The Board’s Role in Budgeting and Decision Making

1. The Board’s Role in Budgeting and Decision Making Grinspoon Institute Conference November 13, 2011 Springfield, MA Jeff Greim Director, MS in Nonprofit Management & Philanthropy Bay Path College jgreim@baypath.edu

2. Question • Are you responsible for a: • Business; • Corporation; or • Nonprofit Organization?

3. Answer • You are responsible for all three • You are responsible for a business that is organized as a nonprofit corporation that is often thought of as an organization. • But your business not about profit maximization. • Your business is about Mission Maximization • creating the greatest possible “social good” for which you have been granted tax benefits by the government.

4. ERGO: Three Imperatives • NO MONEY, NO MISSION • LIQUIDITY is All IMPORTANT • Means to weather the economic storm WHEN it comes; • Provides your organizational independence to try something new without having to first convince a funder of its merit. • NEVER VIOLATE THE PUBLIC TRUST • Don’t do “it” if you don’t want to see “it” on the front page of your local newspaper.

5. A Good Financial Structure is a Prerequisite to Making Good Financial Decisions • Organizational Structure • Policies and Procedures • Recordkeeping • Alignment/Coordination of Financial and Operational Goals

6. Organizational Structure • All Officers of an organization are responsible for the financial integrity of the organization. This includes the Board Chairman and Members, CEO, COO, CFO and/or Treasurer. • Accordingly, all these people have to have access to the financial decision-making process and have access to information necessary to make informed decisions.

7. EVERYONE IS RESPONSIBLEPage 75 Financial Management for Nonprofit Organizations Zietlow, Hankin, Seidner • “….financial responsibility is ultimately shared by everyone in the organization with decision-making responsibilities: the board of directors/trustees, councils, and committees, ED/CEO, and other managerial and program staff. According to IRS laws governing nonprofit organizations, any of the above-mentioned persons can be held liable for financial errors as long as there is sufficient evidence to presume that they should have known about the errors and could have acted to avoid them.”

8. Organizational Structure • Sarbanes-Oxley Law • Whistle blower protect • Board Chair and ED sign Form 990 • Board Committee Structure • Audit Committee without management • Independent Auditor

9. Audit Committee ResponsibilitiesP. 84 Financial Management for Nonprofit Organizations Zietlow, Hankin, Seidner “Audit committees must implement a process that supports their understanding and monitoring of the: • Specific role of the audit committee in relation to the specific roles of the other participants in the financial reporting process (oversight) Critical financial reporting risks; • Effectiveness of financial reporting controls; • Independence, accountability, and effectiveness of the external auditor; • Transparency of financial reporting. …the external auditor should report directly to the audit committee.”

10. POLICIES AND PROCEDURES • SYSTEMS OF ACCOUNTABILITY PROTECT YOUR ORGANIZATION AND PROTECT EVERY EMPLOYEE • If you implement policies and procedures that have checks and balances and controls: • Staff know their respective responsibilities and they are bound to following those procedures and policies. • Consequently: • No one can be accused of any wrong doing; and • When your actions are questioned, you can always say, “I followed procedure.”

11. Policies and ProceduresAreas to be Covered by Procedures • Purchasing—You need a system for how purchases and contracts get authorized and tracked: • Amounts requiring special approval; • Leasing— (office equipment, program space, automobiles, etc.) • Contracts— • Services received, and • Services to be provided. • Payroll/Time Sheets—You need a system for how hours worked with be recorded and verified. • Accounts payable—Need a means of tracking how you are paying your bills and what funds are being used to pay which bills. • Accounts receivable—Need a means of tracking how you are collecting the money owed you and how you are keeping track of what is owed you.

12. Policies and ProceduresREQUIRE TWO SIGNATURES EACH PROCEDURE NEEDS TO REQUIRE AT LEAST TWO SIGNATURES AND/OR REVIEWS BY PEOPLE IN DIFFERENT ROLES AND POSITIONS OF AUTHORITY IN ORDER TO ESTABLISH “CHECKS AND BALANCES.”

13. Don’t freelance!!!! • Don’t ignore a procedure because: • You are in a hurry; or • You can’t be “bothered”; or • You are the “boss.” • It’s when you deviate from procedure that you get yourself and your agency in trouble.

14. Recordkeeping • If you don’t have accurate information in decipherable format, you can’t make informed financial decisions. ERGO • Financial Statements. • Budgets and Variance Reports. • Form 990’s.

15. The building blocks of financial statements Accounts and account numbers get organized into Account Categories and COAs which in turn get organized into Financial Statements.

17. Statement of Financial Position (SFP) • SFP—at a point in time—compares the assets of an organization against its liabilities to evaluate whether or not the organization is “solvent” • Does it have positive net assets or negative net assets? • Does it “own” more than it “owes” or does it “owe” more than it “owns?” • By definition, if an organization has negative net assets then it owes more than it owns. In such a case, the organization’s lenders can call in the outstanding IOU’s at anytime and put the organization out of business.

18. State of Financial Position (SFP)(CONTINUED) • The SFP is based upon the following equation: • This implies that for every $1 of assets there has to be a corresponding $1 of liability (the IOU) and/or net asset. • Net Assets is sometime called “equity.” ASSETS = LIABILITIES + NET ASSETS

19. State of Financial Position (SFP)Template Format • Assets • Xxxxx $$$$$ • Xxxxx $$$$$ • Xxxxx $$$$$ • Total Assets $$$$$ • Liabilities • xxxxx $$$$$ • Xxxxx $$$$$ • Xxxxx $$$$$ • Total Liabilities $$$$$ • Net Assets • xxxxx $$$$$ • Xxxxx $$$$$ • Xxxxx $$$$$ • Total Net Assets $$$$$ • Liabilities and Net Assets $$$$$

20. Statement of Activities (SA) • SA summarizes the financial activities of an organization for a specified period of time—normally the financial year—and evaluates whether the organization “made” or “lost” money during the period. • If the organization has made money, then the “surplus” increases the organization’s amount of Net Assets by that amount. • If the organization has lost money, then the “deficit” reduces the organization’s positive Net Assets or increases the organization’s negative Net Assets.

21. Statement of Activities (SA)(continued) • The SA is based upon the following equation: • If NET REVENUES is positive, then the organization made money and this is reflected as an increase in Net Assets on the SFP. • If NET REVENUES is negative, then the organization lost money and this is reflected as a decrease in the Net Assets on the SFP. REVENUES – EXPENSES = NET REVENUES

22. Statement of Activities (SA)(continued) • SA is presented in several different formats for different analytical purposes. • SAs are formatted by “funds” to see if the part of the organization’s financial resources that are controllable is financially viable: • Unrestricted • Temporarily restricted • Permanently restricted. • SAs are formatted by “functions” to see how different parts of the organization are performing financially: • Programs Areas and individual programs, • Supporting services • Administration • Fundraising • Watch dogs want to see if the organization is financially focused on its mission—not expensive fundraising gala’s and not excessive executive salaries.

23. State of Financial Activities (SFA)Template Format • Revenues • Xxxxx $$$$$$ • Xxxxx $$$$$$ • Xxxxx $$$$$$ • Total Revenues $$$$$ • Expenses • Xxxxx $$$$$$ • Xxxxx $$$$$$ • Xxxxx $$$$$$ • Total Expenses $$$$$ • Net Surplus/(Loses) $$$$$

24. Statement of Cash Flow (SCF)(continued) • SCF evaluates the amount of cash an organization has at the beginning and end of a specified time period—usually the financial year. • This is important because while an organization can be wealthy it will not be able to “buy” its way out of a financial crisis if it doesn’t have enough “cash.” • This directly relates to establishing a Liquidity Target and being vigilant throughout the year about maintaining it. • SCF also shows how an organization increased or decreased its “cash” during the period: • Spent it on investment? • Spent it on Court settlements? • Spent it to cover operating loses? • Gained it from operating surpluses? • Gained it by selling off assets? • Gained it by taking out a second mortgage?

25. Statement of Cash Flow (SCF)(continued) • SCF is based upon the following equation: • Different Formats • Direct Method • Actually shows every increase and disbursement of cast throughout the year. • Indirect Method (most common format) • The change in cash becomes a plug number based upon the other numbers in the statement. • This format easier to use. Cash(Time 1) – Cash (Time 2) = Change in Cash (Time 1 to Time 2)

26. IRS FORM 990 THE IRS REQUIRES MOST NONPROFITS TO SHARE FINANCIAL INFORMATION WITH THE FEDERAL GOVERNMENT ANNUALLY. THE FORM USED TO REPORT THIS INFORMATION IS CALLED FORM 990. YOU CAN THINK OF IT AS SOMETHING LIKE A MODIFIED INCOME TAX RETURN—ALTHOUGH THIS IS A GROSS OVER SIMPLIFICATION.

27. IRS FORM 990 June 8, 2011 • WASHINGTON –– The Internal Revenue Service today announced that approximately 275,000 organizations under the law have automatically lost their tax-exempt status because they did not file legally required annual reports for three consecutive years. The IRS believes the vast majority of these organizations are defunct, but it also announced special steps to help any existing organizations to apply for reinstatement of their tax-exempt status. • http://search.irs.gov/web/query.html?col=allirs&charset=utf-8&qp=&qs=-Wct%3A%22Internal+Revenue+Manual%22&qc=&qm=0&rf=0&oq=&qt=Form+990&search.x=0&search.y=0

28. ALIGNMENT OF FINANCIAL AND OPERATIONAL STRATEGY TO MAXIMIZE MISSION

29. ALIGNMENT OF FINANCIAL AND OPERATIONAL STRATEGY TO MAXIMIZE MISSION • Make all decisions within context of the “Big Picture”—your short and long-term goals. • Financial Planning and Operational Planning has to be done in concert- • The “Left Hand” needs to know what the “Right Hand” is doing at all times.

30. IT’S ALL ABOUT BALANCE From Mission, Money, Merit by Kersti Krug & Charles B. Weinberg

31. BUDGETTING: Major Themes • Budgeting deals with three related components of financial management: • The Budget Process; • The Budgets themselves; and • Variance Analysis. • Financial management depends on vigilant implementation of each component—your management strength is only as strong as your weakest link. • “GIGO” applies as much to budgets as it does to computers. (GIGO—Garbage In, Garbage Out)

32. BUDGETING, BUDGETS, and VARIANCE ANALYSIS The process (budgeting), the product (budgets) and the ongoing monitoring (variance analysis) that enables you to always know the financial condition of your organization.

33. Budgeting: Allocating Scarce Resources • A definition: The intentional allocation of finite resources for maximum benefit—as defined by the organization’s mission and/or its individual program goals. • On an agency-wide/macro level, budgeting involves looking at all your actual and potential revenues and deciding how you will broadly allocate them to pay your expenses in an effort to maximize the public good in the near and longer term that is the mission of your organization. • At bottom, budgeting is “putting your money where your mouth is.”

34. Budgeting + Operational Planning • By necessity, the agency-wide budgeting process has to be intertwined with the agency’s short and long-term strategic plan. If you don’t have and/or cannot plan to get the financial means needed to carry out your strategic plan, then your strategic plan is meaningless.

35. Budgeting: Critical Considerations • At this macro level then, the process requires you—the CEO—to consider and at times work within several limiting parameters: • Your organization’s strategic and operational goals and the financial means needed to achieve them; • Your organization’s liquidity target; • Specific restrictions on near and long-term revenues stipulated by funders, laws, regulations, etc. ; • Specific restrictions/requirements on expenditures stipulated by funders, unions, prior organizational commitments such as employee benefit policies, mortgages, long-term leases, etc.; and • Your organization’s ability to generate unrestricted “revenues”.

36. Budgeting is ITERATIVE • Consequently, budgeting is always an iterative process. It takes time for all involved in the macro decision-making policy to: • Gather and analyze all the information that is required for making informed macro budget decisions; • Evaluate the likely consequences of various possible decisions; and • Develop “consensus” about the budget decisions that are to be implemented.

37. Budgeting is ITERATIVE • The iterative process typically involves developing plans to eliminate the projected gap between the projected revenue and the projected expenditures—sometimes called PEGs. (Plans to Eliminate the Gap) • This involves increasing revenues or decreasing expenditures. • Decreasing expenditures typically involves three possibilities: • Shifting costs to a third party; • Improving efficiencies; doing more with less; and • Reducing services.

38. Budgeting is ITEREATIVE • Use Interactive Spreadsheets to help you do “What if Scenarios” • Identify the variables that will most influence your costs and revenues, place their values in “reference” cells, that are then referenced in the actual budget. • As you change the values in the “reference”, the totals in your formula driven budget will change. • This is a very powerful tool for integrating financial planning and operational planning Note: Go to Excel Examples

39. Budgeting: Building Joint Ownership • The budget process most be a bottom-up and a top-down process. • Those who are going to be held accountable for staying within the budgets must be given a part in developing the revenue goals and the expenditure constraints to which they are going to be held accountable. • Also, top management can’t have perfect knowledge about is happening “on the ground” and so by definition can’t know all the operational ways to generate revenue and/or reduce expenditures. • Top management must be responsible for the overall financial vision of the organization and help mid and lower-level staff understand how that vision relates to the quality performance of their individual jobs and vice versa.

40. Budgeting • Agency-wide budgets are typically compilations of individual program budgets. • Make sure that all these individual budgets reflect the same assumptions including: • % of administrative charges; • % of employee benefit cost; • Allocation formulas for assigning shared costs to various programs.

41. Budgeting: The Product • The product of the budgeting process creates for your organization and its areas of operation a financial roadmap—operational budgets—against which to measure your organization’s financial performance. • Budgets have a place—(an account)—for everything—(every revenue and expenditure)—and everything—(a dollar amount)—in its place.

42. A Template for Operating Budgets Note: Make sure that your COA has accounts for the information you want to collect and keep track of. Accounting software programs will generate financial reports based upon the items and categories of expenses and revenues reflected in your COA.

43. Operating Budgets: GIGO (Garbage In Garbage Out) • Don’t be lazy in setting up your monthly budget projections. Do the work once instead of ever month as you try to figure out why the numbers--“actuals” and the “budget”—don’t match. • Don’t “straight-line” revenues if in fact they are expected to be different amounts throughout the year. • Don’t “straight-line” expenses if this is not the way they will be incurred: • Make sure your budget reflects payroll fluctuations: • 2 or 3 payrolls months and for the accrual associated with the first pay period of each year that decreases the first month’s recorded PS expense and increases the last month’s recorded PS expenses. • If rents are prepaid, make sure this is reflected in the budget. • Account for quarterly or uneven expenses/billings: • Insurance, some utilities, seasonal bills like heating, etc.

44. Operating Budgets: GIGO (Garbage In Garbage Out) • In most non-profits, the Personnel Services (PS) costs are the largest expense category. So pay extra attention to these items when developing your budgets: • Make sure if your are operating a 24-hour program that you budget enough staff to cover all the hours. • Make sure your staffing pattern accounts for paid time off. (There are 52 weeks a year but most staff have 13 paid holidays, two weeks vacation (at least), two weeks sick leave, required training days, etc.) Build into the budget the cost of overtime or extra “fill-in” staff or part-time staff to cover this paid time off. • Make sure you cover all fringe and benefit expense for qualifying workers. These costs can easily be 30% or higher of the employees’ wages.

45. BUDGETING: Variance Analysis • Definition: The ongoing comparison and analysis—at least monthly—of the planned expense and revenue budget numbers against the “actuals”--the actual financial performance--to identify and explain the “variances” – differences—as they occur. • This allows you to address unexpected financial problems as they are developing before it’s too late. • There is nothing worse than a year-end surprise.

46. Template of Monthly Budget Report used in Variance Analysis

47. Template of Monthly Budget Report used in Variance Analysis • Things to notice: • The annual budget comes off the “Annual Budget.” (“Tell me something I don’t know”) • The period “budget” is the budgeted amounts for the given month. • The format allows you to easily see the variance for the given month and the variance year-to-date. • This allows you to easily compare the magnitude of the variances compared to the annual budget amounts.

48. BUDGETING: Variance Analysis Variance Analysis • Things to watch out for that might make you think you are under spending and have more money than you really do: • Infrequent billing of subcontractors. Assume that at some point during the year you will have to pay the full amount of the subcontract unless you verify otherwise. • Always account for the fact that under spending in a program leads to under spending in G&A (General and Administration) costs because the administration cost is normally a percentage of all other programmatic spending. Assume that by year-end you will “spend” out the budget and so be fully charged your share of the admin expenses unless you verify otherwise. Again, don’t overestimate surpluses due to uneven spending. • Don’t be fooled by the first month’s low recorded PS costs. Again, this is due to an accounting convention and this “apparent” savings will be added back to the recorded PS costs in the last month of the fiscal year.

49. BUDGETING: Variance Analysis Variance Analysis • Other Monkey Wrenches that can muddy the Analysis: • Field Staff not submitting bills on time to the fiscal department for payment. (Under spending is simply due to bills not being recorded and paid.) • Fiscal staff not establishing and holding to a set closing date for posting of bills and revenues for a given month. So some months end up containing more days of expenses than others.

50. BUDGETING: Variance Analysis Variance Analysis • Making program managers explain variances is a good way to ensure that they get the invoices in on time. • Determine what level of detail you want to have in your budgets and in your budget reports. • Don’t spend time looking at insignificant amounts of expenditures and/or revenue variance. • Have both program staff and fiscal staff involved in the variance analysis--in the same room at the same time. Each will have questions about “unknown” charges that only the other will be able to explain and/or be able to easily investigate.