Budgeting for not-for-profit organizations is getting more challenging as mission-driven needs exceed available resources. Many have improved their budgeting practices, but more must step up to not just survive but become more successful.
While there are many permutations, just about every not-for-profit organization uses incremental budgeting. Even for those organizations that take a performance or activity-based budgeting approach, incrementalism is at the core of their process. Incremental budgeting involves assessing relatively modest increases or decreases in revenue and expense lines to produce a balanced budget. Performance budgeting uses metrics to make increases or decreases, but it’s still incremental. Activity-based budgeting involves relegating many budgetary decisions to lower levels in the organizational hierarchy, but even those decentralized decision-makers are using incrementalism. Some organizations claim to use zero-based budgeting, but in reality they can’t afford the time and effort it would take to effectively judge each program annually.
Why is incremental budgeting the common practice? It is safe and requires less effort. It creates very little change and causes minimal disruption. It is highly conservative, and it will not rile most stakeholders. The budget simply enshrines the current state of affairs, with modest changes in response to the latest perceived internal needs and constituency pressures. Strategy plays no part, nor does long-term planning based on real-life market positioning.
Move from the old to the new and better
There is a better way. Consider adopting these key elements to create new processes or refine existing ones:
Budgeting approaches — entirely combinable
The overarching principle of budget planning is to start with the strategic plan — not the existing budget.
First and foremost, budgeting must be the short-term quantitative embodiment of an organization’s strategic plan. In the past, strategic plans were a set of lofty goals indicating how new resources (e.g., service fee increases, debt and fundraising) would be used. They rarely challenged the existing expense base in a material way. Those days are over. Now, strategic plans are expected to represent notable departures from the status quo — to define ventures not previously conceived or develop significant redeployments of physical, financial and human resources. Effective strategic plans incorporate meaningful change in response to critical environmental changes. They require trade-offs and, potentially, risks. To make that kind of change, you can’t begin with the existing budget. Instead, you must base your budget planning on your strategic plan. The first rough sketch of the budget should be a mirror of that plan.
Second, you must budget by substitution; every new program or initiative must be funded by reducing or eliminating existing programs, rather than finding new funding. Incremental budgeting shaves a little from some existing programs, adds a little to other existing programs, and funds new programs with new revenue. Budgeting by substitution funds new programs by deleting old programs and taking a much harder look at existing programs. There are fewer small reductions in existing programs, which often compromise quality. Further, a powerful incentive is introduced to force the examination of existing programs and make hard decisions about priorities.
Lastly, use zero-based budgeting as a phased discipline. Every year, select a set of programs to intensively evaluate and consider. Concentrate efforts on how consistent those programs are with the strategic plan and the organization’s mission, compared with other programs. This form of zero-based budgeting provides funding for new initiatives likely to be essential to organizational viability and success.
Incremental: Changes are made at the margins as pluses to or minuses from the existing budget. What is being done now tends to take precedence over what might be done in the future. This is the most popular approach because it is the easiest and most conservative.
Performance: Performance assessment metrics are usually at the core of this approach. Areas that demonstrate improvement are rewarded with new funding. Areas with poor or deteriorating metrics incur funding reductions. This is nice in theory but hard to practice in reality.
Budgeting by substitution: Revenue and key new expense items are identified based on the strategic plan. Inevitably, the projected budget will be in the red at that point. To balance it, items of low priority (usually those not included in the strategic plan) are deleted until the budget is balanced. This is the optimal approach — basing decisions on the strategic plan — but it doesn’t preclude incorporating the best of the zero-based and performance approaches.
Zero-based: All existing programs are put on the table to determine if they should continue to be funded. It’s great in theory, but impossible in reality. A more workable approach is a rolling zero-based process that puts some portion of the budget under the microscope each year.
Ideally, an organization should use multiyear budgeting to plan several years ahead, but that rarely happens. Next year’s budget is frequently perceived by participants as the real one, and that’s what they focus on. The second and third years are usually an afterthought — prepared by staff at the last minute after the real one is put to bed — with the elegance of compound interest (e.g., revenue grows by 3%, expenses by 2.8%) as the fallback.
A good way to create realistic multiyear budgets is to start with the third year and work backward. Create a budget that represents an ideal but incorporates clear trade-offs — the budget must be balanced. Then move backward through the second and first years. Strategy and planning should take the forefront, with the top question being this: “How do we get to ideal?” This is a diversion from the way budgets are generally approached. It creates an incentive for decision-makers to remember that their ideal takes priority over their current state. It makes budgeting by substitution emotionally easier.
Follow overall best practices
Maintain a strong commitment from the top for the integration of planning and budgeting. You will be tempted to compromise to satisfy constituencies that don’t want change.
Rank the priorities as high or low, rather than the typical list of unranked issues that inhibits decision-making. Make priorities clear and actionable. Have a few at the top of the list, and make sure the budget reflects those priorities.
Be resolute in setting clear priorities. Leadership requires courage in the face of opposition.
Identify all the resources required to achieve and implement the strategic plan (i.e., money, people, facilities, IT, etc.) so they can be translated into the final budget. Any plan must include all of the components needed for success. For instance, you can’t create a financial budget for a new program without identifying the required space and IT resources.
Use a budget projection as a component of the strategic plan; it can serve as the basis for the actual budget.
Ensure a continuous conversation between the CEO and his/her leadership team about plans and future budgets so managers know what is likely to be approved or cut. This will speed the budget process.
Keep it simple — complex processes are a distraction from the actual work.