Over the next several weeks, we will discuss different elements of nonprofits budgets. Our goal is to build capacity because we often receive questions from board and staff members that speak to the need for a broader understanding.
Last week, we looked at expense. Today we examine cash flow and forecasting.
The need to manage cash is universal in all industries, for profit and nonprofit alike. However, the need is especially acute for organizations that operate on very thin margins.
Cash flow and forecasting can be a problematic area for finance and development teams as each has a different measure of success. Finance teams need to know how much cash is on hand to pay bills, while development teams need to count all gifts, including pledges to be paid in the future. An example of this tension is an organization whose CFO told the CEO that they were in a major cash crunch, primarily because of timing issues. The CEO’s reaction was to ask the development director to call donors with outstanding pledges and have them pay early. You can imagine how well that strategy worked.
Our colleagues at Nonprofit Quarterly have an outstanding article on cash flow. One of their main messages is that cash flow problems can be a symptom of a larger challenge. Leaders may mistakenly think cash flow is only a timing issue, when in fact it’s much more serious.
How do leaders understand what is a timing issue and what is structural?
If it’s truly timing, then the organization should only need to borrow from its cash reserves or a line of credit for a defined period of time until the receivable is paid. It is a red flag if the cash reserves are being depleted or the line of credit balance continues to increase. The responsibility lies with management to be honest and transparent about financial challenges, but board members cannot abdicate their oversight function because of an assumption that “all nonprofits have cash flow challenges.”
A way to manage expectations is to engage in financial forecasting.
The first step is to create a forecasting practice when creating the annual budget.
For instance, when building the operating budget for FY21, also create a forecast for FY22. It’s important to think ahead as to what that future fiscal year may look like to give finance, development, and program teams ability to plan and not just react. The board does not have to approve that forecast when they approve the budget. The projections will certainly change, but everyone will know the plan and what resources will be needed.
The second step is to document all assumptions in your operating budget.
A budget is based on a set of assumptions made in the current year about what is believed to be true for next year. Every line item in the budget should have notes to articulate how the values were derived. For instance, salaries are based on 20 FTE at the current staffing structure and salaries; or, gala revenue includes 10 sponsors at $X level and 15 sponsors at $Y level. The notes should show the math or indicate if the amount is an estimate. In doing so, it makes any variance easily understood.
The third step is to create a cash flow statement.
This document is complementary to the budget and focuses on timing. The goal is to understand the cadence of cash flow — when large amounts of cash are expected or needed to be received or spent. The finance team will be assessing cash flow on a regular basis but a quarterly meeting with a cross-functional team of finance, development, and program is beneficial to manage expectations and reduce stress.
The fourth step is to do mid-fiscal year projections.
Once a budget is approved, it can become quickly outdated. For example, after one month in you may not receive a grant that was expected. That’s why we suggest operationalizing a six-month review half way through the fiscal year. Look at your actuals vs. budget, review the assumptions noted, and create a formal budget reforecast to account for variances and make adjustments. A budget is a point-in-time document. It’s not a failure to have to adjust mid-year.
The final step is to celebrate.
Budgeting can cause anxiety for all involved. Celebrate the success and recognize the diligence of all those whose efforts made an impact. Meeting projections, managing cash, and balancing the budget is hard work. Take the time to pause and reflect, which improves morale and increases the likelihood that projections are on target.
Article by: Kerri Laubenthal Mollard, Founder & CEO