For a nonprofit organization, the annual budgeting process is typically the primary vehicle for financial planning.
Organizational leaders and stakeholders come to that process with a sense of plans and goals for the year, and (ideally) come to collective decisions about how resources will be allocated to advance and prioritize among them. Then, once the board gives its final approval and the new year begins, the team sets about putting those plans into action and monitoring results, until it’s time to do the whole thing over again next year.
Unfortunately, this “one year at a time” approach can often leave organizations vulnerable to longer-term trends, changes or challenges. Some trends or uncertainties may require years of advance planning and action to effectively hedge against them. And while a formal strategic planning process should always include financial plans and projections, those typically only happen every several years.
So between the year-by-year budget development process and the every-few-years strategic plan, we need some means of considering possible financial changes across multiple years. Otherwise, we risk not being able to make the adjustments necessary to address these long-term trends, perhaps until it is too late.
Examples of situations that can have long-term financial implications that may require significant pre-planning include:
- Increasing personnel costs, especially associated with medical insurance
- Relocation costs as a property lease nears expiration
- Conclusion of a significant multi-year grant
- Possibility of reduced revenue from public sources as government budgets shrink
- Demographic or other social shifts that may affect the scope and nature of an organization’s programming
In addition to those external factors, many organizational decisions themselves have long-term financial implications — for example, a decision to increase staff wages by 3% is not a one-year expense but rather a long-term commitment.
To plan responses to these scenarios, organizations need models that can quantify the financial impact of future possibilities, showing how much of a gap will need to be made up by increasing revenues or reducing expenses (or, to take the optimistic case, how much profit will be available for investment in furthering the organization’s mission).
These models are generally constructed in Excel (so it helps to have someone on the team with facility using that program), and project out long enough to show the financial implications of the scenarios you want to understand—be that three years, five years, ten years, or even longer. Note that this doesn’t mean we’re building budgets for those years, but rather trying to understand the implications of changes to the status quo—this kind of model helps to inform planning and decision-making, but is not itself a detailed financial plan.
Following are a set of basic steps to multi-year financial planning:
- Determine the main trends or uncertainties you need to understand and plan for. These will be the variables in the financial model.
- Construct a financial profile of your organization’s current (or “baseline”) business model—basically a high-level version of the assumptions underlying your operating budget. What are the primary cost drivers? What are the relationships between types of expenses? What are the sources and levels of revenue?
- Use the variables to show the impact to the baseline over time of the scenarios being considered. For example, what does a 4% annual reduction in government contract revenue combined with a 2% annual increase in health insurance premiums look like over the next five years? You may want to look at a few different constellations of factors, such as a best-case, moderate-case and worst-case scenario with varying levels of revenue and expense increase or decrease.
- Discuss and develop plans for mitigating any financial risks demonstrated by the scenarios, including specifying “triggers” for implementing plans.
(A more comprehensive and very useful guide to scenario planning from the American Institute of CPAs and Chartered Institute of Management Accountants is available here.)
While we can’t predict the future—much less control it—looking at the financial possibilities that exist beyond the current budget can at least help us to better plan for it.
Hilda Polanco is the Founder and CEO of Fiscal Management Associates, the go-to advisor foundation and nonprofit leaders seek when addressing nonprofit financial management capacity. Hilda provides capacity building, training and coaching services to foundations and nonprofits throughout the country.