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The Building Blocks of Budgeting

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1 The Building Blocks of Budgeting
How to prepare meaningful and manageable budgets for your organization Presented by: Susan R. Lucato, CGA

2 Susan Lucato, CGA 14 Years Grant Thornton Chartered Accountants
9 Years Victoria Foundation 2 Years consulting practice Active local volunteer Presentation materials will be on-line Good morning everyone: thank you for coming out today Just a bit about myself before we get started: First, I’m no expert – every non-profit is different and has different needs and profiles, what I hope to achieve with you today is to help you understand how to get a better grasp and understanding of how the budgeting process works so you can leave here today ready to make positive change in your organization. I’m here today because throughout my career working within the charitable sector has always given me the greatest amount of joy. I used to spend each April – July working on NPO audits when I was at GT, and my work with the Victoria Foundation exposed me to even more amazing groups here in Victoria and beyond. So, let’s get started and see where the morning takes us – please ask questions when you think of them.

3 TODAY The Building Blocks of Budgeting: Definition
Development – steps in the process Budgeting process Best Practices Preparation Components Key terms / terminology and other important considerations Today I hope to give you resources, ideas and discussion. I will try not to just talk at you – instead let’s try to make this a bit more conversational. Please ask questions regularly, and I may ask you to save them until that time, just to ensure I don’t get befuddled in my train of thought! I’d like to go around the room, as we are a small enough group, and ask you to provide the following: Your name, Your organization, Your role/position What you hope to get out of today’s seminar / Why did you sign up? Any key burning issue you have that we must address! Let’s start with….

4 What is a Budget? “A budget is the numerical expression of an organization’s dreams that serves as a guide or measure of acceptable financial performance.” Jody Blazek from Financial Planning for Non-Profit Organizations I like this quote because it gets back to the heart of the NPO sector – the work you are doing is important and meaningful, yet quite often the financial side is seen as the bad guy / unwanted task. Let’s change that today – your budget being the numerical expression of your dreams! FABULOUS!

5 What is a Budget? A well constructed operating budget will demonstrate in numbers the organization's commitment to fulfilling its mission. It will be based on reliable income projections and expense projections will be well-researched, conservative, and thorough. Those building the budget will understand what components of it are fixed and which can be adjusted as the budget year progresses. Your budget is the guideline / guidepost to achieving your mission and objects within the next fiscal period. A budget is an estimate – your best guess as to what will happen in the next year, BUT it is based on history, experience, known amounts etc. IT is NOT meant to be an exact science – actual results WILL vary from the budgeted ones.

6 Steps for Developing a Good Budgeting Process - Overview
Write it down. Decide who should be involved and when. Establish an annualized timeline. List specific tasks with specific responsibility assignments. Ensure that budget line items and accounting line items are in sync. Develop worksheets, templates, and tools that promote inclusion of all relevant budget components and facilitate "what if" scenarios. DUH Clear defined roles, who’s in charge, who does the field work etc. Realistic – this process takes time YE DEC 31 – budgeting starts in the summer – YES Summer Draft budget to Treasurer by late September Finance Committee review in October Board approval end of November Share the load if you can – but have 1 key person in charge of the compilation of information and meeting the deadlines More to come on this one – we’ll see the reality in our example EXCEL sheet Same as #5

7 Budgeting Process The annual budgeting process should be documented, with tasks, responsibility assignments and deadlines clearly stated. A good budgeting process: engages those who are responsible for adhering to the budget in the creation of the budget, allows time for the Finance Committee to participate, provides adequate time for research, review, feedback, revisions, etc. before the budget is ready for presentation to the full board, So if you are going to be held to the fire on the numbers, you’ll want to be involved in their preparation! Sometimes the Treasurer takes this on and doesn’t involve the staff – this is a mistake in my mind – even though the board is ultimately responsible for the finances of an organization they are not there every day and they may have short history. Always try to involve staff who have the day to day knowledge of the organization and are involved in the financial transactions that will impact the budget.

8 Budgeting Process (cont’d)
incorporates strategic planning initiatives, is characterized by realistic projections for income and expense is income-based (expenses do not exceed the realistic income projections) identifies fixed (indirect) costs and relates them to reliable revenue, is driven both by mission priorities and fiscal accountability Often the strategic plan is done post budget – crazy!!!!! But often a reality...therefore leave space in the budget for Contingency expenses – board approval is a MUST – by specific motion always. This is NOT a slush fund, rather a recognition that strategic opportunities may arise during the year that could not have been predicted when the budget was being prepared. Income based – figure out your income first, then you can spend the money. Be cautious about overly optimistic income projections as sometimes staff are rightly concerned about their programs and jobs when preparing the draft budget.

9 Best Practices - Budgeting
Practice income-based budgeting Analyze and understand your revenue concentrations Confirm your budget's relationship to your mission and long range/strategic goals Don't forget infrastructure Budget for capital in addition to operations Provide narrative notes to explain budget assumptions to the board Pay attention to presentation Good budgeting practices: 1.Practice income-based budgeting. Budgeting is a form of risk management, and the most reliable budgets yielding the best fiscal results for the organization are conservative and income based. This means: •Budget for income first. Base income targets on realistic expectations and only include reliable income in the budget. Never include an income projection that simply fills the gap to cover expenses. This sets the organization up for a budget deficit if the organization fails to hit the "plugged" income targets. •Take care to understand the impact and timing of restricted contributions and releases on the operating budget. •Ensure expenses are lower than the dependable income total. This requires cooperation among all departments in setting organizational and programmatic priorities, timing new or adventuresome programs. 2.Analyze and understand your revenue concentrations. Is your organization overly dependent on single source of revenue? In many cases, lack of diversification of revenue sources can pose a serious risk to the financial stability of an organization should a single large revenue source become unavailable. There is no universally right mix of revenue sources - the right mix for your organization depends on your particular circumstances, your mission, your industry, your staff capacity, and even the age of your organization. 3.Confirm your budget's relationship to your mission and long range/strategic goals. Confirming the budget's relationship to mission requires answering questions such as: • Does the expense budget reflect the mission priorities of the organization by the way resources are allocated? •Are we being pulled off course by going after grants just because they are available, even if they don't support identified mission priorities? •If we are implementing programs that are not high mission priorities, are they at least contributing substantially to financially support the organization 4.Don't forget infrastructure. Folks who work for small and midsize non-profit organizations generally are very hard workers, intensely devoted to mission accomplishment, often working longer hours at lower pay than their for-profit counterparts. They deserve good tools and will perform even more efficiently and effectively with ongoing professional development opportunities and skills training. (Budget to send them to that Excel class!) Include information technology upgrades and maintenance, evaluation, and staff development costs in the budget. High quality programs can best sustain and grow with a well-trained and well-equipped staff, both program and administrative, to support them. Budgeting to provide good pay and benefits for staffers is also a way to keep those well-trained folks with you. 5.Budget for capital in addition to operations. An organizational budget should take into account the organization's annual operating income and expenses, as well as ensuring resources for long-lived and/or non-operating needs - this is the capital budget. An organizational capital budget might cover several years and it should include target amounts and fundraising strategies to achieve strategic and financial sustainability goals. These could include: • creating or increasing an operating reserve •deficit reduction •furniture, equipment, or software purchases •leasehold improvements •a building & equipment maintenance and replacement fund •a fund to support new program initiatives, experimental pilot programs, etc. •a human resource capacity building fund An organizational capital budget is different from a capital campaign budget, which is usually for bricks-and-mortar or other finite project(s), although they could be related. For more about budgeting for capital, see Budgeting for Capital. 6.Provide narrative notes to explain budget assumptions to the board. Board and finance committee members will appreciate explanations to help them understand the underlying thinking behind the numbers in the budget. •It goes without saying* that it is best to use a spreadsheet program to build budgets, but if notes are too many or too wordy to fit conveniently into spreadsheet cells, the notes could be written in a word processing document. Whether or not narrative notes are in a separate document, be sure to add letter or number keys to associate each note to the related spreadsheet line. •*I'll say it anyway: it is best to use the right tool for the right job and let the software work for you. Please, never use word documents for budgeting - it's just plain dangerous - the spreadsheet will do a more efficient and accurate job of adding those numbers up and will automatically revise the totals when changes are made. 7.Pay attention to presentation. Your budget could be brilliant, well-researched, and well-documented, but if it is unreadable, your work will be undermined. Budgets that are easy to read and understand are well-formatted. Characteristics of good formatting: •columns and rows are well-labeled using font size, boldface, and underlines to create emphasis and for clarity, •colors used for shading are chosen with black/white printing in mind, as not everyone will have a color printer (lighter color shading under dark fonts or lighter font colors for darker shading - dark fonts over intense colors are sometimes not readable when printed on non-color printers), •column headers and row labels are carried to any second pages, •enough detail is included, but not too much, •narrative notes are given when appropriate and are keyed to the data they refer to, •print parameters are double-checked before sending out electronic copies to avoid paper waste, Try sending out as PDF •footers include the file name and the work sheet name to assist with locating electronic version locations, •consistent file naming protocols are followed to assist with version control (ORG FY10 Budget (Sept 21), then save new version as ORG FY10 Budget (Oct 5), and so on to have the latest version stack last in the Budget folder). Having an inclusive and thorough budget process, a conservative approach, documented policies, efficient budget tools, and well-formatted budget presentation that tells your mission story "by the numbers" positions your organization to have the best results.

10 Who is the budget for? EVERYONE in the organization – culture
Who prepares – key staff, ED and Treasurer Who reviews – Finance Committee Who approves – Board of Directors Who is ultimately responsible – Board of Directors NOTE – key staff who prepare budgets should have their performance reviews include the results that are IN THEIR CONTROL Make it a culture in your organization to share the summary budget with all staff. You’d be surprised the number of NPO workers who have NO CLUE where the money comes from. You cannot judge budget results against unrealistic expectations. Expenses can be controlled – income often cannot be – remember this.

11 Budget Preparation - Steps
1. Key staff, usually accountant / bookkeeper prepare draft budget documents based on prior year and known upcoming commitments 2. Key staff and ED meet to review draft and add / subtract items based on ED’s knowledge of upcoming year 3. Key staff, ED and Treasurer meet to review draft after changes in #2 have been made – further changes based on board strategic initiatives and Treasurer feedback 4. DRAFT Budget goes to Finance Committee for review & comments This entire process will take upward of three months to complete. Starting from the first stab at a draft budget(s) by staff to the board approval.

12 Budget Preparation - Steps
5. Changes updated by key staff 6. Final DRAFT approved by Finance Committee, “The Finance Committee recommends the budget be presented to the Board of Directors for approval” 7. Board reviews, questions and approves budget 8. FINAL APPROVED BUDGET saved in electronic files, all other versions should be removed, this budget is NOT changed again during the year. I cannot stress enough the last point #8 I see this all too often, then there are multiple budget copies meandering about the organization and no-one is clear where they started . THINK PROJECTION NOT REVISION – GO TO NEXT SLIDE Reporting out on a budget that is significantly different than the one originally approved is not a BAD thing. Use notes on the budget and as mentioned earlier, formatting cues and highlighting and a written narrative from the Treasurer to clarify.

13 Approved Budget Approved Budget vs. Year-end Forecast
A budget is a forecast or financial plan made at a point in time with the best information at hand.   As an organization progresses further into the budget year, it only makes sense that better information will become available that would change the previously expected outcome in one or more line items.   However, unless there has been a truly major change in the organization's structure or programs, it is generally not a good practice to change a budget once a budget has been approved by the board.   It is better to create a column on financial reports that shows a Year-End Forecast, or Year-End Projection, based on the new information, and to explain any significant variances from the original budget. Continue to talk about this important issue! Let’s discuss as a group – what does your organization do around this topic?

14 Budget line items and Accounting line items - MATCH
A mismatch between budget items and accounting items creates extra work for administrative staff or key volunteers who must translate between the two and risks inconsistencies that undermine the usefulness of financial reports. Especially for expenses, when accounting/financial statement line items exist without corresponding budget line items, it can result in budget overages or erroneously reported line item balances. I’ll show you what this looks like on the Excel sheet, but basically you want to set-up your budget document to follow your internal accounting structure. Code your budget (you don’t have to show the board the codes, but they are there for reference should questions be asked) No one should ever have to ask – where are these numbers coming from? The Treasurer should be able to tie the Trial Balance / Income Statement with GL numbers into the budget summary and then be able to talk to the components if questions arise from the board. Conversely, the bookkeeper should never have to wonder what accounts the Treasurer is using to compile the budget to actual results.

15 Budget components Organization budget: Department / Project budgets:
Operating Capital Department / Project budgets: Income THESE ROLL INTO ORGANIZATION BUDGET We are focusing mainly on the org budget as all the same principles apply to a departmental budget as to an overall organizational budget. Two main types of budgets, operating and capital. Operating tends to get the lion’s share of the focus by non-profits as it is the document that tracks revenues and expenses relating to the current year’s operations. However we will spend a bit of time on the capital budget, often ignored completely by NPO – likely because of a lack of understanding as to it’s purpose and worth.

16 Work part-to-whole The format of the budget to be presented to the board need not have the level of detail that staff or finance committee members see. Using detail worksheets as tools to build a "Full Budget" and a "Summary Budget" allows staff and finance committee members to go deep into the trees while presenting the forest to the board. Link these worksheets, or workbook tabs, to a Full Budget sheet in a single, multi-tab workbook. Later we’ll look at some examples in EXCEL BREAK TIME – 15 min I often see these GIGANTIC spreadsheets – multi-legal sized pages being twisted and turned around at board meetings...WHY – poor layout, poor excel skills and poor budgeting skills and not working part-to-whole. Think of the budget document as a pyramid... Base layer is large, mostly seen internally – GL details Next layers are supporting docs for the summary budget Top layer is summary budget that goes to the board. Naming protocol is important here, as are file saving locations on the organization’s shared network drives. BUDGET_YEAR should be a password locked folder on the shared drive. Password should be provided to ED and Treasurer annually.

17 Operating Budget Associated with Statement of Revenues & Expenditures(Income Statement, Profit & Loss) Planning income and expenses for a single fiscal year to accomplish immediate mission agenda Can be projected over multiple years as part of a strategic plan to include implementation of strategic initiatives We’re going to toggle between the Excel Template budget and this presentation. I’ve provided you with copies of the Excel template and so please let me know if you get lost and we’ll stop and regroup.

18 Operating Budget - Revenues
Associate fixed costs with reliable revenue Contractual income, income from term investments, committed grants, committed donations Fundraising events, applied for but unconfirmed grants = NOT reliable Ensure your committed revenues cover your fixed costs Fixed (indirect) costs = rent, payroll, telephone & technology – anything you spend regardless of whether a program runs this year or not FIXED = The cost to keep your doors open! If your reliable revenue doesn’t cover your fixed costs – you could find yourself in financial difficulties.

19 Exercise – take away Take your organization’s operational budget and try to split the costs between direct and indirect. Then, take the indirect costs and calculate the % of indirect costs / reliable income. This percentage will help guide you as you grow your reliable income stream and when you are applying for funding. Not all ratios are created equally – there’s no 1 right answer, instead create some meaningful percentages and keep track of them year over year.

20 Exercise – take away i.e. Organization A: Reliable funding of $2 million per year Indirect costs of $500K per year Percentage 25% This is the percentage you could include in grant applications

21 Budget components – ideas
Supporting analyses: Year over year staffing history Year over year income history Fixed (indirect) vs. Variable (direct) Fundraising events, plans, history realistic, & conservative Ongoing commitments (rent) mid-budget year increases, moves etc. We’ll see some of these in EXCEL – let’s take a quick look.

22 Direct / Indirect Costs
Direct costs relate to a specific project or program.   Indirect Costs or Overhead Indirect costs (sometimes called Overhead or General Administration) do not relate solely and specifically to a particular project or program, but are necessary to its completion.   A formal indirect cost rate can be calculated and negotiated for some grant proposal budgets when allowed by the funder. Overhead is a vital budget component for all projects, whether specifically funded or not, and should certainly be taken into account along with direct costs as funding request budgets are composed.  

23 Indirect Costs Question to ask – does the expense stop if the program stops? Some costs are allocated across programs, but overall are still indirect – would you lay off the ED if a program was cancelled – likely not - this is an indirect cost. Rent – same premise – would you be able to lease less space if a program were cancelled – NO – indirect cost.

24 Capital Budget Associated with Statement of Financial Position (Balance Sheet) Planning for optimal cash position (operating & emergency reserves, other strategic reserves) Planning for capital investments (equipment upgrade/replacement, facilities acquisition and/or maintenance, special projects, etc. over a longer time period) Planning for long term endowment (if appropriate) If you don’t prepare your own depreciation schedule in house – some orgs external accountants still do this (though getting rare), get an estimate of depreciation from your accountant...based on the prior year PLUS purchases you intend to make.

25 Non-profit – a misnomer!
Nonprofits are in fact businesses whose profits (surpluses) remain with the (non-profit) corporation rather than going to individuals or shareholders as in the for-profit business model "not-for-profit" does not mean "no surplus allowed" Nonprofits need operating reserves.  Operating reserves or working capital funds create liquidity and financial flexibility for the organization.  Organizations with a strong working capital position can focus beyond day-to-day cash flow needs and more effectively plan for the long-term health of the organization.  

26 Capital Budget – Operating Reserve Funds
Organization can be thrown into cash flow stress Become distracted from good long-term decision-making or forced to make expensive short-term crisis-based decisions May not have the resources to continue delivery of its programs Organizations with limited or negative working capital by necessity focus on the short term and are less likely to engage in responsible long-term planning. Building operating reserves is a top priority.

27 Example – Internal Restrictions/ Contingency Funds
Removes “operating surplus” excesses Rainy day source of operational funding OR savings for planned expenditures COMMON names: Building R&M Fund Capital Purchases Fund Operating contingency Fund Contingency funds are a good idea. However ensure that they are board approved for both creation and use. Don’t move funds to contingency that you envision using within 2 fiscal periods…otherwise you could find them locked away under board approval when needed for operations. Tend toward longer term savings – i.e. some orgs have a contingency for operations that will not be > 6 months operating expenses Funders may question, so have great docs outlining reason and use parameters, note disclosure on FS is important

28 Operating Reserves – Plan
Set a target each year – much like a Strata Plan does – i.e. 1% of reliable revenues Make the building of a long-term reserve just as much of a priority as the short-term funding of your project(s) Build the “expense” of the reserve into your operating budget – bottom line Create recurring board motion to approve funds - $ doesn’t need to physically move – operating reserve is an appropriation of surplus

29 Project / Department Budgets
It’s important to understand that often staff preparing and managing these may not have a strength in this area – often this results in these budgets being prepared quickly, without care and lacking the back-up information to support the assumptions underlying the numbers. You don’t expect an outreach worker / manager to come in and do the bookkeeping yet they are often expected to prepare their departmental budget and track it...with what background and training!?!?

30 Project / Departmental Budgets
Support from bookkeeper/controller is essential Review by bookkeeper/controller is essential Consistency between departments (format) Consistency of reporting (to finance dept) Accountability is KEY I recommend that the bookkeeper actually be the HOLDER and PREPARER of the budgets with the department head/manager involved and then acting as the reviewer of the document / coder of the ingoing infomration.

31 Project / Department Budgets
Detailed Realistic Manageable Based on past results and current strategic initiatives Beware optimism – reliable funding Embrace caution – variable funding Team approach – ED, project team, finance

32 Project / Dept Budgets Must “feed into” operational budget
Timing – incorporate into annual budget planning process Staff preparing need to be fed certain pieces of information – such as salary allocation of staffing – they should NOT be provided with detailed staffing information

33 Project / Dept Budgets Based on realistic income – prove income estimates in budget document – scan supporting information and include in presentation to controller & ED Research expenses under your control Get estimates of expenses from controller for other items you do not control i.e. Overhead allocation, staffing

34 Budgets for Grant Applications
Most grant-makers will request both a general operating budget and special project budget (if applicable). Budgets are cost projections. They are also show the funder how your project will be implemented and managed. Good budgets reflect carefully planned projects. Your grant application budget should relate in some way to your org budget or project budget.

35 Budgets for Grant Applications
Include your organization’s YE financial statement Include specific notes and explanations, just as you would if explaining to your finance committee or board Include direct costs / overhead

36 Review of Budget Results
Controller to ED and Treasurer – detailed results Finance Committee Distribution – detailed results Feedback – all above involved Board of Directors Distribution – summary results Treasurer presents results Finance Committee and key staff support

37 Review of Budget Results
High dependence on non guaranteed income sources (fundraising, grants) Significant, unexplained changes in expenses – particularly large % expenses. I.e. Don’t focus on a $200 change in a $1,000 account – focus on a $20,000 change in a $100,000 account – both are 20% - so think before you spend time on immaterial items. Significant, unexplained changes in revenues Mission drift – too many new programs – loss of core programs and other issues Year upon year of deficits – it’s not a bad thing to be a non-profit with a profit!

38 Review of Budget Results
Line of Credit balance Unsecured debt Un-secured investments (stocks, bonds) Related party amounts (to/from employees or related orgs) Capital Asset balances – are they relatively current – I.e. Is a write-down in value warranted? Inventory – was a count performed – by whom and when? External and Internal Restrictions

39 Review of Budget Results
TIMING: Budget to actual results – quarterly is a good habit, monthly is too often UNLESS you are in a period of financial uncertainty Delays in reporting may indicate lack of experience in finance department – this is an important area of continuing education for staff (as well as board)

40 Vocabulary Assets, in general, are possessions having value. In accounting, assets are resources owned, or in some cases controlled, by an individual or organization as a result of transactions or events from which future economic benefits are expected to flow to that individual or organization. Contributions are non-reciprocal transfers to a not-for-profit organization of cash or other assets or non-reciprocal settlements or cancellations of its liabilities. Government funding, grants and donations provided to a not-for-profit organization are considered to be a contributions. Current assets are those assets that are in the form of cash, or expected to become cash within the coming year. Current liabilities are those obligations that have to be paid within the coming year.

41 Vocabulary Net assets, sometimes referred to as equity or fund balances, is the residual interest in a not for-profit organization’s assets after deducting its liabilities. Net assets may include specific categories of items whose use may be either restricted or unrestricted. Restrictions are stipulations imposed that specify how resources must be used. External restrictions are imposed from outside the organization, usually by the contributor of the resources. Internal restrictions are imposed in a formal manner by the organization itself, usually by resolution of the board of directors.

42 Vocabulary Fixed costs are not ordinarily affected by the number of projects, programs, plays, workshops, or classes given or clients served.  Examples of fixed costs: permanent fulltime staff, office rent, principal & interest payments on a long-term loan. Variable costs are usually project-oriented and are more controllable or adjustable.  Examples: number of characters in a play, number of participants served by a program, number of weeks a program runs, number of exhibitions or concerts, local or international, additional space rental requirements, etc. Semi-variable costs are in between - these must happen but can be mitigated somewhat.  Examples: choosing color vs. black & white for a print job, bulk ordering of necessary items, short-term rental vs. purchase of equipment, engaging part-time temporary help rather than hiring fulltime permanent staff, etc.

43 Vocabulary Non-cash Budget Items
Depreciation is a way to spread the expense of a large capital purchase over the number of years it will be in use In-Kind Contributions In-kind contributions are net-zero.  That is, the contribution and the expense are equal, so they do not affect the bottom line net income, but they do increase the magnitude of the income and expenses.  When budgeting for in-kind contributions, it is extremely important to ensure that the in-kind expenses are budgeted as well as the income.  It would not be a good thing to balance a budget with non-cash income covering cash expenses.

44 Thank you! Check out my website:
for resources and copies of today’s presentation

45 Articles of Interest Under Control: Proper Financial Controls Can Protect Your Non-profit Various publications for the non-profit sector – free downloads - Publications tab Various publications, articles and advice on running the financial side or your non-profit organization

46 Sources & Resources Non-profit Accounting Basics Canada Revenue Agency
Canada Revenue Agency Volunteer Victoria Charity Village Imagine Canada Office of the Information and Privacy Commissioner for BC BC Societies Act

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