The Budgeting Process: The Necessary Components

Our previous post explored the importance of establishing a budget and the common mistakes many nonprofits make during the process. It is clear the creation of a budget  requires the collaboration of numerous departments, but more importantly, where does the process begin?

First and foremost, a budget period or “time horizon” must be determined. This is an interval of time into which the project period is divided for budgetary and funding purposes. An appropriate budget period will depend on the size and complexity of the nonprofit. Typically, smaller organizations have a budget based on a 12 month period, or a single fiscal year. Larger, more sophisticated organizations with significant resources may require a longer budget period.

It is important to recognize that a nonprofit’s overall budget is, in fact, a compilation of several budgets.  Each of these component budgets offer details about an organization’s financial well-being, which can be used to help drive programming and the overall mission. Regardless of the size of your organization, the following component budgets are essential for  financial transparency.

• Operating budget 

• Capital budget 

• Cash flow budget

Operating Budget

bUDGET-2The operating budget reflects an organization’s planned financial activities for the designated budget period. It outlines how much revenue is expected to be accrued, from which sources, and how much will be spent on operations.

The operating budget is comprised of several separate project or departmental budgets. Most importantly, program directors will state their expected budgets for their programs for the budget period.  Typically these include the funds expected to be received along with direct program expenses.  However, you should note that program directors usually do not address capacity limits or overhead costs. In addition, a departmental budget should also be outlined for special events and fundraising.  

These ” individual” budgets must then be consolidated to achieve an overall operating budget for the fiscal year. It is imperative that this budget corresponds with the organization’s strategic initiatives. 

Capital Budget 

A capital budget relates more to an organization’s financial position: its assets, liabilities, and net assets. This budget should set forth goals and targets for each of these areas. Most smaller nonprofits do not focus on this aspect of the overall budget because they are often struggling to maintain programming in the red as it is. A capital budget is essential to ensure a funding plan has been created above and beyond  the operating budget. This may include a capital campaign, issuance of long-term debt, the sale of other assets such as investments, and so forth. 

Cash Flow Budget

Although a typical budget for a nonprofit organization is comprised of an operating and capital budget, a significant problem can develop due to a failure to implement a cash flow budget.  In theory, the operating budget consists of revenues and expenses, which should be compared to the cash flow budget. However, when dealing with contracts and grants, funding  does not always arrive when expected or even during the fiscal year in which they have been included. Hence, a cash flow component of a budget is critical, especially for those organizations with limited resources.

The annual operating budget is the basis for the cash flow budget. The timing of the revenues and expenses in the operating budget are projected on a monthly basis. This helps the organization to effectively manage cash and identify conditions where  short-term borrowings may be essential in order to balance the cash flows. 

This is a very brief introduction into the basics of nonprofit budgeting. Once the process has been completed and all issue have been addressed, the budget must be approved by the board. Following their approval, it is critical to monitor and regulate the organization budget. Remember, effective financial management requires all parties to be conscious and deliberate about planning for both the organization’s  long-term financial goals and short-term financial health.

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