The Importance of Budgets to Nonprofit Organizations
This piece is Part 1 of 4 in our Budget Building Essentials Series.
The word “budget” has almost universal recognition. Budgets have a very broad spectrum of usage and applicability beyond just nonprofit organizations, ranging from large entities (governments, Fortune 500 companies, professional sport teams) to small businesses, individual entrepreneurs, and even smaller applications such as families juggling home budgets and providing their children with early exposure to budgets through managing allowances.
So, what is the special importance of budgets to nonprofit organizations? Like other entities, nonprofits must also manage acquisition of funds and use of these limited resources, but with the added heavy responsibility that they exist to support the “public good” while being governed by volunteers. For this reason, I argue that budgets serve an even greater role for nonprofit organizations, supporting the management and stewardship of public funds.
Before we explore why budgets are so important to nonprofit organizations, let’s first consider the meaning of the term.
What is a budget?
I like to define nonprofit budgets as “an organization’s strategies, programs, and operational plans in terms of dollars.” Pretty simple but perhaps not as simple as it may appear at first glance.
We provide a more formal definition in the SE4N Glossary of Financial and Accounting Terminology, which defines a budget as:
“[A] detailed financial plan to estimate revenue and support and expenses for a specific period of time, usually 12 months (one year). Budgets are based both on looking back at historical data and looking forward to the future for expenses and revenue and support. It is an essential management tool/function for planning and decision-making processes.”
As one nonprofit accounting services firm concisely puts it, “[a] nonprofit budget is a planning document used to predict expenses and allocate resources for your organization.”
Why are budgets so important to nonprofit organizations?
Without budgets, it would be extremely hard, if not impossible, to successfully manage and operate a nonprofit organization because budgets fulfill key strategic planning and performance assessment roles.
One of the most essential strategic planning roles is to bring the mission, aspirations, and dreams of an organization together with the ability to acquire and manage financial support and revenue. Budgets help nonprofits use (expend) these limited financial resources in a manner that not only advances mission but also recognizes capacity constraints, supports sustainability, and promotes continuity.
Budgets also facilitate balancing and alignment of mission delivery with financial resources and capacity. This is conceptually simple but in practice involves tough strategic tradeoffs. Funding is never easy to procure and sometimes (because of restrictions and timing) does not align with programs and activities where financial resources are needed the most.
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Strategic planning is just the beginning role for budgets. Next comes the performance assessment role, where actual progress is compared to original budgeted expectations. Gauging progress compared to budget benchmarks allows organizations to react to changing conditions, adjust resource allocations, and manage evolving budget surpluses and deficits (the bottom-line). Without budgets, financial performance assessments would be subjective and unreliable.
Types of budgets
For nonprofit organizations there are multiple types of budgets that will be needed depending on the size and complexity of the organization. All nonprofits need to have an operating budget that aligns with the fiscal year of the organization, covering a 12-month period except in the case of the initial (start-up) year, dissolution (closing) year, and/or change in fiscal year (transition year). Operating budgets cover annual expected support and revenue (funding) along with anticipated costs (expenses) for programs and operations.
There are other special purpose budgets used by nonprofit organizations. Capital Budgets (acquisition of long-lived fixed assets), Cash Flow Budgets, Individual Grant Budgets, Multi-year Program Budgets, and Joint Venture, Collaboration and Partnership Budgets are typical examples of special purpose budgets. These budgets fulfill unique roles but also support and add value to operating budgets.
Planning Tip – Even the best nonprofit budgets will be ineffective if key users of budget information (management, staff, Boards, finance committee, and other committees) are disconnected from financial reporting. Monthly distribution of financial reports that include analysis and assessment of performance to budget benchmarks is a critical element. Make sure that these users understand the monthly financial reports and have a means to share observations, make comments, propose reallocation of resources, and ask questions.
There are many layers to nonprofit budget systems and effective budget practices. For example, we have written previously about how culture, management styles and assigning budget responsibilities are important elements of proactive budgeting systems. However, recognition and acceptance that budgets are important is always the first step.
