For many nonprofits, the annual "approval of the budget" is the cornerstone of board financial oversight. However, this annual approval is frequently an empty ritual: one where board members peruse a budget that they are unsure is realistic or appropriate to the planned activities.
Consider the following scene:
The budget discussion is at the end of the agenda, and things are running late. Given a complex budget that "needs to be approved," board members react first by looking for things that they can understand . . . usually a relatively small expense item: "Why is this travel budget so high?" "Can this phone budget be reduced?"
As each question or suggestion is raised, staff respond by explaining why each suggestion for a change is unrealistic. "The travel budget has been funded for Program X so we have to do it." "Actually the phone budget is not that big." After a few instances of staff "explaining" line items, board members realize that asking such questions isn't really going anywhere.
In the backs of their minds is the thought, "It's probably okay. It was okay last year and I didn't understand it then either." So they vote to approve the budget.
In short, board members first nitpick, staff react to questions as evidence of the board's ignorance, and then the board rubberstamps the budget.
The truth is that such approval of the budget isn't a meaningful act on the part of the board. This process acts as if board members are intimately familiar with all aspects of the operations and can knowledgeably respond to a budget. In fact, the board doesn't know whether six outreach workers is too few or too many. The staff knows more about operations, and, appropriately, staff should develop the budget. But board members can meaningfully discuss the goals and trade-offs in the budget.
So what would be meaningful work for the board on the budget?
The board has some important perspectives to bring to the discussion of the budget. Here are questions that take advantage of the board's diverse community perspectives and the finance staff's knowledge and skill:
1. Are there specific financial objectives that we want for the next year?
For example, an organization may determine that it needs $75,000 in working capital to even out its cash flows over the year. The board may ask the staff to include $15,000 as "surplus" in the budget for each of the next several years to begin building that reserve.
There is frequently an assumption that every budget should be balanced; that is, that revenues and expenses would be the same for a given year. It's worth thinking through this question: do we want a balanced budget, a deficit of perhaps $50,000 (perhaps to spend/fulfill an unusual grant or to get through a temporary bad time), or a surplus of perhaps $10,000 (to save or to repay debt)?
2. Are there desirable new projects, program expansions, or changes in compensation?
The staff, for instance, can be asked to prepare cost estimates for some of the following:
- The financial impact of across-the-board 4% raises
- The financial impact of adding a 401(k) retirement plan with a 1% employer contribution
- The financial impact of increasing the child care program by one more class of children
3. Are there large expenses for which we should be saving?
Should we be setting aside $3,000 per year to prepare for buying a new phone system? Should we expect to spend $5,000 per year on computer replacements and upgrades?
4. Should we consider revisiting how we use our unrestricted funds?
Which programs are breaking even or making a surplus, and which are being subsidized with unrestricted funds? Does the management team have a suggestion for how these cross-subsidies should be changed?
5. Is our dollar allocation generally in line with our priorities?
For example, if an organization started as a dance troupe with a few dance classes, it might consider whether the organization's attention over time -- as reflected in the budget -- has come to overemphasize the classes over dance performance.
Alternative budget process
An alternative budget process can look like this:
First, the finance committee leads a full board discussion on programmatic goals and financial objectives. The board establishes some broad guidelines for staff to follow as the staff develops the budget. Examples:
- A budget that provides for increased volume in homeless services while keeping other services at the same level or allowing a slight decline
- A budget that plans for a surplus of $30,000 to help build a cash reserve
- A budget that includes the establishment of a 3% employer contribution to a 401(k) plan
- A budget that includes an increase of $35,000 in board-generated donations
Next, staff prepare a draft budget, with comments about the financial implications of the broad guidelines and projections of anticipated revenue, expense, investment, and cash-flow needs. Their comments might include:
- Increasing homeless services by 5% would cost approximately $85,000 in additional staff, food, and garbage costs. There is some possibility of obtaining a foundation grant for this amount.
- Given the risks of state funding levels this year, a $50,000 addition to cash reserves would be more appropriate and allow for deliberate closedowns of programs if necessary.
- If the 401(k) contribution is made for all employees (whether or not an employee also contributes), the cost would be $35,000. Establishing and administering a 401(k) plan will take significant staff time over the year as well.
- This last year, board-generated donations increased by $18,000 over the previous year. A goal of $35,000 would be a stretch goal, and board members should think through whether this is realistic.
- The attached draft budget allows for a 2% salary increase.
- Combining staff projections with the board guidelines, a deficit of $20,000 is projected for the coming year. One possibility is to decrease the addition to cash reserves from $30,000 to $10,000. Another is to direct staff to make another effort to readjust the budget and bring back a revised budget and projection.
At this point, the finance committee and the staff jointly review the draft budget through a couple of iterations and end up with a revised budget that meets some, but not all, of the board's guidelines. In this example, the revised budget may contribute only 2% to the 401(k) plan and increase profitability in some other areas.
Finally, the finance committee presents the budget to the full board. The board can see the extent to which the guidelines are met and what implications there are for other parts of the budget.
The board can then "adopt" the budget, or authorize the staff to proceed with operations as the budget outlines.
For many organizations, the budget process is, in fact, the process through which board and staff decide on the organization's priorities, interpret its vision in operational terms, negotiate compromises, and agree to go forward together. In different organizations, this process is bound to look different. Whatever process you choose, ask yourself: How does the board add value to the budget process? How can we bring the board's knowledge and leadership into the budget process?
This article is adapted from a section in The Best of the Board Cafe, Second Edition, by Jan Masaoka. Jan is Editor of Blue Avocado, former executive director of CompassPoint Nonprofit Services, and has sat in on dozens of budget discussions as a board member of several nonprofits. With Jeanne Bell and Steve Zimmerman, she co-authored Nonprofit Sustainability: Making Strategic Decisions for Financial Viability, which looks at nonprofit business models.
See also in Blue Avocado: