Focus on the Destination, Not the Route (Budget)!

Nonprofit Finance & Strategy [1] • By Jeanne Bell • August 10, 2009 • forward article

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It's time to stop looking at budgets, argues Jeanne Bell in this provocative finance column, and pay attention instead to projections and financial goals:

In this precarious era, annual budgets have become like new cars: they lose value even as you drive them off the lot.

How many of us could predict even a few months ago what might take place to affect our donations, our foundation grants, or our government contracts? The entrenched practice in many nonprofits of using the approved budget as the primary financial reference point just isn't suited to effective financial leadership anymore.

Focusing on the annual budget -- adopted months ago -- is like setting a course on the high seas and staying with it even when unexpected rocks suddenly appear, or a more favorable, alternative route opens up ahead. Instead of being locked into a carefully constructed annual budget, we need to be freed up to incorporate new information as we make continuous financial choices.

Shifting the focus

What does it mean to shift from a focus on budget-to-actual to a focus on rolling projections? First, as an early part of the budget process, management and the board should commit to an overall financial goal for the year. In some cases they'll want to finish the year with a surplus, in other years, to break even, and at other times they'll want to invest reserve funds through a deficit budget (see my last column for more on these options). This choice and commitment becomes fundamental to all financial decisions throughout the year. This overall financial goal for the year -- rather than the adhering to line items that make it up -- must become the business driver.

In step with this commitment, effective management teams review the organization's performance each month when the financial statements come out. This review fulfills two key responsibilities:

Assessing financial performance year to date, and
Surfacing any new, critical financial information.

The first is the traditional look at actual performance compared to budget, or variance. The latter means asking ourselves things like: "Is this 20% drop in direct mail donations likely to hold for the rest of the year?" and "Are there foundation grant assumptions in the budget that look shaky?" and "If Jane does resign to go back to school next month, do we absolutely need to replace her?"

It's this discussion on the future that enables timely financial projection and decision-making. For instance, the fact that Jane's salary is in the budget for the whole year does not mean that the organization shouldn't take a second look at her job and determine if this is a good moment to save money rather than immediately fill the position. Instead of doing anything because "it's in the budget," leaders are quick to use new financial data to make the best decisions they can make in real time.

Approaching midyear, staff should start a process to update their financial assumptions for the rest of the year, reviewing all major income and expense line items. This analysis should be presented in a new year-end projection column added to the monthly income statement shared with staff and board. This additional year-end projection column does not replace the approved annual budget column. It provides a helpful picture of staff's new best estimate of where the organization will end the year. As the organization approaches the fourth quarter and begins building next year's annual budget, it is these more recent projections, not last year's budget, that become the starting point for next year's planning.

As you can see in this excerpt from a report, the variance from budget is important, but not as a pointer to what decisions need to be made in order to reduce variances. Instead, variances are important as tools to get to the more important guide: the projection for the end of the year. In this instance, the organization had budgeted for a $200,000 surplus for the year. Management's mandate is to meet that goal, rather than to stick to the budgeted revenue and expense items.

This projection also illuminates the choice that management and the board can make at this point: whether to institute changes that will come closer to the financial goal, or to change the financial goal.

Not a reset button

The most important reason to make this shift in focus to rolling projections is that the fiscal year end provides no magical re-set opportunity. We don't get to start over, leaving behind last year's financial missteps to try again with a new budget. We're charged with managing the organization financially every day; each one of our major choices has a lasting impact on the organization's financial health. When we use the most current information we have rather than rely on stale assumptions from last year, we are freed from the weight of a budget set in stone to attain our true goal of managing the organization more effectively.

An important and fairly easy step to take now: Do a revised projection at the end of the current quarter, and have the management team and the board discuss it. Consider these questions:

What are the key discrepancies between what's in the budget and what we now believe is going to happen?
Given this information, do we need to expect a different financial outcome for the year than what the budget was meant to achieve?
What changes need to be made in the management of any revenue or expense items?
What implications are there for the next fiscal year, given the projected financial result of this year?

Taking new information into account has always been something of a problem in nonprofits that use the annual budget as a guide throughout the year. But the current economic climate makes it even more important to see financial projections as the dynamic, changing financial document that helps management and the board think about what might need to be done differently.