3 Rules Nonprofits Should Follow When Approving Budgets
As a consultant, I’ve spent many hours on the technical aspects of budgeting. I’ve designed models, developed spreadsheets, downloaded and uploaded data, and of course, written lots of financial statements.
I’ve also budgeted for my own business as well as other companies where I’ve worked. So, I know something about budgets.
But, recently, in my volunteer position as treasurer of my local Y, I’ve been thinking about how a nonprofit board should approve a budget.
The challenge of any nonprofit is that board members mostly don’t know the ins and outs of the business. And running a community center is particularly difficult as you have at least five to six different businesses contained therein, with very different revenue and cost structures.
In my day job, I never have to model a health club and nursery school in the same project—not to mention a teen musical production.
The other challenge is that, unlike in my day job, the folks I’m working with aren’t necessarily numbers people.
Going through this process at the Y has forced me to articulate certain things I knew in the back of my head but had never fully formulated.
Which leads to my list of three rules nonprofits should follow when approving budgets:
- Assume gradual change
- Get context
- Ask: “What happens if we’re wrong?”
1. Assume Gradual Change
Years ago, I wrote a post on the importance of “zero-based budgeting.” The idea of zero-based budgeting is that you shouldn’t assume that what you’ll spend this year will be the same (plus or minus a few percentage points) as what you spent in previous years. Instead, you need to rethink and re-justify every dollar.
I’ve taken the advice of zero-based budgeting myself—which is why my business is now run virtually, without office space. At a certain point, I could simply no longer justify it.
But at the same time, while big changes can occur over time, planning for big changes in a short time frame is often just wishful thinking.
An example: In a particular Y agency, gym membership had been declining for many years. Over the last few months, it’s been on an upswing. And it’s not unreasonable to budget for the upward trend will continue.
But it is unreasonable to think that it will get back to where it was five years ago in a short span of time.
2. Get Context
When looking at financials, the underlying question to ask is, “Is this good, bad or okay?”
In for-profit business, industry standards for gross margin, ROE and other key metrics are often known by the key business principals. So answering that question isn’t so difficult.
But for nonprofit boards, this question gets harder. The combination of multiple lines of business and a lack of numbers knowledge means that the lines between good, bad and okay aren’t as obvious.
As a result, even the most intelligent board members may reach conclusions that seem reasonable but really aren’t. As in, “It seems to me that we don’t need as many staff doing X.” Or “I think we should be getting more money for Z.”
That’s why it’s so important to have comparatives of similar agencies. Only then can you discern whether what’s going on is reasonable.
An example: I’ve told folks over and over that I know very little about how to run a fitness center or nursery school. Yes, I can model each business to help turn intuition into numbers. But I won’t know whether we’re doing good, bad or okay unless I know what other fitness centers and nursery schools do. Thankfully, there are national organizations that can provide such numbers.
3. Ask: “What Happens If We’re Wrong?”
I read a lot of business books last year—most of which I’ve thrown out. One of the few keepers was “Rework” by Jason Fried and David Heinemeier Hansson. In the book, one central theme is “planning is guessing.”
It’s certainly true that a nonprofit can’t “wing it” to the same degree as a small company. But Fried and Hansson’s insight still applies. Just because we have a lot of detail in our budget doesn’t mean we know the future.
So, after you’ve done everything, you need to ask, “What happens if I’m wrong?” Even if you’ve been conservative in your assumptions, are you sure you haven’t missed something? Have you allowed yourself a cushion for any mistakes?
Have you sat on the board of a nonprofit? What unique budgeting challenges did you face?