Nonprofit organizations have complicated accounting needs. One common aspect of this is budget preparation. Budgets are such an integral part of your organization’s financial well-being – make sure you prepare it correctly. Each year, you prepare a budget for board approval. This budget is a map of how you want to make decisions during the year to not only comply with the direction set forth by the board, but also to have the planned results at the end of the year. Whether the plan is to break-even, have surplus, or a planned deficit, there are several traps that nonprofits need to beware of.
Accounting Basis – Your organization’s finances should be maintained in the accrual basis of accounting, a true measure of the results of operations. Accrual basis measures revenue as earned or promised (rather than only when received) and measures expenses when incurred (rather than when paid). Your budget should also be prepared on the accrual basis. Doing so allows you to truly measure the results of activities and to properly compare planned to actual activity.
Restricted vs Unrestricted Revenue – Your financial statements make a distinction between restricted and unrestricted revenue, but restricted revenue may need to be recognized entirely when awarded or promised. This can scramble the revenue side of your budget since part of the restriction may be lifted in a future year. If you are not careful, you can end up with a budget-to-actual comparison that shows that you brought in much more revenue than planned. The opposite can be true if the expenses planned for this year are based on revenue recognized in prior years, but your budget to actual for the current year does not show that restricted revenue. Make changes to your budget-to-actual report to show only unrestricted revenue plus the restricted revenue that is meant to be spent this year.
Understand the results of each type of activity – Activities in budgets are separated into three types: activities that can result in a surplus (membership, conference, fee-for-service); activities that must result in break-even (most grants that require an accounting of expenses); and activities that will result in a deficit (programs that need to be completed or that the board chooses to pursue). Understanding each of the components of these types of activities allows you to plan your entire budget properly.
Monitoring budgets at least monthly is essential to a healthy financial process. If you have grants that are ending during the year and they need to be fully spent, then you need to monitor and perhaps adjust your budget more frequently. Monitoring using excel spreadsheets is a common practice, but most accounting software now allows you to monitor your budget performance online with real-time information. You do not have to understand how to use the accounting software to have access to these reports. Your software administrator can create direct access to the report once you login.
We all know the consequences of not having a well-prepared budget and monitoring against that budget as the year goes by. One overlooked consequence is cash-flow problems. When you think about it, it makes sense. If your organization is not performing as planned, it will eventually run out of cash. So plan properly, monitor your performance to that plan, and enjoy your organization’s financial well-being!