Basics of Budgeting Pat Roddy Managing Director SIRE

Basics of Budgeting Pat Roddy, Managing Director SIRE, Houston’s Therapeutic Equestrian Centers www. sire-htec. org Volunteer at SIRE for 16 years in a variety of roles including finance and management. SIRE has 3 sites in the greater Houston area and serves about 200 clients weekly. 7/28/2010

Who Needs a Budget? • Anyone that does not have an unlimited source of money - Some people think they have unlimited money and find out they do not - Ex – rock stars, sports figures, the government • Anyone who needs more money - Most funders ask for budgets • Anyone with fiscal responsibility - - Helps to detect fraud - Report to the Board of Directors or someone else

Why is money important? • It has been said that the mission and people of a non-profit are the heart and soul of the organization. Money is the blood that ties it all together. • No money no mission. • Money is not the mission.

What is a budget? • A budget is a plan for getting and spending money to reach specific goals by a certain time. • A means by which management’s plans are reduced to monetary amounts.

Definitions • Operating Expenses – those funds required for the day to day operations of an organization – payroll, horse expenses, facility rent or repair, office supplies, utilities. • Capital Expenses – usually purchases of assets over a specified amount which have a useful life of more than one year. Each organization sets the level above which they capitalize items (SIRE’s limit is $2500). • Depreciation – A way to spread out the cost of an item over many years. • Variance – difference between budget (planned) and actual. • Chart of Accounts (COA) – the list of accounts that your organization uses to manage and report on its financial status. Each organization develops their own.

What is accrual basis and why should you care? • Cash basis – like a checkbook. You record money when you get it, you record checks (expenses) when you write them. • Accrual basis - A method of accounting that recognizes expenses when incurred and revenue when earned rather than when payment is made or received. • Your accountant should tell you which method you should be using. Your budget should be prepared using the method of accounting that is being used in your organization. Then you MAY need to translate that budget into cash flow.

How do you create a budget? • First, establish goals and objectives for the time period covered by the budget. - Example, we will increase our participants by 10%. - We will begin offering driving program in 2011, additional staffing and equipment is required. - We will hire an office person to handle registrations and other paperwork. - We will increase our reserves to 3 months of operating expenses.

• The process should involve program staff as well as financial staff – team effort. In a small organization – it may be the same person. • Start with income then do expenses. • Use a budget worksheet, one for income and one for expenses.

Example of Income Budget WS

How do you predict income? • Assume that income is divided into three broad categories: Revenue – earned income Special Event income – net Support Income – donations, grants

Revenue • Revenue (earned income) should be fairly easy for you to estimate – if you charge a fee, how many clients, how many sessions. • 12 clients * 40 weeks * $35 tuition = $16800 • Apply a % if you offer scholarships or may have cancellations, bad debt etc.

Special Events • Special event income should also reasonably easy to forecast ONCE you have a track record with the event, although many factors can affect the events down the road. You make your best guess. • Tip - The IRS allows you to report NET income for special events – you need to get your auditor to allow this also.

Support Income • Support income is traditionally the most difficult to estimate for us. A large grant in a given month can cause the numbers to fluctuate wildly. This is difficult to estimate on a month by month basis, but over time, the estimate for the year should be reasonable. • For a new or young organization, this is very difficult to forecast

What about expenses? • Create key parameters or objectives first – - Number of clients to serve - Number of horses needed - Number & type of staff needed - Major facility maintenance projects

• Sometimes easier to start with existing programs, then add expenses for new programs. • You may create an opportunity budget – ie if our fundraiser is wildly successful, then we will expand our program. • Bummer, expenses exceed income, what do you do? Fix it!

• Tip - Most people do not like to show a loss on a P&L statement. Most funders do not like to see a loss either, as it indicates the organization is going out of business. • The hidden danger of over budgeting – it keeps you from spending money on something else.

Tips for Budgeting The approval of the budget should be done at a high level, not individual line items. You need some flexibility to effectively run an organization. • A budget is not a substitute for management. • Larger budget items should be subdivided. • Focus your time on the larger items, people costs, horses, facilities. Don’t sweat the small stuff.

Budget summary for Board

Sample detail

• Financial policies & procedures should include the budget process, who, what & when. • Tip – perhaps have one line item for contingency – could be used for a variety of emergency purposes. • Tip - Public Education is a program expense. Newsletters, website, brochures.

How do you know how you are doing as the year goes along? • Someone needs to monitor the budget. MANAGEMENT • Financial policies should define what type of information should be reported, how frequently, and to whom it is distributed. • In QB, budget performance report is best.

Quickbooks Budget Performance Report

What is the difference between a budget and a forecast? • A forecast is the current estimation of income and expenses and will change over time. • A budget begins as a forecast, then through the approval process it becomes an approved budget.

• A forecast may be as simple as a statement that expenses and income are running close to budget and you expect that trend to continue. • Or if money is very tight, a forecast may be very detailed, month by month, or week by week. In these situations, a cash flow forecast becomes MOST important.

• Tip - Even though in many cases, very few people look closely at the detailed financial information, it is still important to distribute it. Otherwise people will start to think you are hiding something. You can encourage people to ask for more information if they would like it. • Since non-profits are required to make certain information available to the public (Form 990), most of the financial information is not confidential. • Items that are generally confidential include salaries and donor information. Be careful that your reports are not so detailed that they divulge this information.

• Use footnotes to explain variances. • Use charts

When do you change the budget? • ALMOST NEVER • Changing the budget creates problems and confusion in reporting. • It is better to disclose the reasons for variance in the footnotes. • Repeating - The approval of the budget should be done at a high level, not individual line items. You need some flexibility to effectively run an organization. • What does this mean? If one line item is over budget, then management needs to identify other line items that are below budget.

Capital budgets • OK to have a different budget calendar for capital. Say July to June instead of Jan to Dec. • A prioritized list is a good start. Add dollar figures. • In many cases for capital you do not spend the money unless you get funding specifically for the capital item.

Topics specific to our industry:

Budgeting for veterinarian expenses • Routine shots, worming, teeth floating are easy to budget • Include some dollars for other “routine” expenses • Unusual large expenses are the tough ones to anticipate, duh…

• Each center needs to determine in advance the circumstances under which they will incur large veterinary expenses: – Colic surgery or other emergency surgery – Anticipated large bills (for us over $1000) – Loss of use

• You will probably not be able to establish a firm policy, as the decision will need to be based on the facts of each situation. Who makes the decision? What about leased horses? At what level is higher approval needed and who makes this decision? • What is the impact of the decision on riders, staff and volunteers? • Will the horse return to full use? • Age of horse. • Value of horse to the program. • Care required during recuperation period – do you have people to do this? • Kind of like an emergency drill or DNR – which horses would you spend lots of $ on – discuss in advance.

So – back to the budget question – • The line item for veterinary expenses should include anticipated routine expenses as well as dollars for some non-routine veterinary expenses. I would not recommend budgeting for worse case, as this may cause money to not be available for other expenses. (danger of over budgeting) • Every organization needs to have a reserve for unexpected, unbudgeted expenses. The smaller you are, the more important this is. Do you have supporters who will contribute in a time of crisis?

• This discussion leads directly into emotional decision making – why is this important for budgets? • By its very nature, making money is not the mission of a non-profit organization. However for most organizations, money is required to fulfill that mission. • Decisions should not be made solely on the basis of money, nor should they be made solely on the basis of emotions. Even a non-profit must stay solvent in order to fulfill its mission.

• • Money is a resource – if you are short of money, are there other resources available to compensate for this? What about volunteer staff? Should you include salary for them in the budget? – No, as this would cause you to overbudget and not have money available for other uses. – You may want to include a statement of impact, should this volunteer leave the organization and need to be replaced by a paid staff member, what would happen to the program? For example, you have a volunteer instructor who does all of your classes, what would happen to your program if they moved away or quit? Are there other volunteers that are certified that might volunteer services? OR would you need to pay instructors? Your board needs to be aware of this potential vulnerability.

How do restricted funds affect the budget? • Restricted Funds – – Only the donor can restrict funds. – The restrictions should be in writing. • You need to track receipt and disbursement of restricted funds closely. • Your auditors will review restricted funds as they must include information about them in the audit.

• What do you do if you receive a restricted donation for something that is not in the budget? – SPEND the money, DON’T change the budget. – Just make a note on the financial report that you are over budget because of the restricted donation. • What if there is a line item in the budget that meets the restriction? – Again, SPEND the money, DON’T change the budget.

• Example, you have a line item of $3000 for horse equipment and tack. You receive a restricted donation of $1000 for saddles. Does this mean you can now spend $4000 on horse equipment and tack. The answer is NO. The budget is still $3000. • Suppose that you receive a donation of $5000 for horse equipment, can you then spend $5000. The answer is YES. The budget remains $3000. You just explain why you are over.

• Tip - encourage UNRESTRICTED donations, especially for small amounts, the tracking expense can outweigh the value of the donation. • What happens if you receive a restricted donation that you no longer need? Or your priorities have changed? – You must go back to the donor with an explanation and perhaps request an alternate use of the money. They may say OK, or they may say give us our donation back. Get any changes in writing, an e-mail from them would be sufficient.

• How to track restricted donations – if you do not receive a lot of them, you may find it easy to track manually. You may be able to use classes or jobs in Quickbooks. • Watch appeals, like Sponsor a Horse, You may need some fine print saying that donations to this campaign are considered donations to the general operating fund. • Can you borrow from restricted funds – NO. You need to be able to refund them if they are not spent. So this means you need to “set them aside” – at least from a reporting standpoint, not necessarily a separate account.

CASH FLOW • Why is cash flow important? • It does not matter how good your budget is if you run out of cash to pay the bills!!!! • Where are the high & low points of your cash flow? – can you do anything to level them out?

Example of cash flow

Beyond the Basics • • • Audits Financial Controls Allocations of Salaries Important Ratios Cost Analysis Zero Based Budgets Donated Materials and Services Chart of Accounts Loans – Line of Credit Resources

Audits • • From Guidestar - The Sarbanes-Oxley Act and Implications for Nonprofit Organizations (2003) – While no standard guidelines mandate when a nonprofit organization should undertake a full audit, the board is responsible for assessing the potential benefits and costs of an audit. Generally, nonprofits that have budgets of more than $500, 000 and that receive federal funds are required to conduct an annual audit. Some state laws have lower thresholds. In addition, participating in the Combined Federal Campaign requires an audit at $100, 000. Smaller nonprofits, for whom an audit would be an unreasonable financial burden, should choose a review or at least have their financial statements compiled by a professional accountant. The boards of nonprofit organizations that forego an audit should evaluate that decision periodically. SIRE pays about $8200 for a full audit.

Financial Controls • Separation of duties is key – if you cannot separate duties, then have someone else check results periodically. For example – whoever writes checks should not balance the checkbook. Whoever receives payments should not be able to create and modify invoices. Key financial people should go on vacation for a long enough period of time that someone else does their work. Electronic payments should be scrutinized. Receipts are required for everything. Payroll changes in writing. Approval process on expenses.

Allocation of Salaries • You may find it important to allocate salaries such as the Executive Director, part to fundraising and administration, part to program. Document the reasons for the allocation, can say it is based on observation of time spent, interview with staff, etc.

Important Ratios • Many funders want to know the percent of money spent on fundraising/administration vs program. • Some ask for it as a percent of expense, some ask for it as a percent of income. • If you have lots of program volunteers, your expenses may exceed these ratios and you will need to explain that to funders.

Cost Analysis • Someone should do a cost analysis for your organization – what does it cost for you to deliver services, what are the major components of this cost, how can you control them.

Zero Based Budgets • Zero based process assumes no program is necessary and no money needs to be spent, ie you must justify the program as if it were brand new. • Incremental budget process treats existing programs as pre-approved, subject only to increases or decreases in resources. • Most people use incremental.

Donated Materials and Services • (In-Kind Contributions) FASB Statement No. 116 guidelines also requires that nonprofits account for contributions of most goods (with the exception of works of art and other items held in museum collections). In addition, volunteer time must be included in the financial statements when either: -The volunteer time results in the creation or enhancement of non-financial assets, such as volunteer labor to renovate a child care center; or -The services volunteered are specialized skills, such as those provided by accountants, nurses, electricians, teachers, or other professionals and craftsmen. • The hidden danger of donated goods – spend more time & effort trying to make something useful than it is worth.

Chart of Accounts • SIRE expense accounts are based on the unified chart of accounts for non-profits with changes for our unique items. Nccs. urban. org/projects/ucoa. cfm • Generally you cannot record income in an expense account, or expenses in an income account. For example, if you receive a donation to pay for shirts for competitions, that must be recorded as income, and the corresponding purchase must be recorded as an expense. • Exceptions to this are expenses associated with Special Events, returns or credits, or cost of goods sold.

Loans – Line of Credit • Tip - Line of credit – get one well before you need it. Keep it even if you don’t use it. Only established programs will be able to get a LOC. May need to secure it with assets. The lender may require a guarantor. • Tip – credit cards – most require a personal guarantee. Require receipts – track carefully if you use these.

Resources • • Nccs. urban. org and urban. org – Urban Institute National Center for Charitable Statistics – Unified COA Board. Source. org Independentsector. org Guidestar. org Tech. Soup. org Form 990. org • • The Budget-Building Book for Nonprofits – Murray Dropkin and Bill La. Touce Financial Planning for Nonprofit Organizations – Jody Blazek Nonprofit Financial Planning Made Easy – Jody Blazek Available from amazon. com or Wiley. com • Capital depreciation reference – IRS Instructions for Form 4562 gives guidelines for how long to depreciate property.

Summary • A good budget process includes reporting and review of the budget as the year advances. Preparing a budget and then ignoring it is just a waste of time. • Remember the cash flow! • Numbers are your friends.