When onboarding a recent client, I was reviewing their internal variance reports and noticed that every year, they had a 7-10% surplus halfway through the fiscal year and would constantly scramble the 2nd half of the year to find projects to spend their funding. While this did lead to some innovative solutions that had positive outcomes, no one I asked in the organization could explain what was happening in their planning cycle that was driving multi-million dollar surpluses when staff were struggling to keep up with their very heavy workload. So I started digging myself and within a year, we had created 12 new permanent full-time positions, upgraded all of the organizations outdated laptops and desktops, and procured new technology solutions and consultants to support them. All of this could be afforded without relying on any new funding.
Too often we hear from leaders in the social purpose sector that they’ve looked at all of their costs and there are no more savings to be had, so they focus on revenue; new funding, increasing sales, partnerships. These are useful places to look and are the key to growth, but improving operations and budgeting practices can create capacity that will be the foundation for that growth. For many organizations, driving operational excellence through the budgeting process can have a great benefit relative to the low cost, especially when compared to the long cultivation process of new donors and the administrative cost of funding (especially small grants).
We are going to share 7 budgeting tips (plus 1 bonus specific to non-profits) so you can make more efficient use of existing resources and grow your organization more intentionally.
The first 3 budgeting tips we are going to touch on can be quick wins. An improvement opportunity for these is easy to identify if you know what you are looking for. They can be fairly simple to resolve, too.
1. Budget for vacancies
In accounting-speak, the savings caused by vacancies are often referred to as “gapping”. For a small organization with very few staff, turnover tends to be infrequent. There is not much need to think about accounting for vacancies in the context of budgeting since it is often immaterial (we’ll talk about materiality later). Talk to any leader of a growing organization though and they will surely tell you about how hard it is to recruit and retain top talent. Simply due to the growth of the organization, turnover, medical leaves, parental leaves, and other types of vacancies become more common and financially material. If you build a budget assuming every position is going to be filled all the time, you are probably not taking advantage of existing funds.
The simplest way to budget for vacant positions is by including a vacancy allowance. At the client I mentioned in the intro, we had the HR coordinator start tracking the vacant positions once every quarter, excluding newly created positions as a result of new funding. We then compared that to the total number of positions in the organization to come up with an average vacancy rate. Using the conservative end of that rate, a vacancy allowance was added equally across the organization to every position during the following budget cycle.
Let’s use a simple example to demonstrate:
HelpCo is a non-profit with 50 employees. They have identified that the actual labour costs are consistently below budget and they have surplus money that they have to find a use for every year. They know that the salaries and benefit rates have been budgeted correctly and that staff in new programs are captured. They can’t figure out what’s going on so they contact Purpose Forward for some help.
Through our analysis, we identify that HelpCo has not budgeted for gapping. They have, on average, 3 vacant positions at a given time. Therefore, their vacancy rate would be 6% (3 vacant / 50 employees). Our advice to HelpCo would be to budget for a vacancy allowance of about 4% the first year and to continue revisiting the rate regularly. There are many factors that lead to vacancies and it is easier to spend extra money if too conservative than to find funds to cover a deficit later if using a vacancy allowance that is too aggressive. Each position in the organization would then be budgeted assuming that they would only earn 96% (100% – 4% vacancy allowance) of their salary. If you know that vacancies are more common in certain roles based on your data, you can also adjust the rate accordingly.
2. Revisit assumptions regularly
All too often, we see organizations set an assumption without a strategy for improving those assumptions with better information over time. In HelpCo’s vacancy example above, we recommended assuming a vacancy allowance of 4% because we know that there are many external factors influencing that rate and we are dealing with a small sample size over a short time. As a result, our 6% observed vacancy rate is not likely to be representative of the whole organization over time so it is important to be cautious.
Would our recommendation have been the same if SocialCo had 1000 employees and they tracked vacancies over the last decade with an actual vacancy rate consistently between 5% and 6%? No, we would recommend a vacancy rate of around 5%. For an organization with a significant scale, that change in budgeted rate from 4% to 5% can add a lot of value if repurposed.
Why would we recommend a different vacancy allowance to SocialCo in this scenario than HelpCo? Because we have better information to make a more precise assumption. Purpose Forward’s recommendation in the first HelpCo example was a 4% rate with a plan to revisit on a regular basis. This requires developing a definition for the measure, a process for capturing the required information, and a way to report or analyze the results (usually including variance analysis).
The goal is to routinely evaluate if the cost vs. benefit analysis of getting more precise is worth it. Sometimes getting more precise is simple on a going-forward basis but not historically, so over time the information gets more accurate by fixing the process to capture the necessary information. In the example of a vacancy allowance this is true – it’s very easy to develop a simple process that can get the precision of vacancy snapshots fairly high with potentially material financial implications. In other cases, investing in additional resources to improve the accuracy can have very little benefit and have significant costs. Travel is a good example of this for organizations that mostly work remotely. You can invest resources in planning how much travel is anticipated and to where, but it’s not likely to find you too much savings so it is not worth the investment. If the costs outweigh the benefits of improving an assumption there is no need to invest at the time. It is, however, critical to routinely come back and revisit whether that is still the case and not assume that the costs will always outweigh the benefits in the future for that particular assumption.
3. Adjust your materiality to focus on what matters
I have used the term materiality several times now, and it can mean different things depending on the context, but in general, it is referring to the relative size of an amount. $1,000 may be considered a lot of money to someone living from paycheque to paycheque, but for a billionaire it is insignificant. With that same logic, an organization that is just starting out with a $50,000 annual budget is going to be more concerned about budgeting very precisely while an organization with a $100,000,000 annual budget might be rounding their budgets to the nearest $1,000 or $10,000 or more.
There are lots of factors to consider when determining materiality. An external auditor concerned about material misstatements of financial performance would have a higher threshold than an accounting manager investigating the theft of petty cash. Determining materiality with precision requires a good understanding of risk, and we encourage relying on experts to help you with this. When thinking about materiality in respect to budgeting though, there is a rule of thumb that can help eliminate lots of wasted time across the sector.
The tendency of leaders and staff in the social purpose sector to micromanage their organization’s funds is both admirable and misguided. We should be frugal, but we must also remember the value of our time. The most constrained resource in the sector is not the money, it’s our capacity. We frequently see non-profits making an emotional decision about materiality.
Our tip for overcoming this is for organizational leaders to put an approximate dollar value, including benefits, to their staff time. By considering the financial value of the estimated time to compare against the incremental benefit of improved budget accuracy, you will find that fewer and fewer factors require revision regularly. In the organization’s infancy, there are many unknowns, so improving accuracy can be very valuable and worth the investment. Eventually the additional time, technology, or expertise to incrementally improve the accuracy of an assumption is no longer worth it. For many items, this level of detail is never worth it.
These next 4 budgeting tips can be more difficult to address since they are engrained in the culture. It can be helpful to think of each of the following recommendations as a building block on the one before. Young organizations may be successful in embedding these recommendations in their culture on their own, but where your organization has fallen into one or several of these pitfalls we encourage you to seek expert advice to help develop a change management strategy.
4. Organizational commitment to the budgeting process
The greatest benefits in the budgeting process come from the conversations. Let’s repeat that, because this is the foundation for a value-added budget process and the most important piece of information about budgeting that you won’t learn from accounting textbooks. The greatest benefits in the budgeting process come from the conversations.
At the core of this issue, there is a reality and/or perception that makes your staff feel like the budgeting process is of no value to them. We will address specific causes and strategies in the remaining sections that follow, but for now we are just going to embrace this idea that your budgeting process will only maximize it’s impact if the organization collectively believes it adds value. This can only be possible if there is enough support from senior leadership.
The first tip for ensuring sufficient commitment is to treat the budget cycle as a formal project and have your CEO/ED as the project sponsor. The commitment of your senior leader will not only set the tone from the top, it will also ensure that the needs of the organization are considered rather than just the needs of the finance or shared services team. Following good project management principles for the budgeting cycle are going to be just as important to success. For example, having clearly defined roles and responsibilities, engaging with stakeholders, and planning adequate resources to support the work are all essential to ensure adequate commitment to the budgeting process.
5. Decentralize the process
Do your finance and human resources teams build the entire budget for your organization? Are program managers and directors developing their program budget? Do programs have any ability to exert control over their budget before it is finalized or are they just being informed? Is their diversity of roles and skills on the team responsible for developing and approving the project plan (remember, we treat this as a project)? How is information gathered and shared? Who is informed of what information and when? Probing at some of these questions can help you gauge if you have adequate engagement and support from the organization that the process is going to be of value to them.
There is often a misconception that the notion of decentralization means that work is being passed off from the finance team to the programs. From our observations, this perception can be especially prevalent in the not-for-profit sector. Our hypothesis is that this is more likely a result of organizations where staff are overworked and they can become defensive of additional responsibilities as a result of the stress. Non-profits commonly fit that mold so this may be why we see this fear of additional work so frequently. The fear that is experienced is not of additional work though even though it may manifest that way. The fear commonly being experienced here is that of the unknown. Of something new and foreign and to do with numbers and math.
It’s helpful to recognize that the decentralization of the budgeting cycle is not focused on process, we will talk about that in the next pitfall. The solution is not to give burnt out staff more work. What we are trying to achieve is a decentralization of information and decision making to overcome the fear of the unknown. Any public health or government official will tell you that being open and transparent while acknowledging stakeholder concerns and dispelling myths with empathy has proven to be really difficult in the current COVID-19 vaccination battle. It is just as hard, if not harder, to convince staff that engaging them in the budgeting process is not creating more work for them. It’s not an easy sell.
The psychology of deferring payment by accumulating debt is well documented with a nice post by ING summarizing the concept here. It’s easy to benefit now from the purchase of something that I can’t afford if I do not have to worry about the consequences of paying until much later. An overly centralized budgeting process creates additional work throughout the year for everyone since programs are typically expected to explain variances for a budget they had little or no influence in developing. From the perspective of the program staff and leadership, a centralized budget is like a credit card for their time. By avoiding engagement in the budget, programs are really just pushing on the work to be more time consuming and difficult throughout the year.
We recommend centralized management of the training, support, and information coordinated through finance resources. The steering committee for the project should represent stakeholders across the agency, the CEO or ED should be the sponsor, program managers and staff should have input into their budget, and senior leaders should have the opportunity to review and note any objections for consideration before being finalized. What we are trying to achieve is an environment where programs feel like their shared service peers are partners in the program’s success rather than administrators that are just creating more work for programs without adding value.
6. Integrate financial and service planning
If you don’t have funding, you can’t hire employees; leaving no one to deliver services. If you don’t have clients to serve, there is no need to waste money on employees and there is no funding. My point is that service planning and financial planning are related and should not be treated as separate initiatives. Before the internet made it possible to collaborate instantaneously without geographic boundaries, and cloud computing made these tools affordable to the grassroots social purpose sector, connecting these processes would have been very time-consuming and expensive. It requires little technical expertise and is very affordable to integrate these processes and the underlying information in a modern environment. The non-profit sector has really struggled with understanding their cost drivers and these silos are a big reason why.
Integrating the service planning and budgeting process is a great way to break down barriers between your programs and your shared services. Over time, it starts to create a common language across your organization and clarity about what is important to measure and why. New informal networks are established across the organization enabling dialogue and creativity that open up possibilities that would not have been considered otherwise. The finance staff start to be seen as partners in the program’s success.
Of all the recommendations we discuss in this article, the integration of the service and financial planning requires the most technical expertise. We recommend working with an expert like our team here at Purpose Forward to help you develop an information management strategy for the details, but there are still basic steps you can take to start to reduce silos. The simplest recommendation we can make is to have a representative of your shared services team attend service planning meetings for programs on a regular basis. Also, variance analysis and budget meetings should be held at least quarterly between the program manager and the finance team to understand cost drivers in an interview style. This work should not be done by email or chat correspondence and is intended to investigate and help both sides learn about the other. It is not a place for punitive actions as a result of not meeting targets. By creating more and more opportunities for cross-functional collaboration, you will begin to build a culture where your shared services staff feel empowered and engaged while your program staff feel that the support teams are valuable partners in the organization’s success.
7. Dream big
Does your organization think of your budgeting process simply as a tool to set baseline financial targets for the year? If you are a non-profit, is your budgeting process just a part of the funding contract that you need to keep receiving your funds? If these are the primary objectives of your budgeting process, you are not taking advantage of a wonderful opportunity to get insight into the operational pressures that are being experienced on the ground. As cross-functional relationships start to emerge through your work in addressing tips 4-6, innovative solutions are going to emerge to systemic issues as well as minor inconveniences, while simultaneously creating opportunities that the organization couldn’t even previously dream of. Now is the time to start to foster these ideas so that you’re ready to take advantage of new opportunities as they arise rather than reacting.
Here are a few simple ways to engage staff and start to capture and document these ideas.
- Create a quick survey asking staff to identify pressures that they face around different aspects of their work. Leave a link on your intranet so staff can comment anytime.
- Develop an innovation fund to support piloting new ideas. At a place I worked they did a Dragon’s Den style program with up to $5,000 plus staff time available to pilot new ideas.
- Have a budget wish list maintained and reviewed at quarterly variance analysis meetings.
- Find ways to brainstorm and engage in creative thinking during service planning meetings.
These initiatives can be fairly easy to implement from a technical perspective but their effectiveness is largely going to be tied to the trust that exists in your organization. The previous tips will all play a role in helping to establish that bond where everyone feels that they are working for a common purpose. Having an understanding of the opportunities available to your organization and the pressures that are being experienced will enable leaders to be flexible and responsive to new opportunities.
“A dream you dream alone is only a dream. A dream you dream together is reality.”
Yoko Ono
(Bonus tip for non-profits) 8. Budget how you operate, not how you’re funded
Having spent the last decade working with not-for-profits leading in their sectors, I’m constantly amazed how uncommon full cost accounting is. This refers to including all of the costs that contribute to the delivery of a unit of goods or services. In the non-profit sector, it’s very common to deal with multiple funding sources that all have strict demands on what does and does not qualify for their programs.
Building an organizational budget based on funding:
- Confuses manager because they have to remember where their staff are charged rather than this being managed in a spreadsheet or table.
- Makes system administration complicated since IT, HR, AR/AP staff also need to know where staff are charged.
- Limits the operational understanding of programs to that team alone, making it nearly impossible for senior leaders and shared service staff to effectively support the operations of individual teams.
So how should a budget be built? As a reflection of how your organization operates and delivers services. Depending on your funding arrangements, designing how to get from your operating chart of accounts to your funding chart of accounts for reporting purposes can require some creativity and planning, but it can be done. Once the new account structure has been designed and implemented, it becomes much easier for analysis to occur to make critical business decisions. Let’s walk through one more example.
PurposeCo has one coordinator to support their 3 programs as follows:
- Program A funded by the federal government for 4 staff with no admin support funded.
- Program B funded by the provincial government with 8 staff plus 0.75 FTE admin staff funded.
- Program C funded by the municipal government for 5 staff plus 0.25 FTE admin support funded.
Using funding as the budget basis would lead to the coordinator charging 75% to program B and 25% to program C because that is where the funding is available. In reality though, the coordinator works 2 days/week each with programs B and C and 1 day/week with program A. Full costing would reflect 20% charged to program A, 40% each charged to programs B and C.
Why is understanding this important? Let’s consider a hypothetical scenario where program B loses funding and will no longer operate starting next year. As a result, 75% of the funding for the coordinator position has been eliminated, but only 40% of the workload. PurposeCo now has to find a way to make up the 35% deficit on the coordinator, but this would only be identified if the full cost was monitored and captured.
Your budgeting cycle can either be a necessary evil that sucks up staff time and energy or it can be a value added project that promotes collaboration and breaks down silos. The choice is yours.
We have helped many organizations with their change management projects, including the financial planning and analysis process. You can see a list of our services here and case studies of our impact here.
Greg Zatulovsky is the Founder and CEO of Purpose Forward. As a Chartered Professional Accountant who spent his early career leading multi-billion dollar enterprise resource planning system implementations at Fortune 500 companies, Greg pivoted to the not-for-profit sector where he has been leading change management initiatives for the last decade. You can learn more about Greg and Purpose Forward here.