🤲Nonprofit Leadership Unit 5 – Nonprofit Financial Management & Budgeting

Key Concepts & Terminology

• Nonprofit organizations are tax-exempt entities that serve a public purpose and reinvest surplus funds into their mission rather than distributing profits to owners or shareholders
• Financial management in nonprofits involves overseeing the organization's financial resources, including budgeting, accounting, and reporting, to ensure long-term sustainability and mission fulfillment
• Fund accounting is a system used by nonprofits to track and manage funds based on their intended purpose or restriction, such as unrestricted, temporarily restricted, or permanently restricted funds
  • Unrestricted funds can be used for any purpose aligned with the organization's mission
  • Temporarily restricted funds must be used for a specific purpose or time period designated by the donor
  • Permanently restricted funds are endowments where the principal must be maintained in perpetuity, and only the investment income can be spent
• Cash flow management is crucial for nonprofits to ensure they have sufficient liquid assets to cover short-term obligations and maintain operations
• Key financial ratios, such as the current ratio (current assets / current liabilities) and the debt-to-equity ratio (total liabilities / total net assets), provide insights into a nonprofit's financial health and stability

Nonprofit Financial Structures

• Nonprofits typically have a board of directors responsible for overseeing the organization's financial management and ensuring compliance with legal and ethical standards
• The finance committee, a subset of the board, focuses on reviewing financial statements, monitoring investments, and making recommendations on financial policies and procedures
• The chief financial officer (CFO) or finance director is responsible for day-to-day financial management, including budgeting, accounting, and reporting
• Nonprofits often establish separate funds or accounts to track and manage resources based on their intended purpose or restriction
  • Operating funds cover day-to-day expenses and general operations
  • Reserve funds provide a financial cushion for unexpected expenses or revenue shortfalls
  • Endowment funds generate investment income to support the organization's long-term mission
• Fiscal sponsorship is an arrangement where a established nonprofit provides financial and legal oversight for a project or organization that lacks its own tax-exempt status

Budgeting Basics for Nonprofits

• Budgeting is the process of planning and allocating financial resources to support the organization's mission and strategic goals
• Nonprofit budgets typically include revenue projections, expense estimates, and a comparison of actual performance against budgeted targets
• Zero-based budgeting requires justifying all expenses from scratch each year, rather than basing the budget on the previous year's numbers
• Incremental budgeting involves adjusting the previous year's budget by a certain percentage or amount to account for changes in revenue or expenses
• Participatory budgeting engages stakeholders, such as staff, volunteers, and constituents, in the budgeting process to ensure transparency and alignment with community needs
• Scenario planning involves creating multiple budget versions based on different assumptions or potential outcomes, such as best-case, worst-case, and most likely scenarios
• Budget variance analysis compares actual financial performance against budgeted targets to identify areas of over- or under-performance and make necessary adjustments

Revenue Sources & Fundraising

• Nonprofits rely on a diverse mix of revenue sources, including individual donations, foundation grants, corporate sponsorships, government contracts, and earned income from goods or services
• Individual donations can be solicited through various channels, such as direct mail, online giving, peer-to-peer fundraising, and special events
• Foundation grants are awarded by private or public foundations to support specific programs, projects, or general operating expenses aligned with the foundation's mission and priorities
• Corporate sponsorships provide financial support in exchange for brand visibility, employee engagement opportunities, or other benefits
• Government contracts and grants are awarded by federal, state, or local agencies to deliver specific services or outcomes aligned with public priorities
• Earned income strategies, such as selling products, charging membership fees, or providing consulting services, can generate unrestricted revenue to support the organization's mission
• Fundraising efficiency measures the cost of raising funds relative to the total amount raised, with a lower ratio indicating greater efficiency

Cost Management & Allocation

• Nonprofits must carefully manage and allocate costs to ensure resources are used efficiently and effectively to advance the organization's mission
• Direct costs are expenses that can be clearly attributed to a specific program, project, or activity, such as salaries for program staff or supplies for a particular event
• Indirect costs, also known as overhead or administrative expenses, are necessary for the organization's overall operation but cannot be easily assigned to a specific program or project
  • Examples of indirect costs include rent, utilities, and general liability insurance
• Cost allocation methods, such as direct allocation, step-down allocation, or multiple allocation base, are used to distribute indirect costs across programs or activities based on a reasonable and consistent basis
• Time tracking systems help allocate staff time and associated costs to specific programs, grants, or activities
• Nonprofits should strive to maintain a reasonable overhead rate, typically 15-25% of total expenses, to demonstrate efficiency and maximize resources available for programs and services

Financial Reporting & Transparency

• Nonprofits are required to file annual tax returns, such as Form 990, which provide detailed information on the organization's financial performance, governance, and compensation practices
• Financial statements, including the statement of financial position (balance sheet), statement of activities (income statement), and statement of cash flows, provide a comprehensive view of the organization's financial health and performance
• The statement of functional expenses breaks down expenses by program, management and general, and fundraising categories to demonstrate how resources are allocated across the organization
• Audited financial statements, prepared by an independent certified public accountant, provide an objective assessment of the organization's financial reporting and internal controls
• Nonprofits should make their financial statements and tax returns easily accessible to the public, such as by posting them on their website or providing them upon request, to demonstrate transparency and accountability
• The IRS Form 990 includes a section on governance, management, and disclosure, which requires nonprofits to report on their policies and practices related to conflicts of interest, document retention, and whistleblower protection

Legal & Ethical Considerations

• Nonprofits must comply with various federal, state, and local laws and regulations related to tax-exemption, fundraising, employment, and financial reporting
• The IRS grants tax-exempt status to nonprofits that meet specific criteria, such as serving a charitable, educational, or religious purpose, and not engaging in substantial lobbying or political campaign activities
• State charitable solicitation laws require nonprofits to register and file annual reports before soliciting donations from state residents
• Nonprofits must follow generally accepted accounting principles (GAAP) and maintain accurate and complete financial records
• Conflicts of interest arise when a board member, staff, or volunteer has a personal or professional interest that may influence their decision-making on behalf of the organization
  • Nonprofits should have a written conflict of interest policy and require annual disclosure statements from key personnel
• Nonprofits have a fiduciary duty to use funds responsibly and in accordance with donor intent and restrictions
• Ethical fundraising practices, such as honoring donor privacy, avoiding coercive tactics, and accurately representing the organization's mission and impact, are essential for maintaining public trust and support

Practical Applications & Case Studies

• Scenario: A nonprofit animal shelter is considering expanding its services to include a low-cost veterinary clinic. The board and staff must develop a budget and financial plan that accounts for the startup costs, ongoing expenses, and projected revenue from the new clinic, while ensuring the organization's overall financial sustainability.
• Case study: A community arts organization faced a significant budget shortfall due to the cancellation of its annual fundraising gala during the COVID-19 pandemic. The organization successfully pivoted to an online auction and virtual event, engaging donors and supporters through social media and email campaigns, and ultimately exceeded its revised fundraising goal.
• Example: A human services nonprofit that relies heavily on government contracts must carefully track and allocate costs across multiple programs and funding sources, using a time tracking system and cost allocation plan that meets the requirements of its funders and ensures accurate financial reporting.
• Scenario: A nonprofit environmental advocacy group is considering accepting a large corporate sponsorship from a company with a mixed record on sustainability. The board must weigh the potential benefits of the funding against the risks to the organization's reputation and mission alignment, and develop clear guidelines for evaluating and managing corporate partnerships.
• Case study: A youth development nonprofit discovered that its former finance director had been embezzling funds over several years. The organization took immediate steps to investigate the extent of the fraud, report the matter to law enforcement, and communicate transparently with its stakeholders. The board also reviewed and strengthened its internal controls and financial oversight processes to prevent future incidents.