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Constructing an Annual Budget for Nonprofits: A Step-by-Step Guide

best practices board finances foundation funding reporting Apr 06, 2023

Constructing an Annual Budget for Nonprofits: A Step-by-Step Guide


     If you're an executive in a nonprofit organization, then you understand that budgetary planning is essential to your success, but putting it together can be another story. So I've put together a step-by-step guide to help you construct a budget in a way that will meet the needs of your organization. Today, we’ll look at the steps to constructing an annual budget for your nonprofit. 

1. Take a look back.

     Take a look back at the rear view mirror of your financial car. Look backwards first. Get a file, a spreadsheet, or a report that has 12 months worth of data. Yes, you do need 12 months of data because if all you do is try to annualize the most recent numbers you have, you’ll be making a lot of assumptions that just might overlook something really important. That’s why I recommend getting a 12 month look back. It allows you to more accurately considers seasonality and it gives you a full year of real data to look at. 

     Once you’ve gathered your 12 months of data, you’ll want to take a look at accounts that are over budget. What does the story tell us? Is there a reason? Was there a change in course mid-year that explains what we would be spending more money on?  You may have added a program and had new expenses. Was there just something we forgot to budget for? Well, make a note of that so that you can add it in.

     Next, we want to move on to looking at what came in under budget. So, which 12 month numbers are actually under the budget? They tell a story too. Are we budgeting for something that we're no longer doing? Are those funds just sitting there available on the sideline? If so, you’ll want to reduce the budget and put those dollars to use in another very important area. This work of looking back is going to give you a deeper understanding and advise you well as you plan for the budget. 

2. Assess all the revenue variables

     Once you’ve analyzed your previous year’s spending, it’s time to look to the future and assess all the revenue variables. These revenue variables may include grant sources. Do you have any pending applications? Do you receive support from a foundation or a grant with a fee for service arrangement? Are there any trends or anticipated changes happening in that revenue source? You'll want to plan for those. 

     Here’s another factor to consider when assessing your revenue variables: What is your level of reliance on contributions. I work with a lot of churches and almost all of their revenue comes from contributions. If this also describes your organization, this is where you’ll want to pause and do a donor analysis to study the following:

  •  Is the total number of givers going up or down?
  •  Is the average gift size increasing or decreasing, and if so, by how much? 

     The more concentrated your funding is in contributions, the more thorough your research needs to be here. You really need to understand the composition. It may look like “tiers” of givers, because a large group will often do a small amount of the giving and vice versa, as the Pareto principle suggests.  

     Another variable to consider would be whether you have a tier of large givers who are all in the same industry. For instance, if a church in a farming community and that particular farming community is heavily impacted by a certain circumstance that reduces their income, your nonprofit may see lower contributions as a result. While these steps can better inform our revenue projections, you’re never going to be able to anticipate everything, so you’ll want the capacity to be flexible throughout the year so you can adjust your expenses if revenues are less than projected. 

3. Evaluate salaries

      In my 25 years of experience, salaries have always been the biggest expense in a nonprofit. I've produced many blogs and videos on the topic of setting and managing nonprofit salaries, which you can search for on my website by clicking here. For our purpose of budgetary planning today, here are a few considerations you want to think about.

  •  Do you have any promotions this year? Do you have any staff who have increased their level of contribution in leadership who should be considered fora promotion from perhaps a coordinator level to a director level?  What are the corresponding salary impacts of such a situation? 
  •  Will you add or subtract any positions? Do you have a situation where you need to combine positions? Do you need to tighten the belt and do away with a position because, while it's been valuable, it's not necessary and those resources should go somewhere else?
  •   Will you be providing cost of living adjustments? As I shared before in this blog post, this decision involves doing specific research about the average cost of living increase in your particular nonprofit industry. Also, nationally, there's many generalized resources out there that talk about the cost of living. In high inflationary times like this, cost of living increases can be a much greater draw on your resources. Staff need to be paid as much as you can possibly afford to keep them in a place where they can manage the effects of inflation in their own personal finances.  Keep in mind that down the street, someone might be paying more, and you want to stay as competitive as you can during these times. 
  •   Examine your salary to revenue relationship. I find, especially in churches, that this is a pretty solid percentage. In your organization, you probably have a historical percentage to compare to. You’ll want to see if that relationship is remaining consistent. If revenues are going down, we really don't want salaries to go up, especially not very significantly, or we're not going to be able to balance that budget. 

4. Consider your expenses

 This is a step that absolutely requires getting staff members involved. You need to get others to help build the numbers they are most familiar with or to formulate the budget requests for the programs they lead and the numbers that they are responsible for through the year. Once again, previous expenses are a very good indicator. Practically speaking, I’ll often just run a detailed ledger of those expenses for the past 12 months and say to that person, “Hey, can you look at this and tell me what you think we’ll need for the next 12 months? Ask for a well-articulated proposal, meaning one that says more than just “$1,200”, but something that says, “Well, we meet with 12 individuals, and we spend about $100 on each of them, so it's a $1,200 budget.” You’ll want those budget request to be detailed out. Additionally, here's where you want to align your strategic planning efforts. Hopefully, you’ve done some planning for your next year about what you’ll do, activities you'll have, anticipated changes, and program adjustments or introductions. Bring all of this info into this step. Follow the vision and put those items into the budget. 

5. Put it all together

Finally, it’s time to  put it all together in this final step. Input your budget using your accounting system. Ideally, your system allows you to put in all these budget numbers, but if it's not quite good enough, you may be using a spreadsheet. I discourage that, but if it’s your only option, you can make it work. Perhaps you use a combination of both. Either way, you’ll want to put all of these numbers together- your revenue, your salaries, and your expenses. Then you’ll want to look at where you land as a nonprofit. Your #1 priority is going to be a balanced budget. In other words, you don't plan to spend more dollars than you’ll bring in. And if you're bringing in dollars, you should either plan to spend them or plan to save them for a particular purpose. So if you get to this step and things aren't working, (if revenue minus expenses doesn’t equal zero) then you need to go back to the drawing board and start reevaluating and tweaking different budget numbers, so that you can land at a balanced budget. 

     Well, there you have it! That's my step-by-step guide to how nonprofits should approach their budget planning process.  Obviously, that's a pretty high level flyover, but I have decades of experience doing this, so I’m happy to help you in your unique situation. Do you have any specific questions? Feel free to email me or message me on LinkedIn. If this was helpful, I want you to know that this is what I offer. I offer this nonprofit CFO expertise and I publish content like this every single week. If you'd like to make sure you don't miss one of those tips, click here to sign up to receive these financial tips straight to your inbox!

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