Tips for Nonprofit Board Members: Budgeting as Part of the Whole Story

Among their fiduciary duties, members of nonprofit boards are tasked with ensuring the financial health and setting the strategic direction of the organizations they govern. Many boards focus their energies in this area on diligently reviewing, approving, and monitoring annual plans and budgets with particular emphasis on understanding the full costs of programming and ensuring sufficient revenue to cover those costs. Nonprofit boards generally adopt budgeting policies and processes centered on the bottom line, often with a mandate to limit operating deficits which have come to be associated with unsustainable business models. Throughout the year, financial monitoring and reporting focus on variance from plans, with reforecasting and adjustments to ensure that the year doesn’t end in deficit.

A Wider Perspective

As valuable as a focus on an annual budget and the full funding of operating costs is, considering nonprofit finances on a single year time horizon (whether an operating budget, the IRS Form 990, or audited financial statements) is limiting, like reading one chapter in the organization’s life story. In service of both meeting organizational goals and ensuring long-term financial health, we invite boards to consider more than one chapter in the organization’s story. The best source for this broader story is to include balance sheet review and analysis into budgeting and financial monitoring. 

In contrast to a budget—and reports in relation to that budget—which covers a set period of time (be it a month, a quarter or a year), a balance sheet is a snapshot that shows an organization’s current financial moment as the outcome of all of the financial events throughout that organization’s entire history. The “cash” line on a balance sheet is the net result of every dollar ever collected by an organization and every dollar spent or moved. And the history represented on a balance sheet—alongside plans and expectations for the future—is the context for what a nonprofit is able (or unable) to do going forward. Ignoring this context in financial planning could lead to decisions that are ill-suited to the opportunities or challenges that an organization faces. 

Key Concept: Consider the full picture of financial condition

The “balanced budget,” one in which revenues and expenses are approximately equal, is often thought of as the goal of the financial planning process. But a break-even bottom line merely preserves an organization’s financial status quo, which may be appropriate in many contexts but could be overly cautious—or too risky—in others. Through balance sheet analysis and focusing on key ratios, boards may uncover:

• Financial strengths, such as accumulated reserves which may be available to support innovation and investment in programs and operations.
• Financial weaknesses, such as high levels of debt, insufficient liquidity, and limited reserves that may require developing new revenue streams, reducing programs, or otherwise altering the business model.

Leaders of organizations with strong balance sheets (consider LUNA as a key metric here) may have opportunities to draw on that past performance to make investments in infrastructure to strengthen the organization for the future or to accelerate advancement of mission goals. While such investments will present as a “deficit” on the organization’s financial statements, the strength of the balance sheet can allow the organization to safely and strategically absorb that deficit. Boards of nonprofits with robust reserves should consider the following questions in their budgeting and financial planning:

• Are there unmet needs for our programs or services that investments in expansion would allow us to address?
• Would paying now for innovations and enhancements to our work improve our ability to deliver on our mission into the future?
• Are there opportunities for investment in internal infrastructure that would benefit us over the long term (for example, technology, fundraising capacity, or physical capital)?

In all such cases, the goal is to use the organization’s accumulated resources to strategically maximize its potential for long-term impact—keeping in mind that continued financial strength is an essential ingredient for that impact.

On the flipside, nonprofits with a weak balance sheet (low or negative LUNA) that set a goal of a “balanced budget” will only continue to perpetuate that weakness. Instead, the goal should be a plan and budget that builds financial resources to restore and maintain stability and flexibility into the future.

This, of course, is a more challenging situation to be in than the former, as donors and funders of a nonprofit typically expect (or, in the case of more transactional funders, demand) to see their contributions translated into program impacts right away. Boards in this situation should approach financial planning and budgeting with the following questions in mind:

• Can we frame our fundraising appeals and grant applications as investments in the long-term health and impact of the organization, and not just on the programs and services we will deliver in the current fiscal year?
• Where is it possible to cut expenses or programs without jeopardizing the core mission of the organization or the infrastructure that supports it?
• Can we appeal to our primary donors and stakeholders (including board members themselves) to increase their giving at least temporarily in order to help us rebuild our financial health?

Careful financial analysis is critical for organizations in this kind of situation, and the board should insist on a full understanding of the costs of programs, services and operations and any gaps between those costs and the revenue available to fund them.