Essential Groundwork to Create and Control Your Annual Budget
Nonprofit boards have a fiduciary duty to effectively manage the assets of their organization.
Approving the budget is the first tool in executing this obligation. Although some budgeting is done
on an ad hoc basis, most budgeting is done on a regular basis. At Cathedral, we believe
December is the perfect time for nonprofit organizations to create their annual budget for the next
fiscal year; as the calendar year and year-end holiday giving draws to a close, both nonprofit
executives and Board of Director members are beginning to think about what they would like the
organization to accomplish next year.
This paper looks to the importance of the annual budget and the essential groundwork needed in
order to create and control the annual budget. See our paper on The Budget Process1 for types of
budgets and processes to establish the annual budget. See our paper on Annual Budgeting2 for
key considerations when creating the annual budget.
Critical to Success
Budgets are critical to the success and systematic growth of a nonprofit organization for several
reasons. Most obvious, budgets indicate management’s objectives and demonstrate how it intends
to use resources to achieve those objectives. As managers allocate resources throughout the
year, they must determine between objectives that advance the organization’s strategic plan and
those that do not. If it is not in line with the strategic plan, it does not belong in the budget. As the
year plays out, the budget keeps the organization focused. For example, the budget vs. actual can
be consulted to determine a large purchasing decision.
Budgets also set the stage for reflecting on previous year’s activities. Weaknesses can be
addressed early and strengths can be pursued in preparation for the new year. Such annual task
can only lead to the systematic growth of an organization year-on-year.
Throughout the year, the budget can serve as a framework for monitoring both the progress toward
mission goals and the overall financial health of the organization. The Executive Director and
Board of Directors should review the budget on a regular basis to ensure that spending is in line
with revenue. This exercise will also allow the Board of Directors to identity any misappropriation of
funds, requiring explanation for any unusual gaps between planned spending and actual expenses.
Cash vs. Accrual Accounting and Budgeting
Nonprofits can choose between two primary accounting methods, cash basis or accrual basis.
Cash basis is most common for smaller nonprofits due to its simplicity. Relating directly to the
checkbook, the cash basis recognizes and records money only when it is received and as it is
1
2
http://www.cathedralconsulting.com/files/Budgeting Process.pdf
http://www.cathedralconsulting.com/files/TOPIC.NOVEMBER NP.2009_0.pdf
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spent. Accrual basis, however, recognizes the commitment of money and when an invoice is
received. Note that some nonprofits chose to use modified-cash basis of accounting, recording
payroll taxes withheld from employees or large revenue or expense items on an accrual basis.
Both accrual and cash basis have their pros and cons. The cash method shows a better picture of
how much cash you have and helps ensure good cash flow, often good in a cash tight situation,
but keeping a close eye on the general ledger and weekly reconciliation of bank statements are
also essential. The accrual method shows the relationship between income and expenses most
accurately, allowing Executive Directors to demonstrate to donors the true value and need of the
organization. This is particularly true if the organization experiences seasonality in donations, has
pledges, or earned income.
It is very important to make sure you are using the right accounting system for your organization.
Using the wrong accounting system can hurt your financial sustainability and cash flow. Not
adapting to the complexity and moving to an accrual basis as the organization grows can lead to
incomplete and misleading financial statements. Regardless, Executive Directors should keep in
mind the chosen method of accounting, understanding how funds are to be managed and
establishing the budget accordingly.
Chart of Accounts
Many organizations have bookkeepers or treasurers that take hold of the finances. The hope is
that when the organization was created, the chart of accounts was also done correctly so that the
Executive Director and/or bookkeeper have no problem in generating financial information needed
to run the organization. For most organizations, however, when a new Executive Director arrives
or the annual budgeting process begins, it is a good time to reevaluate the chart of accounts with
the bookkeeper in order to keep it current to the current needs of the organization. The end goal is
to have a chart of accounts that provides all the information to make accurate business decisions.
Key questions that an Executive Director should ask in reevaluating the chart of accounts:
1. Do I have a lot of accounts with only one item? Note that this depends upon the record;
insurance typically has only one entry but does need to remain separate.
2. Do I have accounts that are unused and several years old that I can eliminate?
3. Are there accounts that can be combined?
4. Is my staff getting the level of data they need to make an accurate decision? Am I?
Most nonprofits have the challenge of determining which categories to utilize so they have enough
information but not too much. This is particularly true as financial software tends to offer hundreds
of possibilities. Those accounts chosen should be general enough to encompass items needed
but are detailed enough to not include unrelated items. They should also be communicated to the
entire staff in order to ensure the fullest understanding of organizational expenses. A common
example is seen when the program staff fills out their expense reports and decide that the supplies
they bought were “program supplies.” The bookkeeper, however, sees the receipt and decides
they are “office supplies.” When it comes around to establish the annual budget, the Executive
Director will look at the total amount of office supplies purchased last year and determine it is
spending too much in office supplies. As a result, the office supplies total In the annual budget is
significantly lowered.
The budget should be determined using the chart of accounts labeling, ensuring that the budget
matches the chart of accounts when completed. All Executive Directors should be prepared to
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provide the overview of the chart of accounts to the Board of Directors through the budget approval
process.
Additional Tips on Controlling the Budget*
1. Enter the budget into financial software. This will allow Executive Directors to reconcile
quarterly or annually by comparing budget with actual revenue and expenses. This will help
keep expenses as low as possible and prevent surprises and the need for emergency
appeals – which tend to be attractive to donors.
2. Monitor the individuals who oversee entering the data into financial statements. If they do
not enter data correctly they can do more harm than good.
3. Centralize purchasing and avoid excess purchases.
4. Take notes when you are establishing the budget so that you can answer the question
“Where did you get that amount from?”
5. Review each expense account at least on a monthly basis, before the ED and CFO are paid.
6. Don't spend now and hope the funds will follow. Don't depend on funds you don't have.
7. Don't pad line items. It is far better to have an accurate line item amount than a distorted
amount. If there is a surplus in a budget, record it as a surplus and use it appropriately.
8. Avoid vague, all–encompassing chart of accounts. Marketing can include meals and
entertainment, travel, and office supplies. Yet, for budget vs. actual and planning purposes,
understanding the true nature of these accounts is key.
9. Revise the budget as many times as necessary to adjust for unavoidable changes throughout
the year. See our paper on The Budget Process for our recommendations.
10. Avoid the "catch–all" miscellaneous account as much as possible. If you must have a
miscellaneous account, limit amounts charged to it to under $100.
11. Don't procrastinate in making an unpopular decision.
12. Be sure every department shares in controlling the budget. Give staff both responsibility for
developing the budget and authority to manage and implement the budget.
13. Celebrate successes. Demonstrating the importance of staying within budget is vital. Have
small celebrations quarterly and recognize departments who are staying within budget.
Articles for Further Reading
1. “Budgeting Basics for Nonprofits.” http://www.slideshare.net/GrossMendelsohn/clc-9-2010budgeting-and-financial-statements-for-nonprofits-slideshare.
2. Rotondi, Ann M. “Create a Budget that Works for You.”
http://www.snpo.org/samples/V150446.pdf. An excellent article outlining processes to
create a realistic budget and tips to assist in the process. Sample budgets are provided.
3. Goodman, Beverly. “Cash or accrual? Selecting the correct method. (Balance Sheet).”
The Nonprofit Times. http://www.allbusiness.com/accounting/241376-1.html
4. NAF Financial Foundations . “The Nonprofit Budgeting Process.”
http://www.nonprofitsassistancefund.org/files/MNAF/ArticlesPublications/BudgetingProcess.
pdf
5. How to Develop a Budget for a Nonprofit Entity: The Importance of and Steps for
Establishing Spending Parameters. http://www.suite101.com/content/how-to-develop-abudget-for-a-nonprofit-entity-a179570#ixzz17SQaLXrl
Peter Giersch is COO of Cathedral Consulting Group, LLC and a Managing Director in the
Midwest office. Michelle Fitzgerald is a former Senior Associate in the New York Office.
For more information, please visit Cathedral Consulting Group LLC online at
www.cathedralconsulting.com or contact us at info@cathedralconsulting.com.
*
Most tips courtesy of Ann Rotondi at Nonprofit World: www.cfw.org/Document.Doc?id=374
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