Topic 2B: Financial Management Practice

Budget Creation Practice Framework

This topic provides a practical, step-by-step guide to creating and analyzing a nonprofit budget. Unlike the conceptual foundations in Topic 2A, this section focuses on the actual mechanics of building a budget from scratch, interpreting budget data, and making adjustments based on financial performance.

How to Create Your Nonprofit Budget: A Practical Guide

Step 1: Gather Historical Data and Revenue Documentation

Before creating a budget, collect the following supporting documents:

Grant agreements – Review past grants, noting restrictions and payment schedules
Donor records – Compile giving history from your donor database
Program reports – Gather documentation of program participation and costs
Expense records – Collect invoices, contracts, and purchase orders from the past 12-24 months
Staff information – Compile salary schedules, benefit costs, and staffing plans
Facility contracts – Review rent, utilities, and maintenance agreements

Step 2: Conduct a Revenue Projection Analysis

Begin by analyzing your revenue streams from the past 2-3 years:

Step 2A: Individual Donor Projections
Multiply your average annual donor gift by the number of expected donors. If you have 50 active donors averaging $400 per year, project $20,000. Then apply a conservative growth rate (5-10% is typical). If you’ve been growing at 7%, apply that growth: $20,000 × 1.07 = $21,400.

Step 2B: Foundation Grants Projection
List each foundation grant you receive. For each, review the grant letter to determine:

Is this an annual grant or multi-year?
Has the grant amount changed in previous years?
Is the funder likely to continue funding?

For example, if you receive $50,000 annually from Foundation A that’s been flat for 3 years and $25,000 from Foundation B that increased 10% last year, project $50,000 + $27,500 (applying 10% growth) = $77,500 from foundations.

Step 2C: Government Contract/Grant Projections
Government funding is typically more stable but requires tracking:

Reimbursement schedules (some pay in arrears – after services are delivered)
Program requirements that might affect the amount funded
Contract renewal timelines

If you have a $100,000 government contract that renews annually, project $100,000 but note in your budget notes any risks if renewal is uncertain.

Step 2D: Fundraising Events and Other Revenue
Track revenue from galas, walks, or other events. If last year’s gala raised $15,000 and the year before $14,000, the trend is positive. Project $16,000 based on this growth pattern.

Step 3: Project Operating Expenses

Break expenses into categories and analyze trends:

Personnel Costs (typically 50-70% of nonprofit budgets)
For each employee, calculate:

Annual salary (or hourly wage × projected hours)
Benefits (health insurance, retirement, payroll taxes) – typically 25-35% of salary

Example: Executive Director at $60,000 salary + $18,000 benefits (30%) = $78,000 total cost

Multiply by number of staff and add 3-5% for cost of living increases.

Program Expenses (direct costs of delivering your mission)
Analyze your past spending:

Supplies and materials used in programs
Training and professional development
Contracted services (consultants, facilitators)
Participant support (meals, transportation, materials)

For example, if you run an after-school program serving 100 students and spent $25,000 on snacks, supplies, and materials last year ($250 per student), project the same unless participant numbers change.

Administrative and Facility Costs

Rent/facility costs
Utilities (office electricity, water, internet)
Insurance (liability, D&O, property)
Office equipment and technology
Professional services (accounting, legal)

These often have clear contracts (rent lease, insurance policies), so projection is straightforward.

Step 4: Create the Budget Document

Format your budget as a spreadsheet with these columns:

Budget line item name
Last year actual
Current year revised estimate
Next year budget
% of total budget

Example structure for a $250,000 nonprofit:

REVENUES

Individual Donations: $21,400
Foundation Grants: $77,500
Government Contracts: $100,000
Event Revenue: $16,000
Other: $5,000
TOTAL REVENUE: $219,900

EXPENSES

Personnel: $140,000
Program Supplies: $35,000
Facility Rent: $24,000
Insurance: $8,000
Professional Services: $6,000
Equipment/Technology: $4,000
TOTAL EXPENSES: $219,900

NET INCOME: $0 (balanced budget)

Step 5: Analyze Budget Ratios and Variances

Program Expense Ratio
Divide total program expenses by total revenue. Best practice: 65-75% of revenue should fund programs.
In our example: $35,000 program supplies ÷ $219,900 = 15.9% (this is low; we need more detail)

Note: To properly calculate, sum ALL program costs including staff time allocated to programs. If the Executive Director spends 40% time on programs, that’s $78,000 × 0.40 = $31,200 in personnel costs attributable to programs.

Administrative Expense Ratio
Divide administrative costs by total revenue. Best practice: under 15%.
In example: $6,000 professional services ÷ $219,900 = 2.7% (excellent)

Variance Analysis – Comparing Actual to Budget
Once you’re operating under the budget, track:

Actual revenue vs. budgeted revenue
Actual expenses vs. budgeted expenses
Calculate variance: (Actual – Budget) ÷ Budget

Example: You budgeted $21,400 for individual donations but received $19,200. Variance: ($19,200 – $21,400) ÷ $21,400 = -10.3% (10.3% below budget, a red flag requiring investigation)

Real Nonprofit Example: Community Youth Center Annual Budget Process

Organization: Community Youth Center (CYC)
Mission: After-school and summer programs for low-income youth ages 6-18
Annual Budget: $400,000
Staff: 15 full-time equivalent employees

CYC’s Budget Creation Process:

In August, CYC’s Finance Director meets with the Executive Director and Program Director to gather data:

Donations: Analyzed 3 years of donor data. Average donor: $450/year. Current active donors: 60. Projection: 60 × $450 = $27,000. Growth expectation: 5% = $28,350
Foundation Grants: Listed all active grants:
ABC Foundation: $100,000 (annual, stable)
Community Trust: $75,000 (annual, stable)
State Education Foundation: $80,000 (2-year grant, year 2 of 2, likely to renew at same level)
Total: $255,000
Government Funding: City After-School Program contract: $85,000 (pays in monthly installments)
Events/Other: Summer Fundraiser gala: raised $18,000 last year, $17,000 year before. Project: $18,500
Total Revenue Projection: $28,350 + $255,000 + $85,000 + $18,500 = $386,850

Expense Projections:

Salaries: 12 program staff (avg $35,000) + 2 admin staff ($45,000 each) + 1 executive director ($70,000) = $517,000. With 32% benefits (health insurance, FICA, unemployment): $517,000 × 1.32 = $682,440. But CYC only allocates $270,000 for salaries (some grant restrictions limit salary allocations)
Program Supplies: $45,000 (snacks, materials, equipment for 200 students)
Facility: $36,000 rent + $8,000 utilities = $44,000
Insurance: $12,000
Professional Services: $8,000 (accountant, legal)
Technology/Equipment: $6,000

Total Expenses: $270,000 + $45,000 + $44,000 + $12,000 + $8,000 + $6,000 = $385,000

Result: $386,850 revenue – $385,000 expenses = $1,850 surplus (small buffer)

Analysis: CYC’s program expense ratio is: ($270,000 staff doing programs + $45,000 supplies) ÷ $386,850 = $315,000 ÷ $386,850 = 81.4%. Excellent – well above the 65% standard.

Understanding Budget Variance: Mid-Year Adjustment Example

In July, CYC reviews 6-month actual performance:

Revenue Variance:

Donations budgeted $14,175 (half of annual), actual $12,340. Variance: -13%. Action needed: Executive Director will contact lapsed donors.
Grants budgeted $127,500, actual $127,890. Variance: +0.3%. On track.
Government contract budgeted $42,500, actual $43,200. Variance: +1.6%. On track.
Events budgeted $9,250, actual $8,100. Variance: -12.4%. Summer event not yet held.

Expense Variance:

Personnel budgeted $135,000, actual $134,200. Variance: -0.6%. On track.
Program supplies budgeted $22,500, actual $26,800. Variance: +19.1%. Requires investigation: Program director reports higher summer program enrollment required extra supplies. With summer fully booked, this variance expected to continue. May need to reduce other expenses or seek supplemental grant.

Action Items:

Apply for emergency grant funding to cover supply overage
Fundraising push for lapsed donors
Freeze discretionary spending in technology and professional services categories

Key Metrics to Monitor Monthly

Cash Position: Track cash on hand compared to monthly cash needs. CYC needs $32,000/month for expenses.
Days Cash on Hand: Cash reserves ÷ daily expenses. CYC targets 60 days (approximately $64,000). Currently at $72,000 = 67.5 days. Healthy.
Revenue Performance: Compare year-to-date revenue against budgeted pace.
Largest Expense Categories: Monitor the top 3-5 expense categories for variances.

Common Budget Creation Mistakes to Avoid

Being too optimistic: Nonprofits often project revenue higher than realistic. Use 3-year averages instead of “best case” scenarios.
Forgetting hidden costs: Include ALL expenses – insurance, professional services, equipment replacement, not just salaries and program costs.
Ignoring cash flow: A $0 net income budget can create cash flow crises if large grants pay quarterly but expenses are monthly.
Not building in contingency: Expert recommendation: include 10% operating reserve or contingency in budget.
Failing to document assumptions: Always note why you projected 5% growth, when contracts renew, any uncertainties.

Your Budget Development Assignment

Using the templates and procedures above:

Gather Data: Collect 24 months of actual revenue and expense records
Project Revenue: For each revenue stream, analyze trends and apply realistic growth rates
Project Expenses: For each expense category, analyze last 12 months and apply appropriate adjustments
Create Budget Spreadsheet: Use format shown above with realistic line items for your organization
Calculate Ratios: Determine program expense ratio and administrative ratio
Document Assumptions: List the growth rates, staffing changes, and other factors you used
Compare to Actual: If mid-year, calculate variances and identify needed adjustments

Your completed budget should demonstrate understanding of:

How to gather data from financial records
How to analyze trends and project revenue/expenses
How to calculate key financial metrics
How to identify budget variances and investigate causes
How to adjust budgets based on changing circumstances