Budgeting and Accounting Software
We’ve had a few requests lately to help with setting up and maintaining a budget especially using the accounting software Xero. This often turns into a wider discussion about what should be budgeted for, and what the budget should show.
A budget is usually a ‘living document’, i.e. it gets adjusted through the year depending on the actuals. For example, if income is significantly below expectations, you can’t always wait until the end of the year to do something about it. Likewise, if funding is perhaps more than expected (or maybe there is an entirely new development not foreseen at the beginning of the year), then action should not have to wait until the next annual budget round.
While Xero does the job well, and some people use Xero very successfully for budgets, it is probably often easier and more effective to do this on a spreadsheet. This is partly because budgets tend to be on a higher level (for example you’ll have one budget line for ‘office overheads’, while your bookkeeping system might break it down in more detail), and accounting software is not good at adjusting for extraordinary items that may occur.
Another disadvantage of the Xero budgeting function is that it is on an accrual basis, whereas most organisations (including businesses) are better off doing budgets on a cash flow basis, i.e. showing the actual money flowing in and out. If you are working with grants and government funding especially, monthly accruals can seriously distort the picture, as the financial reports then do not show the actual money received. An accrual budget will also not alert you to periods in the year where cash might run low.
Budgeting: No accruals, please!
Accountants tend to be very wedded to accrual accounting, as doing anything else doesn’t feel right to us. However, when it comes to day-to-day managing your money, especially as a not-for-profit, what matters is how much cash you have in the bank, and whether it is enough to fund your expenditure. Unlike a business, a not-for-profit does not have investors or other stakeholders who want to see profits, and therefore does not need to budget for one.
Doing a budget, even in a business situation, is best done on a cash basis. You want to know how much money will be paid by your organisation, and how much is coming in to fund it. You need to know if there is money to pay for purchasing new computers, or a much needed vehicle, not what the depreciation figure for such a purchase would be.
A budget starts out with figures for the whole year. Unless your organisation has enough reserves that it can be sure it will not run out of money no matter what, it is a good idea to break this annual figure down into months, and monitor. When breaking down into months, don’t just divide everything by 12, but make sure that the months reflect actual expectations. For example, if you expect a $12,000 grant from Lotteries to come in in September, you won’t enter $1,000 as income for each month, but enter the whole $12,000 for September.
What is particularly important is that for each month a closing cash balance is calculated, which becomes the opening cash balance of the next month. When doing this, you will be able to see at which times of the year you are likely to be low on money, and this figure needs to be compared with the actual figure in the bank.
Highly grant dependent organisations also need to keep an eye on money that is specifically tagged for specific purposes. This can be done by adding another line under the closing bank balance, which states the amount of specifically tagged funding (not generic operational grants), and an adjusted ‘closing’ balance, that shows not just if you have money in the bank, but also whether this money can be used to pay for what you need to pay.
If your closing bank figure is already much lower than expected a few months before the time you expect to hit the bottom, you may have to take action to save cost (or increase income) right away.
When a financial report is drawn up, maybe for a committee meeting, which compares the actual figure with the budget, it is important that this variance in bank balance is included in the report. Whether you make a surplus or deficit at the end of the year is a minor matter compared to the prospect of running out of money.
Did your organisation make a budget for this financial year? Yes? Well done.
And what happened to it afterwards?
A budget that is not monitored against actuals is almost worthless. There is some use in the budgeting process itself, in that the organisation thinks about its cash needs to fund what it wants to do in the coming year, and that may inform its funding applications and other fundraising drives.
But the main function for a budget is to track your actual income and expenditure against it, and to take action if there is a large variance.
Monitoring budget variances is important on two levels. Firstly, your organisation’s governance, i.e. the Board or Committee, can see if its management sticks to the budget that was set. This is especially important if an organisation’s manager more or less has free hand to approve expenditure, and generate income, within the limits of the budget. Secondly, management also gets early warning if budget targets are likely to not be met. In larger organisations, management has much more detailed budget monitoring needs – where the governance is mostly concerned with the organisation’ overall finances, management may need to look at sub-budgets for specific operations.
If there are large variances between actual income and expenditure and those budgeted, the first question needs to be: What does this mean for our organisation’s ability to continue operating. However, the first response is often defensive: a manager or other person explaining why there is a variance. While the reason is important, the impact is even more so, and governance needs to evaluate if action has become necessary.
While there can be unexpected expenditure blowouts, the more likely reason for an organisation to get into cashflow trouble is through raising less income than expected. The appropriate response to this is to cut costs, including wages – the sooner this happens, the less likely people are to lose their jobs altogether. Yet, understandably, Board or committees are reluctant to do this, and are more likely to believe their manager’s assurances that more funding will be forthcoming soon, or will maybe come up with additional fundraising initiatives themselves.
There is also the possibility that income exceeds budget expectations. If such income is from grants or government contract, a corresponding increase in expenditure in the short term is likely necessary, which requires an updated budget – there is no point continuing to monitor against the original budget.
Regardless of what decisions have to be made, the most important thing is that budget variances are being monitored, and significant ones are raised and discussed at Board or committee meetings, regardless of whether they are favourable or unfavourable. Doing this keeps an organisation’s staff safe from losing their jobs.