Part I: Choosing to Create a Program-Centered Budget
“Don’t tell me what you value; show me your budget, and I’ll tell you what you value.”
A nonprofit’s annual budget has the capacity to be the most important communication tool the organization has – both internally and externally. A clear and purposeful budget can simultaneously provide trustees and staff the insights and understanding they need make mission-driven strategic decisions and inspire donors, program partners, and other constituents to engage with the organization.
A great budget tells a story (about what we value) – every bit as much as a great speech, brochure, website, or solicitation. When we develop a budget, it’s our obligation, and a great opportunity, to tell that story intentionally and directly – and (importantly) in a way that doesn’t make most readers feel like they’re reading a foreign language. I believe that the most compelling and effective way to do just that is through a “Program-Centered Budget.”
This is the first in a series of posts about creating and utilizing a great program-centered budget. To start:
What is a Program-Centered Budget (and what are the alternatives)?
The line-items of a budget are the heart of the story we’re trying to tell. What do we spend money on? And where does that money come from?
Let’s look together at the same budget, for a generic nonprofit with unnamed programs, as it would be presented using three broad types of budgets: program-centered, functional, and departmental. The fundamental difference between the three budget types relates to how expenses are organized and presented, so the comparison will focus solely on expenses. (Presentation of revenue is also an important element of great budgeting and will be discussed in later posts, when we get into the steps and considerations that go into creating a compelling program-centered budget.)
A Program-Centered Budget is one that organizes itself around the primary programs (mission-focused activities) that the organization offers or undertakes. All shared expenses, from office supplies up to the chief executive’s salary, are allocated to either (1) one of the organization’s core programs/activities; (2) fundraising costs; or (3) G&A. Once those allocations have been calculated (something we’ll walk through step-by-step in later posts), expenses for a generic program-centered budget would be structured as follows:
It is exciting and powerfully easy to look at a Program-Centered Budget and clearly understand what our organization actually does (the core programs) and how much we spend on each of our programs/activities.
A Functional Budget is on the other side of the budgetary spectrum; it organizes expenses by functional purchases and activities. Expenses for a generic functional budget would be structured as follows:
An understanding of functional expenses certainly matters, and is one of the building blocks of good financial management; it is important to understand how much our organizations pay in total salaries, or total advertising, or even total paper clips. But tracking functional expenses is not a meaningful purpose for an annual budget. A functional budget does not convey what we value. In the functional budget above, for example, we know that we spend more on salaries than anything else. But we have no understanding of what those salaries are invested in (what programs and activities those employees spend their time executing). The same thing goes for contract services, royalties, advertising, etc. Organizations with wildly different programs and priorities could have nearly identical functional budgets. So, unlike a program-centered budget, a functional budget offers very little in the way of insights and understanding to help board and staff leaders make mission-driven strategic decisions, and offers even less that could inspire donors, program partners, or other constituents to engage with the organization.
Apologies for getting a little tax-wonky here for a second, but... In talking with organizations that use a functional budget, many shared that they do so because it matches the Functional Expenses section in the annual filing document for nonprofits – IRS Form 990, Section IX. (A few even said that they thought they were required to budget that way, and were pleased to learn that they are not.) As noted above, it’s important to have an understanding of functional expenses as part of good financial management – and functional expense information is needed for the IRS-990. But the IRS-990 requires that we track and document a considerable amount of information on a variety of topics, far more than any organization I know endeavors to put into their annual budget. In addition, even if one wanted to be guided by Section IX of IRS-990, that section isn’t as simplistic as organizing a budget by functional expenses alone. The expense rows on the form are functional, but there are multiple columns next to each line. On the IRS-990, we have to allocate each functional expense line to either “Program service expense,” “Management and general expense,” or “Fundraising expense.” The IRS-990 asks us to consolidate all programs into one column (instead of tracking expenses by multiple programs), but other than that consolidation, the form’s required columns are exactly the line-items that are used in the program-centered budget example above. In other words, the IRS requires that we track and document expenses both ways, organized functionally and by program. So it is entirely up to us to decide which approach will serve us best in the annual budget we use for internal and external communication.
Finally, a Departmental Budget offers a hybrid approach; it organizes expenses based on the operating departments an organization has defined internally. Expenses for a generic departmental budget would be structured as follows:
This is probably the most common budget type. Its efficacy as a governance, management, and communication tool is all over the place, because so much depends on how the organization’s staff leadership and departments are structured. Departmental budgets are usually more effective than functional budgets (at least salaries and contract services are allocated to the various departments, instead of being listed as a lump sum). That said, they are generally considerably less effective than program-centered budgets, as so many support activities are grouped by function rather than connected to the program they are supporting. For example, in the departmental budget above, we know that the organization’s marketing department has a budget of $400,000 – but we don’t know how much of the department’s time and efforts are dedicated to each of the organization’s core programs/activities. Perhaps one program requires 60% of the budget and another program has no marketing whatsoever. In this departmental budget, we have no way to see how the marketing costs are (or are not) tied to each program. As a result, we are not conveying the full cost of each program/activity. We’re not telling our story – to ourselves or to our supporters. All of the other departmental line-items (e.g. Design, IT, the Executive Director’s salary… everything but the core program/activity lines) present the same obstacle to our ability to see full costs and a clear story.
This is why a Program-Centered Budget is far and away the best tool at our disposal – for both management and communications purposes. As described earlier, in a program centered budget, all shared expenses (all expenses that are not already categorized as direct expenses for each core program/activity) are allocated to one of the organization’s core programs – or to fundraising costs or G&A. This allows us to convey the full cost of each program. It allows us to clearly tell (the expense side of) our story – “this is what we do, and this is what is costs to do it.”
Upcoming entries in this series will dive into how to create a great program-centered budget, step by step, and then how to best utilize it.
Part II of SHOW ME YOUR BUDGET:
Choosing the Right Revenue and Expense Lines (and Naming Them Well)