CHAPTER 8
DEVELOPING OPERATING AND CASH BUDGETS

1. 8.1 INTRODUCTION
2. 8.2 OVERVIEW OF THE BUDGETING PROCESS
3. 8.3 ARE NONPROFIT ORGANIZATIONS DOING THEIR BUDGETING PROPERLY?
   1. (a) Operating Budgets in Practice
   2. (b) Cash Budgets in Practice
4. 8.4 DEVELOPING AND IMPROVING YOUR BUDGETING PROCESS
   1. (a) Preparation for Budgeting (Operations)
   2. (b) Step 1: Establish a Budget Policy
   3. (c) Budget Preparation Philosophy and Principles
   4. (d) Step 2: Gather Archival Data
   5. (e) Step 3: Assign or Begin Collection of Other Area Data Input or Projections
5. 8.5 SETTING THE BUDGETARY AMOUNTS
   1. (a) What Do I Need to Know About Forecasting?
   2. (b) Revenues
   3. (c) Expenses
   4. (d) Extended Example of Actual Budget Development
   5. (e) Budget Approval
   6. (f) Budget Variance Reports and Responses
   7. (g) Cautions
6. 8.6 BUDGET TECHNIQUE REFINEMENTS
   1. (a) Nonfinancial Targets
   2. (b) Flexible Budgeting
   3. (c) Program Budgeting
   4. (d) Zero-Based Budgeting
   5. (e) Rolling Budgets
   6. (f) Scenario Planning
7. 8.7 CASH BUDGET
   1. (a) Uses of the Cash Budget
   2. (b) Steps in Cash Budgeting
   3. (c) Forecasting Your Cash Position
8. 8.8 MANAGING OFF THE BUDGET
   1. (a) Budget Variance Analysis Revisited
   2. (b) Cash Position
   3. (c) Responses to Financial Difficulties
   4. (d) Internal Measures
   5. (e) External Measures
9. 8.9 CONCLUSION
10. APPENDIX 8A: CASE STUDY: THE CASH CRISIS AT THE CHILDREN’S TREATMENT CENTER
11. APPENDIX 8B: CASE STUDY: TRI-CITY ACADEMY

8.1 INTRODUCTION

A primary responsibility of nonprofit leadership is planning. At the core of proficient financial leadership and management is the budget. A budget is a plan stated in dollar terms. The budgeting process is important because it allocates resources, in turn revealing the program preferences of the parties involved in budgeting. After the budget is developed, a nonprofit organization should use periodic reports to compare budgeted revenues with actual revenues and budgeted expenses with actual expenses. This process is key in engaging in sense making that we outlined in Chapter 7. Improving your budgeting and financial reporting processes is a key part of achieving financial management proficiency. Consider that your business model's revenues (and support) and expenses are identified and managed using the budget. Budget-related considerations are at the core of some of your greatest financial management challenges. We quote some excerpts from a study of New York state human services organizations' budgets:

• Among New York's largest nonprofit human services providers, 80 percent have budgets that are 90 percent or more dependent on government funding.
• While charitable contributions have risen over the years, they rarely account for more than ten percent of service providers' budgets.
• An extensive 2015 survey of nonprofit service providers found that 44 percent say that State contracts never cover the full cost of providing contracted services and another 16 percent said the State rarely covered the full costs. Only seven percent reported that State contracts always covered full costs.
• Another survey tied the systemic underfunding of government contracts to the fact that 18 percent of New York human services nonprofits are financially insolvent.
• The low pay and paucity of fringe benefits translate into high and costly turnover for nonprofit organizations … Pay is so low that 60 percent of those working in the sector were utilizing or had a family member utilizing some form of public assistance benefit such as Medicaid or food stamps. As the $15 minimum wage for fast-food and other workers is phased in [in New York], recruitment and retention of dedicated and caring human service professionals will become an even greater challenge for nonprofits struggling under the weight of severely underfunded state government contracts.¹

Is there any good news regarding the potential for the budget process? The highest award for excellence in management in the Chicago area in 2003 was for an organization that revamped its budgeting and financial reporting processes and then began to solicit foundation grants:

The move toward greater fiscal responsibility is just one of a series of steps taken in the last year by…[Ivan Medina, executive director of Onward Neighborhood House, a Chicago social-services group] and the board of Onward Neighborhood House, which provides day care and other programs to low-income immigrants in a Chicago neighborhood that is in the midst of gentrification.

In addition to soliciting foundations in order to reduce its reliance on government funds, the group also revamped its accounting and budgeting systems and trimmed costs. The settlement house, founded in 1868, posted deficits for 7 of the 10 years before Mr. Medina arrived in 2002. However, in the fiscal year ending in June, the charity had a surplus of about $3,337 on a budget of $1.9-million, says Frank Arredondo, Onward's director of finance. A massive leap in Onward's foundation grants – up more than ninefold in the 2003 fiscal year – is largely responsible for closing the gap.

The turnaround garnered an award for financial-management excellence from the Nonprofit Financial Center, a Chicago group that helps charities improve their management. Onward distinguished itself by adopting a new budgeting system with good financial reporting and accounting controls, says Kenneth Tornheim, a director at the Chicago accounting firm of Ostrow Reisin Berk and Abrams, which sponsored the award. Such solid financial management, Mr. Tornheim says, is particularly important in today's difficult economic times. “If organizations are watching expenses and budgeting properly,” he says, “they can stay on course.”²

Each new year brings new challenges: Onward Neighborhood House reported a deficit (negative change in net assets) of almost $42,000 in its 2016 fiscal year.³ Proficient financial managers expertly integrate budgeting into their financial policies and financial management practices. Tara Parson, Vice-President of Administration and Chief Financial Officer at Southwest Baptist University, pursues two financial goals in her role: (1) a positive budget margin (budgeted surpluses), and (2) financial health, with capacity to fund initiatives, facilities, existing program needs, and increases in salaries and benefits. Finance executives across a number of business and nonprofit industries highlighted budgeting and forecasting as the top area where it is most important for board members “to receive critical information and decision-support data from the CFO,” with strategic decision-making as the next most important area.⁴

There are actually three major types of budgets: operating budgets, cash budgets, and capital budgets. When we use the word “budget” without stating which type, we are referring to the operating budget. An operating budget shows planned revenues and expenses for a period of time, usually one year. The operating budget is most familiar to most people who work in the nonprofit field. Proficient managers manage not only revenues and expenses but also cash flows, so a cash budget is developed. A cash budget shows planned cash inflows, cash outflows, and the amount and duration of cash shortages or surpluses for a certain period of time, usually the next 12 months. Its main value is highlighting the periods of imbalance between cash coming in and cash going out, so that the manager can take early action to manage the cash position and target liquidity. As we saw in Chapter 3, a capital budget shows planned fixed asset outlays and other large-dollar, long-lived capital acquisitions such as mergers and acquisitions. This chapter will assist you with the key aspects of the operating and cash budgets. In Chapter 9 we take up capital budgets and long-range financial planning.

8.2 OVERVIEW OF THE BUDGETING PROCESS

Before any budgeting takes place, your organization should have formulated its mission, objectives, and strategic plan. In Chapter 3, the basics of these processes were presented. Even if your organization does no formal planning, inertia alone places your organization in a strategic path for specific programs and initiatives. These are translated into operating plans. Those plans, and donors' and other funders' willingness to support them, give rise to revenues and expenses.

The development of the cash budget is a little more complex. Exhibit 8.1 shows that in addition to operating plans and policies and plans arising from liability management (see Chapter 10), current asset management (see Chapters 11 and 12), and fixed asset management (land, buildings, and equipment; see Chapter 9) are key inputs.

Exhibit 8.1 Budgeting Process

These same policies and the just-prepared operating budget and cash budgets, along with the current-period statement of financial position (SFP) (or balance sheet), provide the input for projecting the upcoming balance sheet. If the projected SFP (balance sheet) is unacceptable based on inadequate liquidity or overly high use of borrowed monies this should trigger a revised operating plan. A projected balance sheet that is “too weak” may arise when an organization's capital budget outlays are partly self-funded (reducing cash) and partly financed (increasing borrowing, leading to a high debt ratio). The remainder of this chapter outlines the context and actual development of the operating and cash budgets.

8.3 ARE NONPROFIT ORGANIZATIONS DOING THEIR BUDGETING PROPERLY?

There is much room for improvement in nonprofit budgeting. In a classic in-depth study of 17 large nonprofit arts, educational, and healthcare agencies, the authors concluded that the budgets were developed in a very basic, even simplistic fashion, and the budgets were not used for control. Briefly, the study established that budget development and use were deficient.⁵

(a) OPERATING BUDGETS IN PRACTICE.  In Chapter 1 and Appendix 1A, the performance of financial management in faith-based charities was outlined as part of the Lilly study. Although 85 percent of responding organizations in the study develop and use an operating budget (showing revenues and expenses), the concern is that 15 percent do not. Budget revisions occur within the fiscal year by 60 percent of the budget-using organizations. This is good practice when uncontrollable external events make previously budgeted amounts useless as standards, but may indicate that budgeting control is largely absent in some organizations. The use of supplemental financial data other than “budget versus actual” variances is seriously lacking. Only 53 percent of budget users monitor their current asset amount on a monthly basis (and merely 12 percent have a target for their current assets), and 41 percent evaluate financial ratios periodically. The fact that roughly 60 percent, or three out of five, do not utilize the insights of ratios points to the significant opportunity for improved financial management in the nonprofit sector. There is no good reason for these deficiencies with the advanced information technology we have today. A basic ratio that we should have at our fingertips is the percent of our operating budget that goes to salaries and benefits. Illustrating, most museums spend between 41–60 percent of their operating budgets on payroll-related expenses.⁶

(b) CASH BUDGETS IN PRACTICE.  Nonprofit organizations were rated only fair in their cash forecasting. The most reliable indicator of how an organization rated overall (in all short-term financial management areas) was whether the organization used a computer to monitor or forecast its cash position. Seventy-eight percent of the organizations did use the computer for one or both of these purposes. Using a computer facilitates cash forecasting, which is one of the ways to implement daily active cash management – a practice of most of the Fortune 500 corporations. Short-term investing and borrowing decisions are improved because of a better understanding of how much excess cash exists now and in the future. With longer maturities yielding higher interest rates, the organization is rewarded for knowing how long it can tie excess funds up. Furthermore, we noted that the organization's cash control is facilitated by computer use, because now it may tie its records via personal computer to its bank(s), regularly updating balances and being able to check yesterday's closing balances at the beginning of today's workday.

Only 8 out of 288 organizations developed daily cash forecasts, whereas 22 projected cash using weekly intervals, and 94 developed monthly forecasts. At a minimum, your organization should attempt a weekly forecast and larger organizations should set their end-of-day cash position by late morning. The higher short-term interest rates go, the greater the rewards for your effort.

8.4 DEVELOPING AND IMPROVING YOUR BUDGETING PROCESS

This part of the chapter provides guidance on how to develop or improve the budgeting process. It starts with what is needed to prepare an organization for budgeting, then moves to actual budget development, and finally concludes with comments about budget refinements such as zero-based budgeting (ZBB), program budgeting, and rolling budgeting.

(a) PREPARATION FOR BUDGETING (OPERATIONS).  The chief financial officer (CFO) (or board treasurer in small organizations) should attend to the organizational and procedural prerequisites before launching into the actual budget development.

The budget director's function shows us what must happen organizationally to get ready for the budget process. The procedural prerequisites show us how the organization mobilizes specific information to ensure successful budget development.

(i) Function of the Budget Director.  The individual heading up the budgeting process, whatever his or her title, is generally the CFO of the organization. It is the budget director's responsibility to ensure that a comprehensive oversight system be set up to include these four areas:

1. Make sure everyone involved gets the information he or she needs. This includes any and all forecasts, organizational goals and policies, guidelines, performance data and standards, and any organization-unit plans that impinge on budget items. This may also include a broader approach to financial literacy, using the budget process as a teaching tool for responsible program, fundraising, and administrative staff.
2. Set up and maintain the appropriate planning system. The necessary information package includes channeling of appropriate information, plan formulation scheduling, and subunit as well as organization-wide checking of adherence to economic and financial guidelines and to organizational goals. Certainly you would not want one group using an inflation rate of 2 percent for its forecasts while another assumed a 5 percent rate.
3. Set up and oversee use of models. These models test for the effect of inside and outside forces on achievement of organizational goals. For example, what would happen if interest rates suddenly went up by 2 percent? Down by 2 percent? One multinational nonprofit had to scale back its headquarters operation by 20 percent during a two-year period due to an unexpected decline in interest rates; interest revenue earned on cash reserves was funding a significant portion of those operations. Poor endowment performance in the early 2000s and the 2007–2009 period brought new reminders to endowed organizations of the value of considering the downside of investment performance.
4. Collect and analyze performance data. For each organizational responsibility center, data should show how plans are or are not being attained over time, and that analysis is made of variances, especially for large expense overruns or large revenue shortfalls. (See the section on managing off the budget in Section 8.8 later in this chapter.)⁷

Ultimately, the budget director may assume responsibility for each of these four tasks. Indeed, in smaller organizations, he or she may perform each task himself. The organization suffers as the latter two tasks are often left undone due to time constraints. Furthermore, department heads may view the budget negatively because it is imposed on them without adequate input on their part.

(ii) Procedural Prerequisites.  Before “budget time” rolls around each year, there are three preparatory steps that you may need to take.

1. Establish budget policy. This step does not need to be done annually, but if your organization has never thought these concepts through, it is time to do that before setting another budget. This element engages the board in their fiscal governance role, providing guidelines and oversight into the budget process.
2. Gather archival data. This step involves assembling necessary documents from the financial reporting system, treasury management, and fund development office.
3. Initiate data collection. We perform this step to get the appropriate offices working on collecting data that are not normally part of the financial reporting process.

Please study Exhibit 8.2 to set in your mind the sequence of these activities as a framework for our discussion.

Exhibit 8.2 Steps Prior to Budget Development

(b) STEP 1: ESTABLISH A BUDGET POLICY.  Every organization should have a budget policy that spells out the purposes of its operating budget, the uses for that budget, guidelines for budget development, revision policy, and the frequency and nature of budgetary reports.

(i) Purposes of a Budget. Reviewing the purposes of an operating budget will convince financial and nonfinancial personnel of the indispensability of budgets. Recall that your operating budget sets out your organization's plan, expressed in monetary terms. Both revenue and expense budgets should be carefully developed and detailed. Some funders will even address budget preparation in their legal contracts.

Budgets are also necessary administrative, financial, and program management tools for nonprofit managers. In most cases, there should be individual budgets for each program or separate activity, and they fold into a single, consolidated budget for the organization as a whole.⁸ In general, the main purposes for operating budgets are

1. Priority control
   • Budget setting should follow mission and program establishment and should not be done simultaneously with those activities.
   • Budgets reveal priorities because they indicate resource allocations and real locations.
2. Fiscal control
   • Limited funds mean need for effective controls over revenue and expenses.
   • Budgets serve this purpose best, in that they allow for regular comparison of budgeted to actual expenditures.
3. Administrative control
   • Nonprofit organizations are established to serve public purposes that are often intangible or expensive to measure.
   • Detailed budgets provide administrators with monetary control where traditional for-profit controls (price-less-cost profit margin targets) are neither possible nor practical.
4. Program control
   • Outside funders may require separate budgets for each program they support.
   • Funding sources may limit spending flexibility by restricting expenditures to specified categories and line items, and they may request that written budget modifications be approved in advance.
5. Audit control
   • Outside funds often have specific expenditure restrictions and compliance requirements.
   • These restrictions and requirements apply particularly for organizations receiving government funds, where budgets are utterly essential to ensure that the annual audit will determine that the nonprofit organization complied with funding-source guidelines.
6. Survival
   • If the organization makes unallowable expenditures that must be repaid to the funding source, liquidity problems will ensue.
   • How will you know if expenses are going to be covered until it is too late, if you have no budgetary projection? Not having a solid budget process puts the organization at great risk.

(ii) Uses of the Budget.  Lack of a budget has several negative repercussions; the organization may face one or more of these situations:

• Overspending. This leads to the situation in which the organization is hit with unexpected operating deficits and a cash crunch, as spending quickly outruns incoming revenues.
• Underspending. This results in the need to return unspent funds to funding sources.
• Mistimed spending. Mistimed spending is the failure to meet required program or activity goals on time, possibly resulting from the fear that revenues are inadequate to cover expenses.
• Misappropriated spending. This includes spent funds outside allowable cost categories, or when spending is audited it is discovered that questioned costs may have to be repaid to funding sources.

(c) BUDGET PREPARATION PHILOSOPHY AND PRINCIPLES.  Several decisions related to budget philosophy and principles are to be made in revising and reporting budget-related data. Budget philosophy involves what approach will be taken, what level of aggregation to use, and the “bottom-line” target to strive for.

The budget approach may be top-down or bottom-up, or a combination of both. The approach used will drive the assignment of budget development responsibilities and level of participation. We advocate the combination approach. When organizations impose budgets on departments, the approach is definitely top-down. When department heads submit their budgets, and these are added together to arrive at a consolidated budget, we have a purely bottom-up approach. A combination approach involves communication of economic and organizational assumptions to be made by all budget participants (to ensure consistency), but department heads have great latitude in establishing budgetary amounts. These are subject to review and mutually agreed adjustment. You may wish to assemble a budget committee, even if yours is a small organization and relies on volunteers.⁹ Regardless, participation and involvement of budget managers is essential, and the absence of their involvement leads to budgets that are weak and ineffective as control tools. Without input from the operating managers, the organization loses the engagement process, which in turn can lead to lack of attention and even cynicism. The goal should be to work with department heads in their budget preparation and encourage staff involvement and subsequent review of actual activities.

The budget's format and level of aggregation also must be determined. The minimum requirement here is to have a consolidated budget (organization-wide). This budget, sometimes called a line-item budget, should list the major sources of revenues and the expenses by type. The expenses are listed by what are sometimes called “natural expense elements”: rent, utilities, salaries and wages, insurance, and so forth. Budgets done at this aggregated level of detail help prevent overspending or underspending and provide the minimal planning, coordination, and control functions. In the revenue and expense budget illustration later in this chapter (Exhibit 8.5), we will show how an organization develops a consolidated budget.

As organizations grow and add support staff and accounting and software systems, they begin to develop a subunit budget for each program, department, or activity. Let's take a look at two logical subunit budgets that you may wish to develop: program budgets and functional budgets.

Program budgets spell out revenues and expenses for each of the organization's major programs. Having information in this format is tremendously helpful for two reasons: it makes program allocations and reallocations obvious, and it makes cost-benefit comparisons for individual programs much easier. We will return to program budgeting later in the chapter. If each program is operated by a different division or department within the organization, the divisional or departmental budgets accomplish the same thing as program budgets.

Functional budgets show revenues and expenses for each separate functional area. In a business, the major functional areas are marketing, finance, and production. In a nonprofit, these might be development, finance, and services. The services subunit can then be further broken down into program subunits, if desired. The main advantage is that each area can be held responsible for costs, revenues versus costs (net revenue), or net revenue versus investment. After-the-fact comparisons not only can pinpoint efficiency or inefficiency in areas such as fundraising, but also provide needed input for redeployment of resources for the following year. Although they are not considered major functional areas, support areas such as human resources and information systems can also be budgeted for separately in the functional budgeting system.

Consider as your budget target the level of net revenue the organization strives for. On a consolidated budget, should we budget a surplus, break-even, or deficit? Peoria Rescue Ministries, the highest-rated homeless shelter in our Lilly study, strives for and achieves a budget surplus each year. This provides internal funding for program expansion and related capital projects.

Some other organizations project a “balanced budget,” even though operating revenues exceed operating expenses. The “plug figure” that balances the budget is called something like “Contingencies,” which may be a means of forced savings to help build up cash reserves over a period of several years. If all goes as planned, these organizations will report a surplus for the year (positive change in net assets) on its statement of activity (SA), assuming there are not nonoperating items such as capital campaigns or investment losses.

Here is another way of having a balanced budget but saving for known future expenditures: Assuming that your organization includes an expense account for depreciation, it could be using a balanced budget target, and the amount reported as depreciation expense (which is a noncash charge, merely a bookkeeping adjustment to match the using of equipment with the revenues it helps generate) could be set aside each year in a special fund. When new capital equipment must be purchased, the monies saved in the fund can provide the financing. If all goes as planned, your organization would be reporting a break-even ($0) SA at the end of the year, using accrual-based accounting, since depreciation expense will be shown on the SA.

In some years, you may actually budget a deficit. An organization with long-term financial problems, but one that has a significant liquid reserve built up, may continue its essential programs while it repositions itself over a period of several years. Eventually, it should plan to break even and then run a surplus.

Anthony and Young in their budgeting presentation, provide some excellent guidance on the subject of how to set a budget target.¹⁰ They argue that in most years we should plan spending to match the available resources, by not overspending or underspending. Therefore, they assert that a balanced budget should be the rule, with some acceptable exceptions. (It is assumed that the nonprofit is recognizing the depreciation of fixed assets.) They offer five reasons why most organizations should not consistently plan a sizable budget surplus, because that may indicate:

1. To clients that are probably not getting the service quality or quantity they might desire.
2. To clients that the organization is charging too high a price, in cases where it is charging for services.
3. To donors that possibly they gave too much.
4. To all stakeholders a lack of achievement on the part of the organization, rather than good management, given that most nonprofits have much greater demand on services than they can possibly meet.
5. To management that it may need to consider the possibility of the organization becoming a for-profit business.

We understand the rationale offered here and see the balanced budget approach as an excellent starting point but we disagree with final approval of a balanced budget, generally speaking. None of the five reasons should preclude your organization from planning a small surplus of up to 8-12 percent of revenues, which we view as a superior target as compared to a balanced budget. We do recognize that some organizations present a “balanced budget” that has in it a line item for either additional savings (not an expense; budget a surplus, then show as an addendum item the amount going to savings) or for “contingencies.” Contingencies may represent a tacit admission of forecast uncertainty, and a buffer to reflect conservatism in the planning process. We agree with a conservative approach to forecasting, but why not budget a surplus with the recognition that the actual amount may come in closer to breakeven? Use some portion of your liquidity target, an amount you call an “operating reserve,” to handle the uncertainty rather than introducing error in your budget projections or mislabeling a budget as a “balanced budget.” In a 2015 survey by the Evangelical Council for Financial Accountability® (ECFA), organizations were asked if they budget for reserves: 38 percent responded never or rarely, the remaining respondents answers were always (22.5%), frequently (16.5%), or sometimes (22.8%).¹¹ Calabrese studied the relationship between accumulated wealth (net assets) and donations, and found that “… future contributions actually increase as available [organizational] wealth increases.” Only when the accumulated surpluses reach very large levels do donors tend to reduce support.¹²

What about consistently projecting a deficit? On the surface, it appears that many nonprofits are in a perpetual financial squeeze, using their revenue shortfall as an effective fundraising ploy. Budgeting a deficit is not advisable as a normal practice, with some years being exceptions. For one thing, if budgeted amounts are realized as actual amounts, you are reducing the flexibility you would have had for spending the income from your endowment, or draining cash from your liquid reserve, which you must replenish (i.e., run a surplus or do extra fundraising appeals) later. Some faith-based organizations and some nonsectarian nonprofits operate under what Peter Drucker terms the “God will provide” mind-set. Certainly events can turn out better than expected, and God does provide – but as a principle, we should prefer receiving God's provision of the funds beforehand in response to faith to receipt after/during a certain period. “God will provide” is a valid mindset underpinning the ultimate cause of your organization's well-being as well as a valuable tool for reflection, but it should not be a budget line item.

Overoptimism and inaction regarding revenues, expenses, and cash flow are seen in many nonprofits, secular as well as faith-based. We find it sobering that the CEO of the Hull House thought that since the organization had always survived cash crunches and cash crises over its previous 120 years that same resilience would continue—but the organization closed permanently in 2012. As one writer put it, “The warning signs were all around Hull House, but it appears that no one could really come to grips with the problems.”¹³ The board chair at the time of the close stated that he thought the management team was providing the board with a rosy financial picture, adding that “The charity's staff members kept a positive attitude, he says, and the board took its cues from them.”¹⁴ See the profile of “the promoter,” below.

Second, we note that some colleges have had to retrench and even close down because of a failure to recognize the need to prefund expenditures. If an organization is impelled to initiate or expand programs for which it does not have anticipated revenues to cover, it can build a preventive mechanism into place. As the organization moves toward the end of its fiscal year, and if it has not received sufficient funds to meet the shortfall, it needs to immediately (1) reduce spending on the new program(s), and (2) recognize that it has suffered from a misdirection. Turnaround management might be necessary.

The practical reality for many organizations is that they have not fully exploited their fundraising ability, either through underinvestment in fundraising or unfocused fundraising. This underinvestment issue came out loud and clear in our Lilly study. Most organizations indicated that the main reason they do not do better in reaching their financial objective is “insufficient or ineffective fundraising.” If new opportunities arise that match potential donors' desires to help, the development office may be able to raise additional funds to cover the added program expenses. This ability to raise additional funds is plausible, despite the “full mailbox” and “donor fatigue” syndromes, and appears to be more characteristic of faith-based organizations than of other charities. In 2016, only 7 in 10 surveyed U.S. charities met their fundraising goals.¹⁵

In technical terms, think about your organization having a “fundraising net revenue function” – although there are “diminishing returns” to additional expenditures for fundraising, certainly the funds raised are almost always greater than the costs to raise them. The implication: Your organization can often raise more money if particular opportunities present themselves, in particular, one-time “golden opportunities.” Fundraising experience shows that people give more freely to great opportunities than to great needs. However, this is much easier done over a long period of time, not on an emergency, late-in-the-fiscal-year basis.

Anthony and Young do recognize these exceptions to their recommendation that organizations propose a balanced budget:

• Discretionary revenue. Basically, this refers to occasions when intensified fundraising can raise more funds. The key is not to rely on this too often or for large amounts (unless you are really thinking about doing this to fund a one-time opportunity).
• “Hard money” versus “soft money”
  • Revenue from annual gifts or short-term grants for research are both considered “soft money” in that onset of recession or other factors may cause severe declines; a recent survey of nonprofits in the Philadelphia metro area found that donations were their single most risky source of funds. Another survey of Oregon nonprofits found: “despite successful fund-raising efforts, 30 percent of nonprofits reported they have reduced services to meet operational costs.”¹⁶
  • One implication might be to budget surpluses during economic booms.
  • Another implication is to build up loyalty and close relationships with clients and/or donors.
• Short-run fluctuations. Count on cash reserves to tide you through any unexpectedly lean years, in which a proposed deficit might be budgeted; this is why it is not somehow immoral or unethical to run a surplus in some years as well.
• The promoter. This is the idea of budgeting more expense than revenue, knowing hotshots can make up the difference; probably not wise, as nothing goes up forever!
• Deliberate capital erosion. Part of your permanent capital is being depleted by operational overspending. This approach is acceptable in limited circumstances, e.g., a cure has been found, so this program can be dissolved. But this is the rare exception and for organizations that plan to exist in perpetuity, capital needs to be protected.

We would add this: If an organization is really program-driven, it might see unfunded needs and foresee anticipated new service delivery several years ahead. It will then build up a “critical mass” of financial resources in the form of a strategic or new initiatives reserve with which to launch the new service(s). Doing so implies running surpluses for several years.

(i) Budget Revisions. Your organization should have a policy on what circumstances occasion a budget revision. Your organization may already have a policy in its bylaws. If not, consider this advice: (1) as you review budget-versus-actual variances each month (and your board does each month or quarter), do a full-year forecast to year-end, using this to determine if your budget is OK as is or if events might require that your board adopt a new budget; and (2) allow small changes to be made by the executive officers but require that changes greater than a certain threshold amount be approved by the entire board.¹⁷

Strike a balance here – don't make it so easy to get a revision approved that you lose the expense control of a budget, but recognize that environmental changes make some budget plans unreasonable. The mere fact that you are experiencing budget-versus-action variances is not unusual but it is to be expected. Consequently, feed the reasons why you are experiencing those budgets into your management processes for the remainder of the year rather than automatically revising your budget. The budget serves well as a control device when targets are difficult but achievable. If a revised budget is used, the original budget assumptions should be maintained in order to keep them in the mix as an aid to future budgeting. Make sure to require compliance with budgeted amounts by having consequences for not making budget amounts, assuming those amounts are reasonable. And resist the urge to revise the budget often to be able to assert that “we've made budget every year for the past X years.” We address how to best use the budget as a management and control tool later.

(ii) Interim Reports. Again, you should prescribe what reports will be made to compare actual revenues and costs to budgeted amounts, and with what frequency. Financial reports are also covered in the next chapter.

To recap our discussion of the first step preparatory to budget development, establishing budget policy, we addressed the purposes of its operating budget, the uses for that budget, guidelines for budget development, the budget revision policy, and the frequency and nature of budgetary reports. Not every organization thinks these issues through, but your budgeting process will be more valuable in supporting program delivery and it will run more smoothly if you have done the groundwork. We move into the data collection phase next.

(d) STEP 2: GATHER ARCHIVAL DATA.  You will consult a number of data sources in your budget development. Here are some of the basic ones:

• Strategic plan and long-range financial plan
• Operating statements: past budgets and statements of activities
  • Revenues
  • Expenses
• Statements of financial position (also called balance sheets)
• Statements of cash flows, if any have been completed
• Mortgage and other borrowing data
• Endowment and deferred giving data
• Previously done projections

(e) STEP 3: ASSIGN OR BEGIN COLLECTION OF OTHER AREA DATA INPUT OR PROJECTIONS.  The degree of delegation possible in getting necessary economic, labor, fundraising, gifts-in-kind, and capital budget data will depend on the budget approach profiled earlier (top-down, bottom-up, or combination). Allow some lead time for this step in the process; some organizations start this process six months before the budget approval date.

• Economic projections¹⁸
  • Income and discretionary income, such as local information if your scope is localized (e.g., you operate single local symphony, homeless shelter, retirement center, or “meals on wheels”). Maybe the best you can do is extrapolate, so get recent historical buying power index data from a recent issue of Sales & Marketing Management (buying power indexes are published in a special issue once a year).
  • Interest rates, including short-term bank rates,¹⁹ mortgage rates, and charitable gift annuity rates (if applicable).²⁰
  • Inflation, such as economy-wide inflation rates and key input (e.g., value of the dollar, commodity) price trends.²¹
  • Labor cost and productivity, including wages and salaries, nonprofit differentials, local differentials, and productivity.
  • Charitable giving (gives check on fundraising, covered below), including national data, regional or state data (if available), and trends.²²
  • Exchange rates if your organization operates internationally.²³
• Fundraising
  • Projected annual campaign receipts
  • Projected special appeal receipts
  • Projected capital campaign receipts
  • Projected bequests and other deferred gifts
• Gifts-in-kind
• Capital projects

Once the appropriate assignments for these vital inputs are made, it is important to follow up to ensure that the worksheets are finalized on a timely basis. If the preparatory work lags, the whole budget process is held up. Budget preparation is stressful enough without having analysts working excessive overtime.

8.5 SETTING THE BUDGETARY AMOUNTS

(a) WHAT DO I NEED TO KNOW ABOUT FORECASTING?  A budget is a plan, and any plan involves an implicit forecast. How much in donations and other revenues will we take in next year? How much should we project for expenses, given our operating plans? These questions motivate the planner to gain a basic understanding of forecasting techniques. We use Exhibit 8.3 to profile the basic forecasting methods. Space does not permit a thorough treatment of these techniques, but we present the basics.²⁴

Exhibit 8.3 Forecasting Methods

Quantitative, or statistical, forecasting methods may be divided into causal (or regression) methods and time series methods. A causal method is one in which the analyst has identified a cause factor for the item he or she is trying to forecast. In the case of simple regression, we have only one causal variable. For example, donations (forecast variable) may be linked to personal income (causal variable). Regression analysis may be used to “fit” an equation to make the relationship precise and usable for generating a forecast. In our example, we might find that the following relationship for donations and disposable income, if we measure donations and (average household) disposable income in thousands of dollars:²⁵

Let's say that disposable income is $40,000. Donations would then be:

Our forecast for donations would be $548,000. Notice that because we are forecasting current donations based on current disposable income, the only way to generate a forecast for donations is to get a (hopefully accurate) forecast of disposable income.

A multiple regression model illustrates the case of multiple causal factor models. Here, instead of one causal variable, we have two or more. Donations might now be linked to the number of individuals in the “empty nest” stage of the family life cycle, along with our original disposable income variable.

Time series models, in which a pattern from the past is extended into the future, are often more complex. Of the group, a moving average is the easiest to understand. A three-month moving average is just the arithmetic average of the most recent three actual values. If your donations for the past three months are $45,000, $50,000, and $60,000, then the moving average forecast would be:

When the next month's actual value comes in, you update the moving average by adding the new value and dropping the oldest value. In our example, if the new value is $65,000, the 3-month moving average becomes:

The moving average forecast has increased by $6666.66 (=$58,333.33 − $51,666.67), as the most recent number ($65,000) is significantly higher than the earlier number that has now dropped out of the calculation ($45,000).

Exponential smoothing and classical decomposition models are beyond our scope, but information on them may be found in a forecasting book.²⁶ As with moving average methods, these time series methods basically extrapolate the past into the future.

There are three occasions in which to use times series models. One is when you cannot figure out what logical causes affect your forecast variable. Another is when whatever causes your forecast variable to change in value also steadily increases or decreases with the passage of time. The time variable (e.g., 2019 is year 1, 2020 is year 2) tends to capture the ongoing effects of the undetected cause variable(s), so in this situation you might use a time series model. Finally, time series models make sense when you have many small-dollar items to forecast, making the application of causal or qualitative modeling too time-consuming and expensive.

(b) REVENUES.  Before budgeting expenses, a reasonable amount for revenues should be estimated to set the revenue budget. An accounting definition of revenues is “inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major or central operations.”²⁷ Be careful, though, when laying out the revenues for the operating budget. The items included are slightly different from the Statement of Activities (SA) we presented in Chapter 6. Excluded from the SA are increases in the entity's net assets that result from “peripheral or incidental transactions.” These are considered “gains,” not revenues. However, do include both revenues and anticipated gains or losses when estimating budgetary sources of funds to cover expenses. We will reinforce the importance of including both of these later in the section on cash budgeting.

Many organizations budget for revenues and other inflows an amount some percentage above last year's, if that's been the pattern of growth historically. This policy is dangerous in recession or when important drivers of your operating results change. Besides, as we have shown in the forecasting section, you may gain accuracy with the aid of computer-based statistical forecasting models. Applying statistical modeling is one of those projects that are ideal for a college intern or for college course consulting, as most college and university business schools offer business statistics courses to provide basic training to their students in the art and science of forecasting.

(c) EXPENSES.  Technically, “expenses are outflows or other using up of assets or incurrences of liabilities (or a combination of both) from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity's ongoing major or central operations.”²⁸ When arriving at budget amounts, look at inflationary increases, those changes in the environment that you can foresee, program changes you anticipate, additional resources required, and labor cost increases. Remember that labor-related expense is usually your big-ticket item and should be estimated carefully.

Because the budget may have to be adjusted when significant environmental changes occur within the year or when establishing flexible budgets, we need to understand variable, semivariable, and fixed costs.

• Variable costs. Costs that vary with each unit of activity – labor in manufacturing process (if production increases 10 percent, total labor costs will increase 10 percent because labor cost per unit does not change). Of course, when the cost of the labor increases, total labor costs will rise proportionally.
• Semivariable costs. These costs increase as activity increases, but not in direct relationship to it; for example, (1) maintenance costs – machinery may have some base level of maintenance that must be performed regardless of how intensively it is used, and beyond that maintenance expense varies with machinery usage; the latter component may not be proportional – doubling the usage may only increase the maintenance expense by 1.5 times; (2) adding a daycare worker for each four pupils.
• Fixed costs. These costs remain the same regardless of the level of activity: for example, rent, insurance, top management salaries, property tax for a facility, depreciation expense on previously purchased fixed assets. Even if service delivery is doubled, the amount of this cost element will not change. It is important to note that fixed costs are fixed within the short term – say, one year. Over the long run, there are no fixed costs. In areas experiencing high inflation rates, even those costs considered to be fixed costs may spiral upward quickly (as in the case of rent or salaries).

What is the relevance of these cost types to expense budgeting? We have already noted that a budget is a plan. When laying out the planned expenses, our method is simple:

• State expected level of activity (number of units of items produced or delivered).
• Then estimate how much the costs will be based on this activity level, so that the budgeted amount accurately reflects whether this item is a variable, semivariable, or fixed cost. Overhead costs are especially important to estimate if your budget development is in support of a grant proposal.²⁹
• This whole process takes on added importance when doing flexible budgeting, because in that method of budgeting one must calculate the amount of each expense element for various levels of activity – not just the “most likely” or projected level of activity (see Section 8.6).

(d) EXTENDED EXAMPLE OF ACTUAL BUDGET DEVELOPMENT.  We use the actual budget development of Peoria Rescue Ministries (PRM) to illustrate revenue and expense projections. PRM was one of the top financial management performers identified in the Lilly study.³⁰

Before portraying the operating budget, we first demonstrate PRM's capital budget worksheet in Exhibit 8.4. (See Chapter 9 for more on capital budgeting.) We include the capital budgeting template (Exhibit 8.4) to show how the capital budget is incorporated into the operational budgeting process. Exhibit 8.5, the operating budget, shows the prior year (year-to-date actual plus prior December's actual amount), the current budget, and the projected budget. The “rationale” column is especially helpful for your study: It gives background or the person responsible for developing the figure, as well as factors considered in developing the budgeted amounts. Information from both the operating budget and capital budget will be necessary for development of the cash budget, which is discussed next.

Exhibit 8.4 Peoria Rescue Ministries Capital Budget Template

Peoria Rescue Ministries - Peoria IL - Operating Budget Development
			Memo:
DESCRIPTION	DEC 2006 PLUS YTD/NOV 2007	RATIONALE	BUDGET 2007	BUDGET 2008
INCOME (Revenue & Support)
Individual Contributions	758,756.14	Development and General Director Plans based upon Previous Year	775,000	825,000
Special Appeals Indiv. Contribs.	201,834.04	In House Special Appeals Planned Using Last Year as a Guide for 2008	275,000	260,000
Church Contributions	131,303.91	Development and General Director Plans based upon Previous Year	125,000	140,000
Special Appeals Church	1,038.92	Same as Immediately Above	2,000	1,000
Bus/Org. Contributions	88,116.61	Dev. Dir. & Gen. Director Plans based upon Previous Year and new Bus. Contacts	68,000	90,000
Bus/Org. Contributions Special Appeals	5,073.68	Dev. Dir. & Gen. Director Plans based upon Special Projects that Bus. Would Support	5,500	5,000
Memorials	26,226.87	Past History Guidelines	30,000	30,000
Education Contributions	1,308.00	Based upon Past History and Planned Appeals. Gen Director & Dev Director	500	1,000
Evening Offerings	7,876.05	Based Entirely on Past History with Alterations for Additional/Fewer Services	8,000	8,000
Speaking	4,258.97	General Director Input based upon Previous Years and New Contacts for 2008	8,000	5,000
Special Events	131,754.90	Dev Director, Gen Director & Events Coordinator on plans for 2008	145,000	140,000
Grants	1,000.00	Dev Director on Grant Applications Pending and Proposals for New Year	1,000	1,000
Wills & Estates	634,543.18	Dev Director estimate for 2008 Plus New Estates based upon History	200,000	250,000
Trusts	104,837.72	Dev Director Known Trust Payouts and New Trusts to Start in 2008	12,000	40,000
Life Insurance	100.00	Gen Director Input based upon Current and New Projected Policies	300	300
Interest Revenue	19,376.92	Business Manager Interest based on Current Rates and Bank Balances	11,000	14,000
Book Sales	2,523.63	Development Director Plans for 2008 Book Sales based upon His Plan of Events	1,500	2,000
External Appeals	57,704.27	Dev Director Bus Mgr and Gen Director on Planned Acquisition Appeals Contract	84,000	60,000
International Ministries	37,258.96	Budgeted Known Entities That Support Our Intl. Min. - Gen Director Provides Guidance	65,000	40,000
Sale of Pallets (Earned Income)	773,160.24	Based Upon Past History and Planned Appeals - Past History is for Guideline Only	795,000	825,000
Sale of Livestock (Earn. Inc.)	555.13	Farm Director Provides based on Projected Cattle for Sale	1,000	1,000
Sale of Wood Chips (Earn. Inc.)	65,694.61	Pallet Production Mgr. Provides on Known History and New Contracts	85,000	65,000
Delivery (Earn. Inc.)	9,481.84	Pallet Production Mgr. Provides on Known History and New Contracts	14,000	10,000
Vending Income	1,573.58	Based upon Our Vending Machines, New Additions, and Projected Prices	3,000	2,000
Designated Gifts	141,465.51	Special Projects Planned for Coming Year. - Dev. Director with Bus. Mgr. Input	140,000	100,000
Gifts In Kind	131,000.00	Past History and Planned or Known Gifts Coming	125,000	140,000
Emergency Assistance Fund	2,600.00	Budgeted based upon Past History	2,500	2,000
Miscellaneous	4,251.00	Provides For all Items Not Specifically Budgeted - Business Manager	4,200	7,000
Total Income (Rev. & Support)	3,344,674.68		2,986,500	3,064,300
EXPENSES
Payroll	976,535.12	Staffing Needs & Review Wage Costs for Budget Year - Bus. Mgr., Gen Dir. Review	993,000	1,035,000
Employee Benefits	202,176.42	General Director & Business Manager Review Benefit Costs to Set Budget	196,000	228,000
FICA Tax	73,960.82	Bus. Manager Factors Payroll Taxes based upon Payroll Amounts	75,000	78,000
Stipends	38,385.00	Ministry Directors based Upon Client Needs and Projections for Year	41,000	40,000
Equipment Purchase & Repair	83,212.00	General Director with Consultation of Equipment Needs With Ministry Directors	90,000	90,000
Postage	14,945.91	Business Mgr. based upon Expected Usage and Mailing Plans	17,500	17,500
Office Supplies	37,549.16	General Director/Bus. Manager Review Needs and Project 2008 amount	34,000	37,000
Program Materials	10,782.55	Ministry Directors based Upon Client Needs and Projections for Year	17,600	10,000
Medical Client Expense	2,901.41	Ministry Directors and General Director Review Client Expectations for New Year	3,500	3,500
Bad Debt Expense	1,334.00	Business Manager based upon Receivable Conditions and Expectations	4,000	1,000
Promotional Material & Exp.	138,684.14	Development Director and General Director based on New Year Plans on Promotion	130,000	140,000
Travel & Transportation	41,383.95	General Director and Bus. Mgr. based on Mileage Allowance and Vehicle Expense	42,000	44,000
Insurance	77,421.14	General Dir and Bus. Mgr. based upon Ins Needs and Projected Coverage	75,000	70,000
Building Maintenance	61,790.51	Routine Maintc Ministry Directors/Gen Director and Maintenance Mgr. based on Need	55,000	50,000
Building Improvements	6,232.26	General Director based On Planned Improvements	15,000	6,000
Client Expense	9.911.53	Ministry Directors Budgeted for Each Ministry	14,000	12,000
Mission Support	58,300.00	Approved by Gen Director and Board Approval	50,000	65,000
Mission Staff Support	6,735.00	Approved by Gen Director and Board Approval	6,000	7,000
International Aid-IM	5,791.99	Approved by Gen Director and Board Approval	18,000	6,000
International Ministries	247,400.68	Approved by Gen Director and Board Approval	135,000	140,000
Conferences	10,812.05	General Director Provides By Approving Planned Conference for Employees	15,000	12,000
Electricity	63,500.07	General Director/Bus. Mgr. Determine based on Current and Future Contract Rates	72,000	75,000
Natural Gas	37,560.45	Same as Above	65,000	40,000
Water	14,857.38	Same as Above	25,000	16,000
Telephone	39,364.14	Same as Above	39,000	38,000
Janitorial Supplies	17,468.60	Ministry Directors Provide per Ministry with Approval of General Director	20,000	18,000
Food	8,048.45	Determined After Total Revenue & Support Budgeted - Determined by General Director	10,000	10,000
Emergency Assistance Exp.	4,759.82	Each Ministry Director With Consultation of General Director	2,000	2,000
Livestock	2,801.01	Farm Director Provides based on Projected Cattle for Sale	1,000	3,000
Pallet Production	60,481.10	Ministry Director with Consultation of Bus. Mgr. and General Director	60,000	44,000
Shop Expense	32,358.42	Farm Director based upon Shop Income and His Assessment of Needs	38,000	34,000
Special Events	54,967.92	Dev. Director based upon Events Planned for Year	68,000	60,000
Special Appeals	119,589.62	Dev. Director based upon Special Mailings Planned for 2008	62,000	95,000
Book Sales Expense	2,403.53	Dev. Director based on Planned Book Events	2,500	2,000
Professional Fees	22,857.43	Business Manager based on Contracts for Professional Organizations	10,000	14,000
Memberships/Subscriptions	10,998.45	General Director on His Approval on Memberships for Directors	9,000	12,000
Miscellaneous	2,650.00	Business Manager based on Unclassified Bills	2,500	3,000
Gain/Loss Sale of Assets	(114,787.17)	Bus. Mgr. and General Director on Planned Sale of Unused Assets	(100,000)	(65,000)
Total Expenses	2,486,124.86		2,412,600	2,493,000
Net Income/Deficit	$ 858,549.82		$ 573,900	$ 571,300

Source: Reprinted, by permission, from David L. McFee of Peoria Rescue Ministries.

Exhibit 8.5 Peoria Rescue Ministries Total Ministries Budget for a Given Year

Note from our example schedule several things that will help you develop an operating budget.

1. Some items are estimated, others are calculated. Estimations involve subjective judgment. Calculations involve (a) finding a historical relationship between one variable (some measure of activity) and the expense element, or (b) simply extrapolating the historic growth rate.
2. The feedback from this year's year-to-date actual (which is annualized by adding in the remaining months' prior year actual amount) is used to help estimate the new year's proposed budget. That is, we do not simply make a mindless adjustment based on a historical growth pattern, but adjust up or down the calculated amount where appropriate.
3. PRM budgets for a surplus. Notice that PRM does not show depreciation expense, so some of this surplus will be eventually be used for plant and equipment replacement. Other portions are for (a) intrayear cash receipts versus cash disbursements imbalances, (b) to offset any negative developments on either the revenue (unfavorable variance being less-than-budgeted amounts) or expense fronts (unfavorable variance being greater-than-budgeted amounts), and (c) to fund anticipated growth. PRM is growing, in total revenues, at double-digit percentage rates from year to year.

This example also verifies one of our main points in this chapter: The main uses for operating budgets are to set out a plan in monetary terms, anticipate possible problems, explicate assumptions, and benchmark actual performance.

(e) BUDGET APPROVAL.  Once a budget is agreed on by all parties, assuming some participation has been allowed, a commitment is fostered. The budget agreement itself signals bilateral commitment between an operating unit and top management. The PRM budget approval process is indicative of good practice.³¹ After the initial preliminary budget amounts are determined, a budget meeting is set with the PRM board's finance committee. This meeting includes an intensive line-by-line ministry analysis – with input to modify or change programs and budget amounts if warranted. At that meeting, the general/executive director and the business manager are present, and a financial spreadsheet is “live” on a computer screen so the preliminary figures can be adjusted immediately and a new “bottom line” for the consolidated budget can be arrived at. In this way, the finance committee members can conduct what-if scenarios and see readily how a change to the budget affects the overall budget. We will examine scenario planning later in this chapter. At the conclusion of this meeting, each person is given a copy of the proposed budget for further review preparatory to its consideration by the overall board. Copies are mailed to all board members who are not on the finance committee. The overall board receives the proposed budget at its December meeting, which is usually at least two weeks after the finance committee meeting. PRM also prepares its capital budget in conjunction with the operating budget, in order that program personnel may plan for program needs as they develop their future programs.

(f) BUDGET VARIANCE REPORTS AND RESPONSES.  We noted in Chapter 7 that the first level of your financial reporting, done for internal users, is the budget variance analysis (BVA) report. This report is first in importance for managerial usefulness. Typically, the BVA is associated only with the operating budget, and we begin our discussion with that budget.

(i) Operating Budget. This process should be ongoing on a monthly basis during the year to avoid surprises at year-end. Variances are the difference between actual (what happened) and budgeted (what was expected). A variance is a symptom that may be linked to many different problems, some more severe than others. Someone must identify the reason(s) behind any significant favorable (actual better than budget, which would be revenues greater than budget, expenses less than budget) or unfavorable variance. This is where the engagement of the responsible manager comes in. The manager that works with the intricacies of the day-to-day operations of their department is best suited to flag problems and offer potential solutions. It is a good practice to consider the responsible manager as a part of the financial management system, reviewing and critiquing accounting reports and seeking clarity. Being alerted to ongoing or emerging significant problems enables the manager to initiate corrective action. Sometimes the cause of the variance implies an obvious correction: Uncollected pledges receivable suggests more and firmer follow-up contacts and better front-end donor education. Other times the variance springs from uncontrollable factors, such as a change in exchange rates (for which no protection was provided through a hedge, such as a currency swap), or a drop in interest rates earned on cash reserves, and the organization will have to make offsetting adjustments in controllable areas. Of course, information from this year's results feeds back into new budget development even before the year is closed. Generally, the variance reports should conform to the checklist shown in Exhibit 8.6, with some pointers applying to monthly variance reports and others applying to weekly, quarterly, or annual variance reports.

---

• Weekly or daily variance reports should be prepared for selected items over which management has control and that are vital to the success of the organization. Waiting until month-end is sometimes too late. For example, radio and TV stations conducting telethons give constantly updated totals for management use and for prompting donor response.
• Show month's variance (both % and $) to the left of the revenue line item, and the year-to-date or full-year variance to the right of the account information. A brief explanation can be included to the right of the tabulated variances if space permits; otherwise provide the information below the table.
• Implement management-by-exception by highlighting variances that pass threshold tests – say, greater than 10 percent of the budgeted amount or greater than $500.
• Highlight positive variances as well as negative ones. Usually, show unfavorable variance numbers (lower revenue or higher expense amounts) within brackets; favorable variances should not be bracketed.
• Include in the written explanations not only variance cause(s), but also what will be done to correct the problem.
• Show enough detail so that offsetting variances within an expense category does not disguise underlying problems. For example, if “donations” is shown only in total, a mail campaign positive variance may be offset by a negative variance on face-to-face fundraising, and no corrective action gets triggered for the latter.
• Highlight controllable items for special management attention.
• Recognize that a variance may signal a faulty budget or a change in the environment, which should trigger the development of a revised budget to guide the remainder of the fiscal year.

---

Exhibit 8.6 Variance Report Checklist

In some organizations, the budget development and variance analysis processes are highly political. What can be done to eliminate political conflict? The following five precautions, some of which must be taken at the time the departmental or program budgets are developed, may be helpful:

1. Have final budgets prepared by a cross-departmental committee, and then have everyone affected by the budgets review them.
2. Have the manager that prepared the budget explain the variance. Whoever oversees the reporting process should make sure actuals are not massaged to hit budgeted amounts.
3. Include and retain budget development assumptions in the final budget documentation.
4. Do not blame departments or individuals for variances, but focus attention on positive ideas for reversing the problems. Blame should be eliminated as it doesn't solve problems, not does it aid in responsibility setting.
5. Find the causes of the variances, and to the extent they are linked to a faulty budget, ensure that the next budget that is developed is done on a more accurate basis. Also, instead of blaming someone for the inaccurate budget, develop a revised budget (refer back to our earlier discussion on when to revise a budget). Some organizations persist in estimating expenses and then writing down a revenue figure to match total expenses. This practice makes revenue variance analysis almost useless – unless the organization sets within-year targets that serve as control points if and when the revenue forecast is not realized.³²

We will return to the specifics of presentation format and what generic actions your organization can take if revenues are below budget or expenses are running above budget in the later section in this chapter entitled “Managing Off the Budget.”

(ii) Capital Budget.  We showed an example of a capital budget request template earlier in Exhibit 8.4. The capital budget evaluation techniques are presented in Chapter 9. Compile a summary report at year-end to show what projects were totally or partly implemented during the year. Compare that to the capital budget(s) approved in the past year(s). Postaudit the actual project expenditures, by project, to find out if they matched anticipated amounts and if not, why not. This will greatly help your organization in future capital project analyses.

(iii) Cash Budget.  The cash budget preparation is demonstrated in Section 8.7. The variance analysis is similar to that used for the operating budget. How is it to be used to do after-the-fact analysis? Quite simply, it is used to check the accuracy of your year-earlier forecast and see if seasonal or trend patterns emerge in the actual cash flows that occurred. Determine in which months your forecast was farthest off, and why. Use that information to guide your development of next year's cash budget. Of chief importance, consider whether the target liquidity should be adjusted based on the past year variance. Let's consider the two cases of positive and negative variances in the net cash flow, which we define as:

Case 1: Net cash flow comes in above budget. In this case, the cash position is growing, unless the trend was spotted during the year and additional expenses incurred or assets purchased. Possibly, the liquidity target should be adjusted downward, but whether you do so depends on several considerations. Some of the factors you should look at are:

• If the trend is temporary and is about to be reversed (possibly because of special factors such as one-time undesignated gifts to the organization), do not change the liquidity target, because your cash position will return to its normal level in the near future.
• If some of the cash receipts were simply proceeds from borrowing,³³ the amount must be repaid, bringing the cash position back to its normal level.
• If the trend is permanent, and you do not anticipate increasing service provision, you may reduce the amount of liquidity because you have a level of operations that brings in cash revenues more than covering expenses.
• If you are not sure about the cause or permanence of the change, gain interest income and retain flexibility by parking some of the cash buildup in slightly longer-term securities, say with one-year or two-year maturities, making sure to choose those that are readily marketable.
• If your organization is growing rapidly, sit tight with the higher level of liquidity until you have a better idea of how much liquidity you need.

Case 2: Net cash flow comes in below budget. In this case, cash expenses are outstripping cash revenues, and you have less cash at the end of the year than you originally anticipated. Possibly, you borrowed some money to meet the shortfall. To the extent possible, you will probably want to rebuild the drained cash reserves. Recognize now that you will need to discuss increased fundraising activity to meet that target. In some cases, taking the flip side of the list we just looked at, the change is temporary, and possibly self-correcting. More often than not, nonprofit executives and board members blithely assume that such events are self-correcting, but you should take the change seriously. It may be that your organization is heading for chronic deficits and a rapidly eroding cash position. Your organization may also need to change its programming, if fees are part of the revenue base, or engage in earned income ventures to supplement donations. If your organization is growing rapidly, the problem is compounded, because quite often funds are disbursed to finance the growth before the donor base responds to the increased outreach. See additional ideas in Levels 2, 3, and 4 of the annual financial reporting pyramid presented in Chapter 7.

(g) CAUTIONS.  Anthony and Young note four aspects of budget review that you should recognize:

1. You will face time constraints. Count on it! You won't have time to go into sophisticated budget procedures, or be a perfectionist.
2. There are budget review effects on behavior: Problems arise because so much of nonprofit spending is discretionary. This fact suggests that negotiation be used and that ability, integrity, and forthrightness are not soon forgotten.
3. Politics and gamesmanship often occur.
4. Watch out for the “budget ploys.”³⁴

(i) Budget Ploys.  The following four budget ploys are prevalent in the nonprofits we have observed:

1. Foot in the door. Here, a modest program is sold initially, but once the constituency has been built and the program is under way, its true magnitude is revealed. Sometimes this is triggered by “resource hunger” in which the budgetee's motivation is to acquire as many resources as possible, especially when output cannot be reliably measured and the output-input relationship is unclear. Your best hope is to detect this ploy up front and disapprove the program. Failing that, force the program advocates to hold to the original cost estimate.
2. Reverence for the past. This ploy is used to maintain or increase an ongoing program. The argument goes that the amount spent last year was necessary to carry out last year's program, so the only thing to negotiate is the increment to add to that base for this year's program. Time for careful consideration is often lacking, so try to implement selective zero-based budgeting (ZBB) over a period of several years; we address ZBB in greater detail later in the chapter.
3. Make a study. Users of this ploy are trying to avoid having their program's budget slashed. The advocate tries to buy time or block the action by demanding that all repercussions of such an action be studied. Sometimes the best response is to make the study and be persistent in cutting the program, assuming the study verifies the original reasoning. Other times, stick with your guns and cut the budget without further delay.
4. We are the experts. Here again, the goal is to forestall cuts. Budgetees are arguing that they have superior knowledge that the supervisor or budget director does not have. Professionals (teachers, scientists, physicians, and clergy members) are especially adept at this. The best answer is to insist that the “experts” phrase their reasoning in terminology and expression understandable to all.

(ii) What Hinders an Effective Budget System?  Methods and techniques used in the budget system have only limited impact on budget system effectiveness.³⁵ Of course, organizational personnel should understand methods used, budgets need to be done on time (and often are not), and variance reports showing actual-versus-budget differences should be prepared regularly, accurately, and on a timely basis. The key determinant of success or failure is the use made after the budget is in place. And the use made is primarily aided or hindered by communication. Communication problems arise in the following relationships:

• Between the budget department and operating management
• Between the different levels of the management hierarchy (e.g., top and middle management)
• Between the manager responsible for the budget and his or her direct supervisor³⁶

Budgets are yardsticks, and sometimes they are taken seriously and operate effectively. At other times there is political maneuvering to escape the restraint of the budget. Breakdown in verbal communication is more often the culprit than written communications such as budget variance reports. The way you use the budget and the attitudes of top-line management are most important. Some of these problems can be prevented by the budget guidelines, others by the engagement process described earlier.

(iii) Is the Finalized Budget Consistent with Financial Targets and Policies?. This reality check is essential before publishing the budget. There should be a direct tie between your strategic plan and the budget as well as between your long-range financial plan and your budget. If done at the same time, there should be a very close correspondence between the first year of your five-year financial plan and your operating budget for next year. If the financial policy is to run surpluses for the next three years, obviously your budget should show revenues exceeding expenses. Your budgets and five-year plans should both show achievement and maintenance of your target liquidity level. The importance of this consistency cannot be overstated. Organizational alignment cannot be achieved without it. Finally, your budget should follow a very similar format to the operating revenues and operating expenses part of your Statement of Activities, assuming you segregate operating items to show an operating measure on your SA.³⁷

8.6 BUDGET TECHNIQUE REFINEMENTS

Although technique is not the most important indicator of operating budget effectiveness, some organizations have found value in using newer, refined budget techniques, including nonfinancial targets, flexible budgets, program budgets, ZBB and scenario planning.

(a) NONFINANCIAL TARGETS.  Many businesses include nonfinancial targets in their annual budget reports. We strongly advocate that you consider doing this, assuming your budget development process is running smoothly. What nonmonetary budget targets might you include? Anthony and Young recommend three output measures: (1) workload or process measures, (2) results or “objective achievement” measures, and (3) a framework for the objective achievement measures.³⁸ The latter framework might be the use of a management philosophy known as management by objectives (MBO), which is defined as the use of quantitative measures for measuring planned objectives, possibly including objectives to maintain operations, objectives to strengthen operations, and objectives to improve operations. In this situation, benchmarking and reengineering studies are helpful. This aligns with recent trends where funders are seeking more objective data regarding programmatic outcomes. We might think of financial resources as an input, and program delivery as an output.

(b) FLEXIBLE BUDGETING.  Sometimes called variable budgeting, flexible budgeting is particularly useful for organizations operating in an uncertain environment, where you plug in the expense budget only after you find out exactly what level of output you're going to be producing or how many clients you plan on treating in a time period. On the expense side, flexible budgeting works well, you might have guessed, only for variable costs. Organizations that do not develop flexible budgets must adapt to changes in the environment “after the fact” – scrambling to prepare a revised budget to fit the new realities. You'll live with the original budget? Not if you want the budget to serve as a control and coordinating device, in which managers are held responsible for meeting or exceeding budgetary amounts.

Let's use a greatly simplified example, which builds on our earlier classification of variable, semivariable, and fixed costs. Recall that labor expense is the major cost to be managed by nonprofits. This is really a semivariable expense in many organizations: New staff and laborers do not have to be added for each additional client served, but perhaps one laborer must be added for each additional five clients. Salaried workers basically represent a fixed cost. Utilities, insurance, and mortgage payments are fixed costs. Supplies used in client engagements are a variable cost; the more clients served, the more supplies used.

Let's start with a base case budget for the year 20XX, based on the “most likely” figure of 1,000 client engagements. We have annotated it to show the cost type for each item in Exhibit 8.7.

(1,000 Client Engagements) January 1–December 31, 20XX
Expense Element		Amount
Variable costs:	Client supplies	$40,000
Semivariable costs:	Labor expense	120,000
Fixed costs:	Salary expense	60,000
	Utilities	5,000
	Insurance	4,000
	Mortgage payments	15,000
Total expenses:		$244,000

Exhibit 8.7 Base Case Budget Worksheet

To develop a flexible budget, we need to have a way to figure the amount for each variable and semivariable cost expressed as a percent of activity level (services delivered). Recall that the “base case” budget (the one you would have used if you did not go the extra step to develop a flexible budget) was based on 1,000 client engagements. This implies that client supplies cost $40 per client engagement:

Expressed as a formula:

Semivariable costs have both a variable component and a fixed component. To get the fixed component, you need to determine how much of this cost element would be necessary to have a minimal service delivery (say, one or a very few clients). For labor expense, our organization projected $120,000 based on 1,000 client engagements. The staff director suggests that even if the organization had only 20 client engagements (the smallest number it could have and still remain open), the labor expense would be $20,000. What that tells us is that for the remaining 980 clients (1,000 clients assumed in the base case budget, less the 20 minimal-level clients), there would be $100,000 of labor expense ($120,000 base case budget less the $20,000 minimal level). This data implies that the variable component is:

Let's express the relationship we have just discovered in a format we can use to calculate the semivariable cost for any level of clients. We saw that labor expense is $20,000 plus $102.04 per client engagement. Our formula is:

The easy part is estimating the fixed cost. By definition, a fixed cost does not change regardless of the amount of services delivered. So all we have to do is add all fixed costs:

Salary expense	60,000
Utilities	5,000
Insurance	4,000
Mortgage payments	15,000
Total fixed costs	$84,000

Our formula for fixed costs is very simple: Total fixed costs = $84,000.

And now, the grand finale: Let's add the three formulas together to get one overall formula to simplify our flexible budgeting:

Using this formula, we can determine the expense budget for any level of activity we desire. For example, if client engagements double to 2,000, total costs could be:

As actual figures for client engagements begin to come in, we can compare actual amounts to an adjusted “flexible budget” amount, which correctly states what the budget is at that particular activity level. This way, managers are not penalized for expenses that are running higher due to a higher caseload. Further, budget revisions based on environmental changes are no longer needed. The change in caseload due to environmental changes is automatically reflected in budget expense levels. In more technical terms, we no longer have to concern ourselves with a “volume variance” – an actual versus budget difference that is strictly due to changes in service activity. We can then limit our concentration on “price variances” that are due to changes in the unit cost of an input, such as a change in the minimum wage, or “mix variances” that are due to a changing composition in the types of clients we serve. One other benefit of doing the extra work involved in flexible budgeting: When cutbacks or expansion of your organization are being considered, you will already be prepared to pinpoint the likely financial effects. Prepare staff ahead of time by identifying by priority the spending allocations during the budget development process.

(c) PROGRAM BUDGETING.  Recall that with line-item budgets, the focus is on expense elements. We noted earlier that program budgets may be a type of subunit budget. A program budget may also be your organization's primary budget format as well. With program budgets, instead of concerning ourselves with the type of expense, we focus on programs and their associated expenses. Essentially, think of it as having subunit budgets, one for each program. By directing our attention to individual programs instead of the overall organization, the manager is aided in allocating the right amount of financial and human resources to each activity. Furthermore, from a control and coordination perspective, program budgeting links spending directly to planned activity levels of the organization's product(s) or service(s). Furthermore, if revenues are shown with programs (for those charging fees or for which donations are raised to support them, specifically), one can see the degree to which the programs are self-supporting or require subsidization. An organization with a well-developed strategic planning process will find that it has already done some of the work necessary to establish the program budgets.³⁹

(d) ZERO-BASED BUDGETING.  Budgets, whether line item, flexible, or program, are usually arrived at by changing the past year's budget slightly, perhaps based on new economic assumptions or based on noted actual versus budget variances from this year's experience. A more radical, and some would argue superior, approach is to force each program or other subunit to justify its existence and budgetary allocation “from the ground up.” This approach to budgeting is known as zero-based budgeting (ZBB). ZBB has five key components:

1. Identify objectives.
2. Determine the value of accomplishing each activity or program.
3. Evaluate different funding levels.
4. Establish priorities.
5. Evaluate workload and performance measures.⁴⁰

The idea here is to look at all the organization's discretionary activities and priorities in a fresh way, and then to redo the budget allocations accordingly. Particularly important is the review of all support allocations. Basic or necessary operations are separated from discretionary or optional tasks. Every dollar of discretionary cost must be justified. The finalized money allocation must be based on a cost-benefit comparison of each competing activity's goals, program for attaining those goals, expected benefits and how one will know if they have been attained, alternatives to the program, consequences from not approving the activity and its corresponding budgetary allocation, and who will carry out the activity's program(s). We emphasize that you would not typically do this every year and you might select certain line items to be developed from a zero base, say, every four years.

Once the supporting data have been put together, it is time to rank the various activities. This ranking may be done first by program directors for all activities within their programs, then higher-level managers may assemble rankings of organization-wide alternatives. Management must rank order all of the alternatives from most beneficial to least beneficial, then decide how to allocate the overall budget to achieve the greatest good. For example, a charity might decide that for the coming year, computer software training will do more good than the usual in-service client relations training.

Some proponents of ZBB argue that it can actually simplify the budgeting process and bring about better resource allocation of funds. It does so by making managers consider the various priorities and how funds should be allocated to them. With the list of ranked activities, managers have an additional tool for augmenting or reducing activities as the allowable expenditure level changes as the budget year begins.

Deloitte Consulting has identified that successful ZBB can lead to significant savings and can help organizations overcome entrenched departments and methodologies. Deloitte lists these advantages and disadvantages in ZBB:

Advantages

• Resulting budget is well justified and aligned to strategy
• Catalyzes broader collaboration across the organization
• Supports cost reductions by avoiding automatic budget increases, often resulting in savings
• Improves operational efficiency by rigorously challenging assumptions

Disadvantages

• Costly, complex, and time consuming
• May be cost prohibitive for organization with limited funding
• Risky when potential savings are uncertain
• Execution challenged by budget cycle timing constraints
• Requires specialized training
• May be disruptive to operations
• Could harm organizational culture or brand⁴¹

Very few nonprofits are using this technique, but it would be an excellent technique to use once every four or five years because of the disciplined look at expenses that it forces on the organization. In some cases, graduate students report that organizations for which they work, or those that they have heard about, use this method every year, or at least periodically. We recognize the effects of politics and other budget ploys that must be overcome to make this exercise truly effective, however. We recommend that organization elect to do this periodically in order to leverage the advantages, and avoid or mitigate the disadvantages.

(e) ROLLING BUDGETS.  Rolling budgets involve redoing the budget within the year and projecting at least the following 12 months (some businesses project out for 18 months). Technically, unless you are updating data and forecasts on a real-time basis based on new financial, operational, and economic information, you are using modified rolling budgets. Exhibit 8.8 provides the rationale and some specifics of rolling budgets that have been gleaned from their use by businesses.

---

• Many companies are recognizing that the conventional static budget – produced near year-end and then used as a guide for the following year even though it's out of date – is just not good enough.
• Instead, they are turning to rolling budgets – forecasts that are updated every few months – in effect, reassessing the company's outlook several times a year.
• The result: an always-current financial forecast that not only reflects a business's most recent monthly results but also any material changes to its business outlook or the economy.
• Implementing rolling budgets doesn't necessarily require any fundamental change in the way a company has been doing its budgets – except, of course, it no longer does the job just once a year. However, companies that decide to step up to rolling budgets may want to take advantage of the decision to make changes in the way they approach the task. They may search for new ways to speed up the budgeting process and make it more useful.
• In the view of many accountants, traditional budgets too often are useless because they are hopelessly out of date soon after they are assembled.
• When a company uses a traditional static budget process and finds that it misses its sales targets in the first month, it typically pushes those projected sales into subsequent quarters, acting as if the outlook for the full year remains unchanged.
• For rolling budgets to work, management must access and process information more quickly, and that often means acquiring special software that does the job.

---

Source: Randy Myers, “Budgets on a Roll,” Journal of Accountancy 192 (December 2001): 41–46.

Exhibit 8.8 Features and Advantages of Rolling Budgets

We believe that rolling budgets keep the organization's eyes on a full-year-ahead horizon, not merely what will happen between this point in the year and the end of the fiscal year. Furthermore, we see rolling budgets as taking advantage of advances in information technology, including web-based budgeting and planning software, web-based banking, improved accounting and record-keeping systems, and more rapid availability of information. They also enable larger nonprofits to decentralize budget setting (after assumptions have been handed down from the main office), as has been done by two nonprofits, International Missions and Mercy Health Partners.⁴² A study being conducted by two accounting groups in England and Wales reached this conclusion, which also applies in the United States:

Part of the reason budgeting has changed and why budgets can be more flexible … is that information can be gathered much more easily now than was possible even a decade ago. Because data is collected, stored and analyzed more readily, frequent reforecasting and adaptation is possible if an organization is willing to invest the time to set up the systems. This allows the budget to be forward looking and more strategic, and forecasts can be more precise. Some participants in the…budgeting forum actually suggested that forecasts are more important than budgets in their businesses.⁴³

Reforecasting into the next 12 months is a good discipline for any organization, and a best budgeting practice.

Once the operating budget is finalized, it needs to be calendarized (distributed across months, as some months are higher-revenue or expenditure months than others). That concludes the operating budgeting process; now, the cash flow ramifications need to be spelled out. The process for showing when cash comes in and goes out is called cash budgeting, which we profile below.

(f) SCENARIO PLANNING.  If we think of the annual budget that is prepared, approved, and disseminated to stakeholders, we might think of this budget as the most likely scenario. During this intensive planning process we should also develop scenario budgets. We might think of these as the “what if” plans.

Global Business Network (GBN) develops a model of planning that is based on examination of scenarios other than the most likely scenario. Scenario thinking and planning can be used to examine a variety of possible outcomes, challenging the status quo (as we do in ZBB). Scenarios are hypotheses, not predictions, that capture a range of future possibilities and help the organization plan for them in advance. This method can be used in strategic planning as the organization examines driving forces that organizations must navigate in order to remain viable in a change environment. It can be brought into the budget process by asking what if: revenues come in lower or higher than our most likely scenario? How would the scenario affect our operations, financial position, and especially our target liquidity?⁴⁴

8.7 CASH BUDGET

If your organization's accounting is done on a cash basis, your operating statement provides the input for the cash budget. The cash budget differs in purpose, in that it highlights the cash available to the organization at various points in the future. It is very revealing, especially the first time it is constructed, because nonfinancial managers typically are unaware of just how unsynchronized cash inflows and cash outflows are.

(a) USES OF THE CASH BUDGET.  We start our presentation on cash budgeting with a definition: The cash budget shows the timing of cash inflows and outflows, usually on a monthly basis for the next 12 months. It is sometimes called a cash plan or cash forecast. Exhibit 8.9 shows the value of a cash budget. The cash budget has five major purposes; it shows the:

Exhibit 8.9 Cash Budget: Uses

1. Unsynchronized nature of inflows and outflows (e.g., see October figures in historical cash flow table in Exhibit 8.10)

   Month	Oct.	Nov.	Dec.	Jan.	Feb.	Mar.	Apr.	May	June	July	Aug.	Sep.
   Line item:
   Cash Receipts (Total Deposits)	$1,373,317.26	$1,495,458.64	$2,296,298.05	$1,600,345.48	$1,585,682.34	$1,455,742.97	$1,474,501.30	$1,410,048.27	$1,528,613.80	$2,872,784.74	$1,928,010.02	$1,405,515.21
   –Cash Disbursements (Total Pymts/Withdrawals)	1,866,433.15	1,358,838.60	2,191,922.40	1,826,944.39	1,598,544.96	1,516,459.75	1,417,947.23	1,360,117.18	1,469,020.89	3,064,544.94	1,715,130.63	1,459,922.01
   Net Cash Flow	($493,115.89)	$136,620.04	$104,375.65	($226,598.91)	($12,862.62)	($60,716.78)	$56,554.07	$49,931.09	$59,592.91	($191,760.20)	$212,879.39	($54,406.80)
   +Beg. Cash (Beginning Balance)	$626,414.41	$133,298.52	$269,918.56	$374,294.21	$147,695.30	$134,832.68	$74,115.90	$130,669.97	$180,601.06	$240,193.97	$48,433.77	$261,313.16
   =Ending Cash (Ending Balance or New Balance)	$133,298.52	$269,918.56	$374,294.21	$147,695.30	$134,832.68	$74,115.90	$130,669.97	$180,601.06	$240,193.97	$48,433.77	$261,313.16	$206,906.36

   Exhibit 8.10 Collecting Historical Information

2. Seasonality of these flows (e.g., donations run high around Easter and especially between Thanksgiving and Christmas)
3. Degree of mismatch (surplus or shortfall)
4. Duration of these surpluses or shortfalls (how long they last, in months)
5. Necessary inputs for short-term investment or borrowing planning (together degree and duration of mismatch provide this, with the output being amounts and maturities of short-term investments or borrowing)

(b) STEPS IN CASH BUDGETING.  The four steps in developing a cash budget are:

1. Determine which measure of cash to manage and forecast:
   • General ledger cash balance (checkbook balance if that's your only accounting)
   • Bank balance (preferred)
2. Decide on presentation format.
3. Collect historical information (see Exhibit 8.10 for an actual nonprofit's prior year cash flows).
4. Develop cash forecast.

(c) FORECASTING YOUR CASH POSITION.  When actually laying out your cash budget, you may choose one or more of several formats. Because you already are probably developing a statement of cash flows (SCF), one alternative is to use the SCF format. You would then show projections for cash from/(to) operating activities, cash from/(to) investing activities, and cash from/(to) financing activities. This works well for an annual consolidated projection but is unnatural for monthly or daily projections. An alternate format, which you may decide to use for your daily or monthly projections, is the cash receipts and disbursements method (see Exhibit 8.11).

Exhibit 8.11 Basic Cash Budgeting/Forecasting Template

To operationalize this method, we would need to provide the necessary detail for each category of cash flow and for the minimum necessary cash:

• Categories of cash inflows
• Categories of cash outflows
• Needed minimum cash (may be transactions cash, may be all cash and equivalents that are part of your target liquidity)

Basically, all we are doing here is looking back to see what items provided our cash inflows and outflows in the past, and deciding how much detail to show for each category.

Let's look more closely at projecting our cash receipts, and then we'll comment on cash disbursements.

(i) Determine Cash Receipts.  The determination of cash receipts proceeds in a logical and orderly, six-step fashion:

1. The operating budget is your starting point.
2. Accrual versus cash basis adjustment may need to be made (if necessary – if already on cash basis, don't worry about adjustments).
3. Watch out for the common oversights:
   • Don't forget prearranged financing inflows.
   • Don't forget (formerly) restricted net assets, such as deferred giving or time-restricted or purpose-restricted prior gifts that will become unrestricted this period.
4. Calendarize the full-year receipts and disbursements by putting the amounts expected in each month.
   • Study history to see seasonal patterns.
   • Consider special factors that may have caused numbers to appear in a different month or quarter in the past than they will most likely occur in the upcoming period.
5. Anticipate changes in the forthcoming 12 months.
6. Show quarterly totals to provide one checks-and-balances monitoring sequence.

(ii) Determine Cash Disbursements. Again, the operating budget expenses are the starting point. Because of accounts payable, you may have to make an accrual-to-cash basis adjustment (if necessary) to show exactly when the payables are paid. Do not include depreciation expense. Watch out for the capital budget outlays; many organizations forget to include them in the cash budget. Then calendarize the cash outlays correctly, recognizing seasonal or other ups and downs. Pull together quarterly subtotals to use down the road for comparisons with actual cash flows.

(iii) Put It All Together.  Now we are ready to bring the cash receipts and disbursements together to find the difference (“net cash flow” [NCF]) for each month. Once we have that, we will add it to beginning cash to arrive at ending cash. We compare ending cash to minimum cash required (by subtracting the latter), and see if we have a cash surplus anticipated for the month's end or a cash shortage. Summarizing, we have a three-step sequence that you should carry out at least monthly and probably weekly or even daily.

1. Compute NCF (Cash inflows – cash outflows), ending position, cash surplus/(shortfall) for each month.
2. Analyze pattern(s). Are there distinct seasonal highs or lows for either cash receipts or cash disbursements? How will this feed back into our cash planning (i.e., building up larger reserves) or fundraising appeal timing?
3. Make recommendations with regard to not only cash reserve buildup (how does the sum of the forecasted amounts of cash, cash equivalents, and short-term investments compare to your target liquidity level) and fundraising campaign timing or frequency, but also for short-term investments (amount and maturity of securities) and short-term borrowing (amount and anticipated maturity of any short-term borrowing, if such borrowing is used).

The cash forecasting exercise is valuable in assisting with your implementation of financial policies, particularly your target liquidity level, and with carrying out your financial management processes.

(iv) Use the Cash Budget to Help Set Target Liquidity Level. For background on our discussion of how much liquidity an organization should have, you may wish to refer back to our discussion of the target liquidity level in Chapter 2. We also noted, in Chapter 5, some pointers on the optimal liquidity level, which we recap here. As for the optimal level of target liquidity, you will have to do the analysis yourself because no technique will give you that specific target level.

As a starting point, take a look at the low point in your fiscal year, which for many nonprofits is late September or early October. Set a liquidity level for your peak season, probably early January, that is sufficient to cover your organization through the dry season. This is where your annual cash budget reevaluation is so helpful. Study past cash flow patterns carefully and note when the cash crunches came as well as how much liquidity should have been held earlier in the year to prevent each cash crunch. Determine if there were anomalies in cash balances (i.e., one-time events such as unexpected areas of expenditure or revenue) and adjust for these. It is helpful to review more than one year's cash patterns in order to determine trends and causality.

The degree of flexibility your organization has in managing off of the budget (see Section 8.8) will also help you determine the size of your safety buffer of liquidity.

In addition, consult Exhibit 8.12, which provides you with a road map to determine whether your organization has too little liquidity. Work through it carefully, providing answers to the areas listed. Notice the key considerations: slow growth, missed opportunities, risky financial posture, small or zero net interest income (investments income less interest paid on borrowed funds), wage/salary freezes or minute increases, loans turned down or received on unattractive terms, recurrent cash crunches (or cash crises), late invoice payments (or lateness on other amounts paid), and ongoing stringency in financial posture despite successful fundraising campaigns. Once you have worked through these diagnostic questions from the vantage point of evaluating illiquidity, consider the opposite of each of these factors, in order to determine whether your organization might have too much liquidity. Readjust your target liquidity level according to your answers.

Exhibit 8.12 Determining Whether Organization Has Too Little Liquidity

8.8 MANAGING OFF THE BUDGET

We have provided much information on budgetary reports, but up to this point we have not given very much guidance on what to do when the BVA shows a deteriorating financial position. In this section, we will provide some pointers.

(a) BUDGET VARIANCE ANALYSIS REVISITED.  Some organizations either ignore their target liquidity levels or never set them in the first place. An example is the Midwest Finance Association; the association continued to experience operating budget deficits for a series of years without taking any correction action. As it continued to run deficits, what do you suppose happened to its liquidity? Right! The cash reserves continued to dwindle, until the viability of the organization was in jeopardy. Although this should not have been a surprise, it often is because no sense-making mechanisms have been built into planning. Finally, the president of the MFA wrote the members of the chronic deficits and notified them that the dues were being almost doubled in order to bring the organization back to a breakeven or surplus position and, more important, to preserve and rebuild the cash reserves. In the MFA's case, the corrective action took place after annual results were evaluated to see how they fit into the past years' established trends. Most organizations can react more quickly by harnessing their ongoing financial reports.

Three reporting principles will help you manage off the budget:

1. An exception reporting focus will help shine light on the large-dollar or large-percentage items that contribute most to the problems and therefore the likely solutions. Many organizations provide guidance in their budget policy in terms of variances that require narrative explanation and plans to remedy.
2. Inclusion of year-to-date (YTD) variances, as well as the last month and/or last quarter, will give the needed perspective for decision making.
3. If possible, include actual versus forecast as well as actual versus budget (two comparisons) in your variance analysis reports.

The third principle necessitates more management time for preparation, because each month or quarter you not only have to review the past performance but also do a new forecast, which possibly varies from the budgeted amounts. Organizations that use flexible budgets, if recalculated, may eliminate the need to do an actual versus forecast because the revised budget may have been a new forecast based on how things have changed.

Progressive organizations are moving beyond mere financial reporting and including nonfinancial items in their periodic reports. Let's face it: Your financial results three or five years from now are going to be closely linked to nonfinancial factors and trends. If we keep in mind that finances are mission supportive, we can better connect money to mission.

Accordingly, universities and businesses are adopting a new approach in their monthly or quarterly meetings, in which they highlight key financial performance indicators (KPIs) and possibly cost drivers. KPIs include contacts made by the admissions office, follow-up letters written by academic unit heads, and the like. Indiana State University board members receive a report of KPIs at each board meeting based on consultation provided by business students and a faculty member, as refined by the internal auditor.⁴⁵

The focus in a KPI report is on selected areas of performance in which satisfactory results will ensure the organization's competitive success, meriting top management time and attention.

Several other success factors seem to enhance the potency of your budget reporting and its usefulness to the organization. One is the importance of doing your variance analysis and situation analysis in conjunction with ratios and other indicators. As we saw in Chapter 7, ratios taken as a group provide a composite picture of the organization's financial health. We illustrate with a ratio that expert Vonna Laue, who audited and consulted churches for 20 years while at CapinCrouse LLP and now serves as Executive Vice President at ECFA, recommends that churches monitor:

[There are several] important indicators every church should understand and monitor…

Debt to Unrestricted Contributions [determined by dividing Total Debt by Unrestricted Contributions]… measures how many times your debt is greater than annual unrestricted gifts. Lenders expect debt to be funded through unrestricted contributions. They determine what debt load a church will be able to handle on top of other required expenditures (salaries, benefits, facility expenses, mission expenses, and so on).

The lower the ratio, the less the debt will strain the church's budget. A ratio that is too high indicates your church's debt levels are placing an excessive burden on the budget. It also indicates your debt may be at a level that lenders consider too great for your church to support.⁴⁶

There are a number of other indicators that can be used beyond what has been presented here, and all the important indicators should be assessed. Gross, McCarthy, and Shelmon provide five classes of indicators of impending financial trouble: (1) reduced community support, (2) decreased financial independence, (3) declining productivity, (4) deferred current costs, and (5) ineffective management practices (i.e., a pattern of budget cost overruns, revenue shortfalls, lower investment returns, higher interest charges, and delayed/unclear/incomplete reports to board or top management).⁴⁷ A second success factor we noted in our Lilly study is the importance of the “1,000-word picture,” in which graphs or charts are used to depict to top management or the board what is happening to the organization's financial position. For example, in our field study, we observed that two board members who were employed as engineers at Caterpillar in Peoria, Illinois, drew up trend-line charts to show revenue and expense trends for the Peoria Rescue Ministries CEO and other board members. Related to this, a third success factor is to include not only trends but also comparative data if available (peer analysis). This gives a more balanced view of the present situation. Fourth, we noted in the Lilly study the importance of the verbal presentation accompanying the reporting of financial results. Learn to walk your management team and board through the maze of financials that they might not have the time, energy, or expertise to wade through. Finally, you might be surprised at the importance of annotating the financials with brief interpretive comments (because your listeners will forget the verbal presentation and possibly misinterpret the graphs and ratios).

(b) CASH POSITION.  As your cash position changes, you will be in the position of advising management and the board of the seriousness of the change and what corrective actions, if any, are needed. You will want to provide this guidance each quarter or, if warranted, more often. Some organizations take a new look at the liquidity weekly or even daily. As cash manager of the organization, assuming you have enough cash to make it worth your while, look each day at the checking account balance to determine whether and how much to transfer to overnight or longer investments.

Now that we have an idea of the role of analysis and reports in “managing off of the budget,” we turn to some of the responses you might consider in coping with financial difficulties. You also may wish to look at these as ways to fine-tune your already healthy financial position.

(c) RESPONSES TO FINANCIAL DIFFICULTIES.  Many organizations within and outside of the nonprofit sector are engaging in reengineering. This happens when service delivery and internal management processes are opened up for radical redesign instead of just incremental improvements. The approach is much like zero-based review or zero-based budgeting, except it is applied to efficiency of service delivery and internal management processes.

Some organizations are noting the difficulties that similar organizations are getting into and are moving ahead of time to build an endowment income stream or their cash reserves as money for the rainy days. Related to this, financial analysts are planning for the overhaul of aging plant and equipment so as not to be caught short when the time comes for refurbishment or replacement. Residential colleges, churches, and museums must be especially careful to plan for the fixed asset needs for which they will have to plan internal funding or arrange funding. Other organizations are noting the need for pension funding or benefits funding.

But what if it's too late to plan ahead? Let's profile some responses to financial shortfalls:

• Quickly eliminate deficit spending.
• Quickly increase internal control.
• Quickly increase the role and prominence of the finance department. (It sounds self-serving, but it certainly helped the Church of the Brethren and the Church of God Missionary Board, as well the organization highlighted in the beginning of this chapter.) It also aids in enhancing financial literacy throughout the organization.
• Quickly reorient the organization to a more deliberate program expansion (whether new programs or expansion of existing ones):
  • Managed growth, which means a measured, manageable rate of growth (practiced a number of nonprofits, including Cedarville University, Cedarville, Ohio)
  • Sustainable growth rate⁴⁸
  • Internal growth rate⁴⁹

In addition to these stopgap measures, there are some internal and external measures you can take to stem a long-term decline.

(d) INTERNAL MEASURES.  There are six major financial strategies to embark on within your organization. Briefly, they are:

1. A new emphasis on cash forecasting with shorter horizon (month) and interval (weekly). 3M's policy is to accurately forecast cash sources and uses and take whatever actions are deemed appropriate so that adequate cash is on hand at all times and so that daily and long-term liquidity needs are met at the best price. Consider adding a statement similar to this to your liquidity management/cash reserves policy.
2. Asset sales. This might be called “strategic disposition” in order to focus better on core areas of operation. This can be a red flag however, so narrative needs to be developed in order to communicate this activity.
3. Expansion strategy. Land purchase, lease to builder/leaseback to the nonprofit organization: This strategy enables the builder to utilize the depreciation (40-year) expense deduction against income taxes, whereas the nonprofit would be unable to.
4. Asset redeployment. Place scarce labor and volunteer resources in critical areas.
5. Cost reduction/containment. This is the “downsizing” or “rightsizing” we hear so much about.
6. Treasury strategies. Much of what is in mind here involves revising your treasury management approach and operations based on benchmarking. We provide techniques in Chapter 11 and benchmarks to begin using to gauge your treasury operation in Chapter 15.

(e) EXTERNAL MEASURES.  The external measures that organizations may take to cope with financial problems fall into three major categories:

1. Fundraising. Increase the intensity and focus of your fundraising efforts. Many smaller organizations do not receive grants simply because they do not apply for them: According to the most recent GrantStation “State of Grantseeking Report,” despite the fact that three-fourths of organizations that only submitted one grant application won an award, but only about three in five small organizations submitted at least one application in the last six months of the survey year.⁵⁰
2. Bank borrowing. Document future cash flow improvements to merit short-term financing to bridge the gap.
3. Merger/acquisition partner or strategic alliance. Join hands with a partner that has deep (or deeper) pockets.

Budgeting practices are most valuable when they are well planned and carefully executed, and include the types of control and follow-up we have discussed.

8.9 CONCLUSION

In this chapter, we have shown how to develop operating and cash budgets. We show the sequence of steps that should be followed, so you can set up the process. We provide warnings of the pitfalls that many nonprofit organizations face along the way. Most notably, budgets are rarely tied to long-range financial plans and strategic plans. Budget enhancements are also discussed; ZBB and flexible budgeting, in particular, might merit further study on your part. Budgets are valuable management tools for planning and coordinating your service delivery, despite the weaknesses inherent in the budget process and the way it gets implemented in organizations.

Organizations that do not budget are losing financial control and cannot enable sense making. Organizations that do budget find the budget system most effective when it is tied to the strategic plan. Once in place, the budget may be compared to actual dollar amounts as the budget year progresses, with management taking action on the corrective actions that are signaled by the budget variances.

We conclude our budgeting discussion by taking a look comparing nonprofit and governmental budgeting practices with corporate budgeting practices to see what conclusions we can draw from and adapt to use as best practices. Our data comes from the Association for Financial Professionals nationwide survey of over 600 finance professionals, including 73 nonprofit respondents.⁵¹ We compare nonprofit and governmental responses (they were combined in the reported findings) to publicly-held businesses with less than $1 billion in sales. Relevant findings include (note that the rounding of some of the percentages means the responses may not add up to exactly 100% of each group of respondents on any given question):

• Less than half (46%) of nonprofit/government respondents rate their budget as “very effective” or “extremely effective” in delivering on its primary purpose, versus 49% of business respondents giving those ratings;
• When asked about the flexibility of their budgets, 25% of nonprofit/government respondents (and 10% of business respondents) indicated they were “iron-clad,” 27% of nonprofit/government respondents (and 40% of business respondents) said “tight,” 42% of nonprofit/government respondents (and 33% of business respondents) said “loose,” and 5% of nonprofit/government respondents (and 16% of business respondents) said “non-binding”;
• Asked for their agreement with the statement, “In actual practice, budgets are managed based on the company's top line (revenue) and/or the bottom line (Earnings Before Interest, Taxes, Depreciation, and Amortization, income, etc.),” 45% of nonprofit/government respondents (and 72% of business respondents) indicated “true,” and 56% of nonprofit/government respondents (and 28% of business respondents) said “false”;
• Asked whether they agreed with the statement, “Managers have authorization to manage their budgets as long as they meet their top and/or bottom lines,” 71% of nonprofit/government respondents (and 65% of business respondents) indicated “true,” and 29% of nonprofit/government respondents (and 35% of business respondents) said “false”;
• When asked whether “operational targets matter equally or more than financial budget targets,” 55% of nonprofit/government respondents (and 62% of business respondents) indicated “true,” and 45% of nonprofit/government respondents (and 38% of business respondents) said “false”;
• When asked about the frequency of use of the budget by various potential users during the year, nonprofit/government respondents in 70% of the organizations surveyed said “The Board of Directors” (versus 69% responding this way for businesses), and in 63% of the nonprofit/government organizations “line management” used the budget during the year versus in 56% of the businesses;
• For government/nonprofit respondents, of the time spent discussing finances during “past performance finance reviews” (overall organizational performance), about one-fourth (22% in nonprofits/governments, 26% in businesses) of the time is spent on comparison to prior-year actuals, roughly one-half of the time spent is on budget versus actual (60% for nonprofits/governments, 50% for businesses), and the remainder is spent on comparing actual to prior forecast (18% for nonprofits/governments; 24% for businesses);
• Both groups spent time, about equally distributed, on current forecast versus prior forecast (about one fourth of the time spent related to discussing forecasts), current forecast versus budget (about one-half of the forecasting discussion time), and current forecast versus prior year actual (about one-fourth of the time allocated to forecast discussions);
• When asked if the budget represented a valuable tool, 75% agreed or strongly agreed (no breakdown of organizational type was provided), with 16% saying “somewhat agree,” 8% “disagree,” and 2% “strongly disagree”;
• Roughly one-third of nonprofit/government organizations spent 9-12 weeks developing their budgets (the same as businesses), but 36% of nonprofit/government organizations spent more than 12 weeks on this versus only 16% of businesses (41% of businesses spent 4–8 weeks developing their budgets);
• There was considerable attention paid to reforecasting the finances to year-end: None of the nonprofits/governments did so weekly (versus 3% of businesses), 21% of nonprofits/governments did so monthly (27% of businesses), 35% of nonprofits/governments did so quarterly (40% of businesses), 35% of nonprofits/governments did so semi-annually (22% of businesses), and 9% of nonprofits/governments did so on a different interval (versus 8% of businesses).

We see reason for optimism in these findings as well as several small concerns. When we think about whether the budget serves as an “iron-clad” revenue and expense instrument, and see that nonprofits are more prone to use it that way, this can signal good discipline on funding and on keeping costs under control. Or, it could mean there are more budget revisions. We believe the finding on whether budgets were managed based on the top line (which for us would be revenues and support) or the bottom line (which could be taken as surplus or deficit, or change in net assets), fewer nonprofits responded affirmatively. We would like to think they are, instead, managing to their liquidity targets in such cases, but cannot be sure. We find the lesser emphasis on the part of nonprofits on operational targets (which for us would be program outcomes and mission-related achievements) versus financial targets surprising (but acknowledge that the government respondents might account for some of this). This does confirm what we noted in our Lilly study findings in Chapter 2, that nonprofits at times manage their level of programmatic expenditure based on meeting their financial objective. We were pleasantly surprised by the amount of intrayear forecasting being done by nonprofits; we noted this as a best practice earlier in the chapter. We were also pleased to see the amount of comparison being conducted: this included budget-versus actual being supplemented with budget-versus forecast, new forecast versus previous forecast, forecast versus last year's actual for the same period. Perhaps the increased use of budgeting software, covered in Chapter 13, will bring the budget development time down for nonprofits.

Notes

1. James A. Parrott and Brent Kramer, “Undervalued and Underpaid: How New York State Shortchanges Nonprofit Human Services Providers and their Workers,” (March 2017): 4. Available online at: http://fiscalpolicy.org/undervalued-and-underpaid-fpi-releases-report-on-human-services-workforce. Accessed: 1/19/2018.

2. Maura Webber, “Turning Red Ink into Black: A Chicago Settlement House Commits to Fiscal Responsibility – and Wins Grants,” Chronicle of Philanthropy, November 13, 2003. Available online at: http://philanthropy.com/free/articles/v16/i03/03003001.htm. Accessed 8/14/2017.

3. “Onward Neighborhood House Financial Audit 2015 – 2016,” (June 30, 2017). Available at: https://onwardhouse.files.wordpress.com/2017/08/onwardhouse_fy2016-audit.pdf. Accessed 1/19/2018.

4. CFO Research, “The Six Key Areas Where CFOs Fail to Deliver for the Board of Directors,” White Paper (November 2017): 2–3. Available at: http://info.kyriba.com/the-six-key-areas-where-cfos-fail-to-deliver-for-the-board-of-directors?_ga=2.33823335.795980067.1516378843-1892432173.1493909222. Accessed 1/19/2018. Respondents were able to select multiple areas. The research was from a survey conducted by CFO Research in collaboration with Kyriba. Three areas tied for third in ranking: cost control/reduction, growth strategy support, and compliance and reporting. In sixth place was strategic/operational risk management, which we take up in Chapter 14.

5. Anthony J. Gambino and Thomas J. Reardon, Financial Planning and Evaluation for the Nonprofit Organization (New York: National Association of Accountants, 1981), 21–35.

6. Association of Art Museum Directors, “2017 Salary Survey,” n.d. Available at: https://aamd.org/sites/default/files/document/2017%20AAMD%20Salary%20Survey_0.pdf. Accessed 1/19/2018. Size is important: The smallest museums spent, on average, 65% of their operating budgets on payroll-related expense.

7. Budget Executives Institute, “Statement of Duties and Responsibilities of the Budget Director,” reprinted in Readings in Cost Accounting, Budgeting and Control, 5th ed., ed. William E. Thomas (Cincinnati: South-Western Publishing Company, 1978), 82–83.

8. Most of this section and the next are based on the insights of Gregg Capin, of CapinCrouse, LLP, Atlanta, GA, from a seminar entitled “Financial Management for Nonprofit Leaders,” sponsored by the Christian Management Association, Indianapolis, IN, May 12, 1992.

9. Volunteers best suited to serve on your budget committee “should have the following qualities: (1) A familiarity with prior years' activities and the changes that are contemplated in the year(s) to come, particularly the objectives in the strategic plan; (2) A desire to serve the organization as a whole rather than to lobby for a particular project; and (3) A knowledge of ordinary budgeting, whether on the personal or business level.” There may be some volunteers not having all of these qualities that are motivated to learn and they might also be valuable budget committee members. This material quoted from Virginia Society of Certified Public Accountants, “Budgeting: A Guide for Small Nonprofit Organizations,” (September 2012): 2.

10. David W. Young, Management Control in Nonprofit Organizations, 10th ed. (Cambridge, Massachusetts: The Crimson Press, 2016), Chapter 10.

11. ECFA, “Top Ten Highlights from the 2015 Nonprofit Financial Management Survey 1.0,” (2015): 5. Available online at: http://www.ecfa.org/PDF/TopTen_NP_FinanceManageSurvey.pdf. Accessed 1/19/2018.

12. Thad D. Calabrese, “Do Donors Penalize Nonprofit Organizations with Accumulated Wealth?” Public Administration Review 71, no. 6 (November/December 2011): 859–869.

13. Rick Cohen, “Death of the Hull House: A Nonprofit Coroner's Inquest,” NonProfit Quarterly (August 2, 2012). Available online at: https://nonprofitquarterly.org/2012/08/02/hull-house-death-nonprofit-coroners-inquest/. Accessed 1/19/2018. See also Irv Katz, “Reality Time for Human Service Organizations,” Stanford Social Innovation Review (February 15, 2012). Available online at: https://ssir.org/articles/entry/reality_time_for_human_service_organizations.

14. Maureen West, “Some Fear Hull House Closure Is an Omen for Struggling Charities,” Chronicle of Philanthropy (February 2, 2012). Available online at: https://www.philanthropy.com/article/Collapse-of-Famous-Hull-House/157181. Accessed 1/19/2018. One of the most befuddling comments we have seen, hopefully quoted accurately, is this one: “Clarence Wood—a former chief executive of Hull House who retired last year—criticized the board for not understanding the idea of ‘living on the edge.’ According to Mr. Wood, ‘the reason the staff members like me were staying positive in attitude was that we are very used to social-service agencies always being on the brink of destruction.’” (Rick Moyers, “Hull House Collapse Is a Cautionary Tale for Boards and Executives,” Chronicle of Philanthopy, (February 27, 2012)). Available online at: https://www.philanthropy.com/article/Hull-House-Collapse-Is-a/190601. Accessed 1/19/2018.

15. Nonprofit Research Collaborative, “Winter 2017 Nonprofit Fundraising Study (NFS),” (May 1, 2017). Available online at https://npresearch.org/images/pdf/2017_reports/NRC-W2017-FINAL.pdf. Accessed 1/19/2018.

16. The survey was jointly conducted by Portland-based Collins and Technical Assistance for Community Services, with over 450 responses. “Survey: Nonprofit Contributions Insufficient to Cover Rising Overhead,” Portland Business Journal, December 16, 2005. Available online at: http://portland.bizjournals.com/portland/stories/2005/12/12/daily34.html. Accessed 10/31/2017.

17. Id. Note # 9, p. 7. This source offers four examples of actions that could be taken rather than developing a revised budget when an expected large contribution (or, we add, grant) that is in your budget does not come through (1) seek other sources of funds, perhaps using the CRM module in your accounting system to identify donors that might support you in this case; (2) cut expenses; (3) rearrange expenses, perhaps using a gifted asset to offset the expense budgeted for its purchase; and (4) move a scheduled new program launch to another period. The authors further advise that such decisions in light of the current cash and financial picture.

18. Here are some online sources to help you gather economic forecasts and data: Economic Forecasting Survey (60 economists): http://projects.wsj.com/econforecast/#ind=gdp&r=20; Recession Probability (60 economists): http://projects.wsj.com/econforecast/#ind=recession&r=60; Wells Fargo economic commentary (to help you keep up with the economy): https://www.wellsfargo.com/com/research/economics; https://www.northerntrust.com (then select Insights and Research, then Economic Update, U.S. Economic Outlook, or Weekly Economic Commentary); https://www.bloomberg.com/markets/economics; Comerica Bank's economic commentary: https://www.comerica.com/insights; and the Federal Reserve's explanation of its current monetary policy: http://www.federalreserve.gov/monetarypolicy/default.htm.

19. Current interest rates are available online at: http://www.wsj.com/mdc/public/page/2_3020-moneyrate.html?mod=wsj_mdc_additional_interestrates; https://www.bloomberg.com/markets/rates-bonds/government-bonds/us; you may sign up for a free weekly newsletter, “The Fix,” at https://www.bloomberg.com/markets/fixed-income. For actual and forecast values of a very short-term interest rate forecast (60 economists), the federal funds rate (which serves as the base for all U.S. short-term interest rates): http://projects.wsj.com/econforecast/#ind=fed_funds&r=16 and http://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html/; for actual and forecast values of the 10-year Treasury note rate (60 economists): http://projects.wsj.com/econforecast/#ind=tenyear&r=16.

20. Annuity rates are available from the American Council on Gift Annuities, which posts “Suggested Rates”: http://acga-web.org/gift-annuity-rates.

21. Information on inflation is available online at https://www.sifma.org; search for the most recent U.S. Economic Outlook. (Example: https://www.sifma.org/resources/research/economicoutlook20172h/.) Compilations of professional economic forecasters' inflation forecasts are located at https://www.philadelphiafed.org/research-and-data/real-time-center/survey-of-professional-forecasters/historical-data/inflation-forecasts. The Cleveland Fed's inflation expectations data is at https://www.clevelandfed.org/our-research/indicators-and-data/inflation-expectations.aspx; set up an email alert for when that estimate gets updated at https://www.clevelandfed.org/en/newsroom-and-events/subscribe.aspx (select Inflation Expectations, then subscribe; you may also wish to select Inflation Central, then subscribe; for actual inflation data, select Median CPI, then subscribe).

22. Information on giving trends is available online at the Association of Fundraising Professionals website: http://www.afpnet.org/Audiences/ReportsResearchList.cfm; some data is only accessible for AFP members.

23. Information on exchange rates is available online at: http://www.wsj.com/public/page/news-currency-currencies-trading.html; and https://finance.yahoo.com/currencies.

24. Although not tailored to nonprofit applications, an excellent source for understanding and applying forecasting methods is Jae K. Shim and Joel G. Siegel, Handbook of Financial Analysis, Forecasting, & Modeling, 2nd ed. (Englewood Cliffs, NJ: Prentice-Hall, 2001).

25. Financial spreadsheet software will do the trick to analyze the raw data numbers to arrive at an equation of “best fit.” Microsoft Excel is very adept at this, and one does not have to be a “techie type” to do the analysis.

26. Regression, moving averages, exponential smoothing, and classical decomposition time series techniques are also presented in a cash forecasting framework in Chapter 11 of John Zietlow, Matthew Hill, and Terry Maness, Short-Term Financial Management: Text and Cases, 5th ed. (San Diego: Cognella, 2017).

27. Paragraph 3.28 of Financial Statements, Statement of Activities, as cited in AICPA, AICPA Audit and Accounting Guide, Not-For-Profit Organizations (New York: AICPA, 2017), 70.

28. From paragraph 3.40 of Financial Statements, Statement of Activities, as cited in AICPA, AICPA Audit and Accounting Guide, Not-For-Profit Organizations (New York: AICPA, 2017), 73.

29. For help in estimating grant proposal overhead, see Elizabeth K. Keating, “Is There Enough Overhead in This Grant?” Nonprofit Quarterly 10 (Spring 2003): 41–44.

30. For more on budgeting, consult David C. Maddox, Budgeting for Not-for-Profit Organizations (New York: John Wiley & Sons, 1999).

31. For another example of how a nonprofit may develop a budget see this excellent guide developed by Hilda Polanco and John Summers and made available by the Wallace Foundation: http://www.wallacefoundation.org/knowledge-center/resources-for-financial-management/pages/planning.aspx#result1. A video guide showing how to build your overall budget by first projecting program budgets is here: http://www.wallacefoundation.org/knowledge-center/resources-for-financial-management/pages/program-based-budget-template.aspx; an Excel budget template for doing your revenue scenarios is here: http://www.wallacefoundation.org/knowledge-center/Resources-for-Financial-Management/Pages/Revenue-Analysis-Worksheet.aspx; an Excel budget template for doing your program budgets is here: http://www.wallacefoundation.org/knowledge-center/resources-for-financial-management/Documents/Program-Based-Budget-Template.xlsx.

32. Michael C. Thomsett, The Little Black Book of Budgets and Forecasts (New York: AMACOM, 1988).

33. This should not be the case if you followed the recommended format offered at the end of this chapter. In that format, each month gives a cash surplus (if positive) or cash shortage (if negative), with the cash shortage reflecting the cumulative shortfall and therefore the borrowed balance at that point in time. So the loan amount does not appear in cash receipts at all.

34. Robert N. Anthony and David W. Young, Management Control in Nonprofit Organizations, 7th ed. (Boston: McGraw-Hill Irwin, 2003): 204–209.

35. Geert Hofstede, Uncommon Sense about Organizations: Cases, Studies, and Field Observations (Thousand Oaks, CA: SAGE Publications, 1994), 140–153.

36. Id., 232, 620–626.

37. On operating measures see NACUBO, “FASB Takes Preliminary Steps to Define NFP Operating Measure,” (November 14, 2013). Available online at: http://www.nacubo.org/Business_and_Policy_Areas/Accounting/Accounting_News/FASB_Takes_Preliminary_Steps_to_Define_NFP_Operating_Measure.html. Also see NACUBO, “Defining an Operating Measure for Independent Colleges and Universities-Revised March 2011,” (March 31, 2011), available online at http://www.nacubo.org/Business_and_Policy_Areas/Accounting/Advisory_Reports/Advisory_Guidance_Defining_an_Operating_Measure_for_Independent_Colleges_and_Universities_Revised_March_2011.html. Both resources accessed 1/19/2018.

38. David W. Young, Management Control in Nonprofit Organizations, 10th ed. (Cambridge, MA: Crimson Press, 2016).

39. For a comparison of a line-item budget to a program budget, see David W. Young, Management Control in Nonprofit Organizations, 10th ed. (Cambridge, MA: Crimson Press, 2016). For more on program budgeting, see Jerry Soto, “Is Your Program Budget a Monster in the Making?” Nonprofit Quarterly 8 (Fall 2001): 54.

40. Tom M. Plank, Lois Ruffner Plank, and Donald Morris, Accounting Desk Book with CD, 24th ed. (Riverwoods, IL: CCH, 2015).

41. Deloitte Consulting (2015). Zero-Based Budgeting: Zero or Hero. www2.deloitte.com/us/em/pages/operations/articles/zero-based-budgeting.html. Accessed 4/28/2017.

42. Marie Leone, “Rolling Budgets, with a Twist,” www.cfo.com (June 3, 2003): 1–4. Available online at: www.cfo.com/article.cfm/3009422. Accessed 8/14/2017.

43. Robert Colman, “Better Budgeting,” CMA Management (October 2004). Available online at: www.managementmag.com/index.cfm/ci–id/2014/la–id/1.htm. Accessed 12/31/2005. Also see Hilary Johnson, “Rolling Budgets Catching On,” Crain's New York Business (July 31, 2011). Available online at: http://www.crainsnewyork.com/article/20110731/SUB/307319999/rolling-budgets-catching-on. Accessed: 1/19/2018.

44. Diana Scearce and Katherine Fulton, What If?: The Art of Scenario Thinking for Nonprofits (Emeryville, CA: Global Business Network, 2004).

45. The key performance indicator approach, sometimes referred to as “key financial success indicator” approach, is documented in Mary M. Sapp and M. Lewis Temares, “A Monthly Checkup,” NACUBO Business Officer (March 1992): 24–31. For a deep dive, see David Parmenter, Key Performance Indicators for Government and Non Profit Agencies: Implementing Winning KPIs, (Hoboken, NJ: John Wiley & Sons, 2012). We strongly advocate that you evaluate using this approach in your management reporting, regardless of your organizational type.

46. Vonna Laue, “Six Debt Ratios and Measurements Your Church Should Monitor,” Church Law and Tax, (March 2015): 1. Web-only publication available at http://www.churchlawandtax.com/web/2015/march/six-debt-ratios-and-measurements-your-church-should-monitor.html. Accessed 1/19/2018.

47. Malvern J. Gross, John J. McCarthy, and Nancy E. Shelmon, Financial and Accounting Guide for Not-For-Profit Organizations, 7th ed. (Hoboken, NJ: John Wiley & Sons, 2005): 425–426.

48. For information on the sustainable growth rate, see Hill, Zietlow, and Maness, Short-Term Financial Management, Chapter 3.

49. The internal growth rate is profiled in most introductory corporate finance texts.

50. GrantStation, “The Spring of 2017 State of Grantseeking^TM Survey and Report,” (Spring 2017): 8.

51. Association for Financial Professionals, “2017 FP&A Survey: How Relevant is Your Budget?” (August 2017). Available online at: https://www.afponline.org/trends-topics/topics/articles/Details/fp-a-survey-is-your-budget-relevant. Accessed: 1/19/2018.