Planning for the Next Annual Budget Cycle: Where Do You Start?
Compiling the annual budget for the next fiscal year is always a challenge and requires as much pre-planning as possible. During periods of unpredictable volatility, we need to get started early and consider new strategies we might not have used in the past. Top-down budgeting and stress testing your funding sources might be the best way to get started on next year’s budget.
A bottom-up budget approach is driven by mission and program planning, with an expectation that sufficient funding will be obtained. This approach has been common during the past three to four years, in which nonprofits have been riding a wave of strong economic conditions. In contrast, a top-down (or “revenue aligned”) budget approach is driven by expected funding levels that can be counted on with a high degree of success, with mission and programs goals aligned accordingly.
To be safe and conservative, we should assume that obtaining funding could be more of a challenge next year than in recent years. During these unpredictable times, next year’s budget should include conservative and obtainable (rather than aspirational) funding targets that can be met with a high degree of success. This not the time to assemble a budget that could drift to deficits quickly if all does not go according to plan.
Consider supplementing this approach with a new strategy: a stress test for your expected sources of funding. This strategy divides funding into different buckets based on probability of success in acquisition. I like to use a three-level approach, with buckets for high probability (Rock Solid), medium probability (Vulnerable), and low probability (Shaky).
Use the “Rock Solid” bucket for sources of funding that you have a high degree of confidence of receiving next year. Use the “Vulnerable” bucket for sources of funding that are exposed to volatility risks based on the crisis and the evolving economic conditions. Lastly, use the “Shaky” bucket for sources of funding that were part of your pre-crisis strategic plan but have been dramatically impacted by the crisis (e.g. suspended/cancelled programs and expansion plans put on hold, etc.).
After assigning all sources of funding to one of the three buckets, apply an acquisition percentage success range and target rate to each bucket and compare the results to the prior year budget.
The buckets could be designed as follows:
Rock Solid: 80% to 100% acquisition success range – mid-point target 90%
Vulnerable: 50% to 80% acquisition success range – mid-point target 65%
Shaky: 0% to 50% acquisition success range – mid-point target 25%
Examples of assigning sources of funding could look as follows:
Rock Solid: Membership Renewals, Federal Grants, Medical Clinic Co-Pays
Vulnerable: New Memberships, Municipal Grants, Virtual Workshop Registrations, Donations
Shaky: Membership Upgrades, Private Foundation Grants, In-Person Event Registrations
This stress test approach gives senior management a way to explore best case vs. worst case funding models for the next annual budget cycle.
Planning Tip – Get started early with your funding stress test and be transparent. Keep your funding stress test simple and not overly detailed. Run the stress test early in your budget compilation cycle and share the results with staff and board members (not just with senior management). The results will help shape planning and provide a platform for the size of next year’s annual budget.
Using a top-down budget approach and stress test strategy for your next annual budget cycle will help you to protect the financial health of your organization and improve sustainability during a time of uncertainty. As true recovery takes hold and a clear path for new normal can be seen, we can then go back to the more aggressive bottom-up budget strategies that fuel growth, mission advancement, and organizational evolution.
