needs or our services aren't that warranted.
Oh, please pardon the duplicate post.

Is there a level of unacceptability regarding a fiscal loss?
I realize it's all relative as to how much or if there is an endowement.
Nonprofit X has $1,000,000 in total expenses for a year.
Nonprofit X brings in $850,000 in donations/fundraising.
Any interest from the endowement, positive or negative either adds to the loss or adds to the income.
Lets assume the above situation has been occuring for 7 years.
Most non profits mission's are great and their programs are needed.
However, after what stop loss point should this organization start to cut programs/employees?

How important is it for a non-profit to complete it's budget by year-end? We haven't passed our budget until January for the last three years that I have been employed as executive director and I haven't seen any problems occur because of that. In my last board meeting a couple of nights ago, a couple of members of our board wanted me to have the budget complete by the middle of November. I realize that many, if not most, for profit and maybel non-profit organizations, require budgets to be done by the end of the year, but, as I said, we have had no problems resulting from passing it in January. When I asked everyone on the board why it was important to do this, no one could come up with a real answer, I received very vague responses that basically translated to most businesses do it that way or that's the way I or my business have always done it. All I am saying is that it seems better to have the accurate figures you would have by budgeting in January vs. two months worth of forecasted figures. I'm open to being convinced of their position, but they can't seem to tell me why it makes more sense. Advice?

Without a budget in place the ED has no legal authority to spend money. Of course, the Attorney General isn't going to swoop down on you on January 1 but personally I would make sure we had a budget in place even if I had to arrange a special board meeting on New Year's Eve. My routine is to close out the 3rd quarter and use the first nine months of the year and the last three months of the prior year to give me a good baseline for projecting forward. I draft our budget in October, the board does a first review in November and we approve it in December. You can get very accurate budgets if you have a good baseline and know the constraints facing your organization extremely well. The following link discusses budgeting in more detail: http://rideon.org/pdf/Strides_%20Better_Budgeting.pdf
Bryan McQueeney

Please emphasize that nonprofits should make money to exercise their fiduciary responsibility for sustainability. A healthy nonprofit should have income centers beyond grants and donations.

Great comments that are all helpful as we navigage challenging economic times. Is there a "rule of thumb" when it comes to an appropriate level of debt for a non-profit? Is there a debt ratio?

HELP....maybe I am not understanding this whole concept....I can do more than break even?

How do you justify a termination benefit for a former ED who claimed constructive dismissal and we had to settle for 70,000 dollars due to the ED not having the proper Board insurance. Last year we were able to pay 12 thousand extra to that liability, however, in applying for grants how does one justify that?Thank you

I'm president of a non-profit arts organization that has debt that is approximately 20% of annual revenues. And this year, our budget will probably generate an addition to that debt.

I'm just wondering: What is the average debt to revenue ratio for most non-profit arts organizations?

very helpfull for what i was looking for. Thanks Mike

It's important to keep your most productive and dedicated employees in place, both from a morale standpoint and from a productivity standpoint. The bottom line is that there's no simple solution to painful cuts. Asking staff for their ideas about how to streamline operations is helpful, but you've got to accept the leadership role and make the ultimate decisions. One final suggestion - many agencies cut back on travel and training while they're reducing staff to show how they're cutting corners and tightening belts. I do the opposite; if you have less staff, it's more important than ever to make sure those staff are well-trained and appreciated. Panikattacken Behandlung

Our non-profit raised $32K for an event in the summer of 2012; this event occurs every 2 years. After the 2012 event, we have $12K left over. We'd like to carry these $12K restricted funds (for this event only) to the 2014 event. Is that legal? At the discretion of the board? HOw would we do the accounting on that one? thanks in advance...

I'm curious if this is a view held by more or fewer nonprofits today that it five years ago.

Very nice summary, thank you!

We are working on a budget for this next fiscal year and have a Board Member who feels strongly that we adhere to a "balanced budget". We will have a cash carryforward from this year and would like to use the available cash carryforward for program use this year. Any suggestion on how to present a "balanced budget" and still use the cash carryforward funds?

This article is one of our on the topic.  Here's another past article, Focus on the Destination, Not the Route:  http://www.blueavocado.org/content/focus-destination-not-route-budget

What would you say to a non-profit that not only did not have a surplus but has run the non profit into a $138,000.00 debt? Issue.A Recreation Association is formed in 1979 to take control of 1.67 acres of land given (free & clear) to a community as a recreational area. A woman takes over as president with her husband as treasurer in 1999. They make the Rec. Association a nonprofit. By everyone's account this Recreation Association has been a failed exercise financially and otherwise. The people living in the community are not HOA members nor want to be part of any HOA. The female president decides to form a separate HOA exclusive of the rec. association. The Rec Association does a merger with the HOA and gives the property to the HOA. The Rec Association proceeds to take a HELOC (Home Equity Line of Credit) out on the president & her husband's house to "keep the rec. center" running. For the next 15 years the rec center loses money. However, in the merger that the Rec. Center Association formed with the HOA that she formed, it allowed the Rec center who manages the HOA, to borrow money and lien the HOA that she created. The Rec Center president now is selling the property( owned by the HOA) which she is not even a member of nor can she be per the agreement because her and her husband live in another city and don't own any property in the community in question. She also has told us that she will take the profit from the sale of the HOA owned rec center when she is not even a member of the HOA. She is president of the Rec. Center that manages the HOA but not a member of the HOA. What would you do?

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