If your nonprofit is at the point where scaling makes sense, then you’re ready to shift from survival mode to active, long-term financial forecasting. It can be quite a challenge because it not only requires a change in mindset but also an overhaul of traditional accounting approaches. This is particularly evident when it comes to budgeting because you go from a future based on historical assumptions to a strategic roadmap that sidesteps challenges and capitalizes on opportunities as they arise.
The 80/20 Pareto Principle
According to the Pareto Principle, or 80-20 rule, 20% of effort delivers 80% of results. It’s about prioritizing and optimizing the 20% of factors that will deliver outstanding (80%) outcomes. For example, 20% of a nonprofit’s donors generate 80% of its revenue. Unfortunately, when it comes to accounting, most nonprofits have it backwards. According to a Sage survey, 92% of accountants spend the bulk of their time on admin, leaving little time for strategy and forecasting. [1]
Here are three reasons this is such a problem.
- Time Trap: The survey also found that only 50% automate recurring tasks. Instead, they carry on with manual tasks, like processing payroll and tracking down receipts. Without software automation and integration, they are doomed to repeat the same functions with the same results, ensuring they never have enough time for strategic analysis and scenario modeling.
- Lost Opportunities: With their heads down and their minds occupied by input/output, accountants seldom have the opportunity to look up at the horizon. This means two things. 1) They deliver the same old data in the same old format, the same old 30 days behind. 2) Leadership has to make “strategic” decisions based on historical data. Both keep the nonprofit stagnant.
- Retention Crisis: High-level or senior accountants, or even those who want to broaden their experience, are unlikely to remain with a nonprofit that offers no opportunities for growth, including problem-solving, financial forecasting, and long-term goal setting. Tedium leads to apathy, which leads to burnout and resignations.
Wrapping up: Internal accounting departments burdened by historical recordkeeping have no choice but to keep facing backwards. This makes forecasting and scenario modeling impossible. Update your nonprofit’s accounting system to release the bottleneck and provide a stable yet flexible financial platform.
Revenue Shock When Annual Budgets Fail
Flexibility is important because a rigid, static budget can’t cope with unexpected disruptions. It decreases the fragility of nonprofit budgets while increasing their resilience in the face of global economic uncertainty, for example.
- Static Budgets: Static annual operating budgets provide a roadmap for the fiscal year. However, they can’t withstand sudden shifts in external conditions. Their guidelines are moot, and leadership scrambles to adjust resources and priorities.
- Payroll Panic: Static budgets aren’t conducive to active cash flow forecasting. Organizations are unaware of short-term liquidity challenges and don’t always have the reserves to cover the gap. For example, a donor check hasn’t been processed before payday, causing a payroll panic.
- Proactive Scenario Planning: This is the opposite of static panic because it’s narrative-based and uses the “sandwich method”. It relies on context and transparency. So, you might tell boards or funders that the current global economic uncertainty has led to a 20% decline in registration. However, you have alternative solutions in place. For example, virtual offerings that reduce bank charges and admin expenses. As a result, your nonprofit maintains vital cash reserves.
Wrapping Up: It’s possible to plan for the unexpected, like revenue shocks, provided you have an active, rolling cash forecast that allows you to model multiple scenarios and adjust operations proactively. However, you cannot future-proof your organization if your financial data is currently built on a distorted, dated, and manual foundation.
Cash Distortion: Where’s Your Financial Foundation?
When you first started your nonprofit, you probably used a cash-based accounting system. And that’s perfectly fine, because it’s a great starter system. The problem is that it’s not designed for the complexity of nonprofit accounting, including grant funding, donor restricted funds, and accurate forecasting. Nonprofits work best with an accrual-basis accounting system. In fact, GAAP (Generally Accepted Accounting Principles) requires nonprofits with an annual revenue in excess of $250,000 to use an accrual system. [2]
Here are three reasons why.
- Cash Flow Blindspot: Cash-basis accounting only records transactions when cash actually enters or leaves your bank account. It seems like the best way to track cash flow, but it actually creates a blind spot because it doesn’t take major outstanding commitments, upcoming accounts payable, or multi-year grant awards into account.
- Accurate Forecasting: Accrual accounting ensures that revenue is recorded when earned and expenses when incurred. This is a far more accurate view of your organization’s financial situation. It builds a stable platform or launchpad for multi-year forecasting and scenario planning.
- Tracking Restricted Funds: Accrual accounting is essential for tracking restricted grants and donor-restricted funds. Accuracy here ensures compliance with external regulations and allows you to pass annual independent audits with flying colors.
Wrapping Up: Transitioning from a cash to an accrual system seems like an unnecessary complication, but it eliminates financial distortions and provides leadership with the reliable, compliant data required for forward-looking projections.
Future-Proofing Growth (Developing Multi-Year Projections)
Scaling or growing a nonprofit requires vision and long-term planning. It’s not easy when it feels like you’re stuck in a short-term survival loop. This is where strategy and growth reveal their worth, as they help to develop multi-year financial projections and establish a comfortable cushion of reserves.
- Long-Term Projections: Quarterly financial planning isn’t wrong. Nonprofits do need a plan to get through the upcoming three months. But they also need long-term planning to survive economic downturns, government funding shifts, or policy changes. It’s recommended to build in a contingency fund that is typically 5-10% of your operating budget. [3]
- Teamwork: You’ve heard of key person risk? Where all crucial organizational information resides in one person, who takes it with them when they leave. That’s why a successful multi-year projection cannot be created in an executive silo. Involve all team members who are responsible for program execution and financial processes across the organization to streamline the planning process and increase its ultimate success.
- Funder and Board Confidence: Proactive, multi-year forecasting allows your team to engage in sophisticated “financial storytelling”. By connecting your financial metrics to real mission outcomes using a compelling narrative, you inspire board confidence and establish the credibility needed to secure major grants and donations.
Wrapping Up: Collaboration is the key to accurate, multi-year financial forecasts, successfully transitioning from reactive crisis management to strategic, future-proof growth. Your nonprofit needs to plan for the future and actually implement the forward-looking blueprint to make the data-driven decisions required to increase your impact and extend your reach.
Conclusion
The only way to successfully scale your nonprofit is to reassess your accounting model and transition from the traditional cash-based system to an accrual model. This enables you to adopt a forward-looking approach that doesn’t just put out immediate fires, but also anticipates your cash flow needs for the next one to two years.
It’s important to know that you don’t have to navigate the transition alone. You can partner with an outsourced accounting company that specializes in nonprofits, including fractional CFO services that provide access to the strategic leadership and technical expertise you need to grow.
This flexible, scalable approach maintains a stable financial platform that is regulatory compliant, and provides the data-driven insights necessary to secure a healthy financial future.
