Budgeting for Nonprofit Organizations and Why It’s Important to Start with Revenue and Support
This piece is Part 2 of 4 in our Budget Building Essentials Series.
Assembling a budget for a nonprofit organization often feels like an endeavor that requires more artistic methods than scientific computations. This is especially true when it comes to budgeting for revenue and support, which is usually hard to predict with accuracy. To help balance the art (intuition) with the science (analysis) of budget building, consider using a “funding-first” approach.
The funding-first approach to budget building prioritizes budgeting for revenue and support before assembling the expense side of the budget. Front-end funding assessment and estimates will help nonprofit organizations to better align and scale programs, activities, and operations to available funding. This will help organizations to actively manage the budget bottom-line, add to operating reserves, and avoid unintended budget deficits.
This process will also help nonprofits to focus on funding risks such as changes in constituent demand for services, donor satisfaction, and funder temperament, all of which will impact the willingness of patrons to continue to purchase services, donate, and award funding.
To facilitate this process, separate funding sources into three categories:
Revenue (earned income also referred to as exchange transactions which includes fees for service, sales of merchandise, advertising, service-based membership dues, etc.);
Support (contributions, grants, sponsorships, awards, etc.); and
In-kind contributions (donated goods and services).
Each of these funding categories will react differently to changing conditions. For example, during a natural disaster, contributions could increase while registration fees decrease due to canceled or rescheduled programs.
Predicting future revenue and other funding sources can be a real challenge. Relying only on past historical performance for continuing programs and operations can be misleading, especially if there has been a lot of recent disruption and unexpected changes. For new programs and activities, history may not be any help.
To help assess, manage, and estimate future funding sources, establish a three-tier assessment scale for each of the three categories above:
“Rock Solid” (predictable, stable, and reliable);
“Vulnerable” (exposed to external factors, changing economic conditions and sentiment); and
“Shaky” (new funding, deteriorating trends, grant renewals, and research extensions).
Revenue listed in the Rock Solid tier will be relatively easy to document and explain, so start here.
Next, consider funding you would list in the Shaky tier. This tier will need extra documentation but will have little to no impact on total proposed funding because most of this funding will not be included in the proposed budget. This information will be used as a placeholder for when future conditions change and windows of opportunity open.
The Vulnerable tier will be the most challenging of the three, requiring more documentation, supporting explanation, and thoughtful messaging. This tier is where art crosses paths with science and where risk vs. reward decisions reside. Documenting the supporting case for these sources of funding will require analysis of trends and other factors, with supporting schedules (science). Making the “go vs. no go” decision will require elements of intuition (art) based on management confidence in expected outcomes.
Plan to complete the Rock Solid and Shaky tiers first, reserving extra time for the Vulnerable tier to allow for in-depth discussions, risk analysis, and possible redrafting to get these funding sources to a sufficiently high enough confidence level to include in the proposed budget.
It is possible for similar funding sources to end up in multiple tiers. For example, registrations for an annual conference that sells out each year would be included in the Rock Solid tier while registrations for a new pre-conference extra-day educational program might be included in the Vulnerable or Shaky tier because attendance for this new event is hard to predict.
Planning Tip - Fee-for-service price-setting decisions should be separated from the annual budget building process. These decisions will have long-term implications and require a complex balancing of factors that are often overly influenced by rising costs first confronted when assembling the next annual budget. For example, attendee satisfaction and price sensitivity are key decision factors that are just as important as the cost of the program. Ultimately, programs will need to be assessed outside of the annual budget building process in order to effectively evolve to meet both participant needs as well as cost controls.
Using a funding-first budgeting approach will help most nonprofit organizations. The increased confidence in funding that results from this approach will facilitate setting budget parameters for expenses. Often organizations use the “hope and pray” method, first building out program and operational expense budgets based on the high “hopes” to grow and do more, and then “praying” they can come up with adequate funding to match. Funding-first budgeting will help cure this over-aspirational approach.
