Making Your Budget the Backbone of Your Nonprofit - Part 4
What is Below-the-Line Budgeting?
Below-the-line budgeting is a tool that nonprofit leaders can use to address the full cost of operating their organizations. More specifically, leaders can use below-the-line budgeting to:
- segregate non-operating revenue and expense for better communication and planning;
- address balance-sheet needs; and
- communicate how surpluses would be used intentionally to invest back into the organization.
As we explore best practices in budgeting, we’ll be using a case study to illustrate real-life numbers and scenarios: Hope Through Housing (HTH). A nonprofit dedicated to providing food, clothing, mentorship, and job opportunities to young people in Philadelphia, HTH was founded on the belief that everyone deserves an equitable chance in life. Jordan Johnson, Founder and Executive Director of HTH, continues to explore new ways for HTH to better support youth in actualizing their dreams.
As we all know, life throws curveballs, and the necessity of being able to offer uninterrupted services is never lost on organizations like our case study, HTH. This is why it’s so important to have a longer-term mindset when it comes to budgeting.
To explore how to use below-the-line budgeting, let’s first look at the concept of full cost and help Jordan identify some of her longer-term balance sheet needs.
What do we mean by "full cost"?
Full costs include day-to-day operating expenses (both program and overhead expenses) plus a range of balance sheet costs for both short- and longer-term needs. Nonprofits need to budget surpluses large enough to (re)invest in the organization’s immediate and future health.
I’ll rewind to several questions that came up after Jordan Johnson, our fearless leader at HTH, presented her budget to the treasurer. “How are we going to build reserves for the future? Can we do this through the annual budgeting process?”
To begin the conversation, I proceeded to ask her a few questions that you could also ask yourselves:
- Do you have any debt that you need to pay off?
- This would include debt owed to banks, board members, and other creditors that has not been paid back on a timely basis. In addition, I have also worked with organizations where – on more than one occasion — the Executive Director had temporarily foregone taking a salary, which could also be considered a debt owed. The goal is to identify a plan to intentionally pay all creditors back.
- Do you have fixed assets that need to be repaired or replaced during the coming year? Or would you like to set aside an amount in a fixed asset/equipment reserve?
- This could be replacing old computer equipment or making leasehold improvements.
- Would you like to purchase or invest in new fixed assets?
- This might include the purchase of an automobile or van, furniture, or other equipment.
- How much would you like to set aside in savings this year and subsequent years?
- All organizations should come up with an amount that they would like to set aside each year.
Please note, while you will not find any of the above items in your annual operating budget, they are very important to include in the annual budget that the board will approve. One idea that we advocate is to incorporate a Non-Operating Section below the operating surplus/deficit line. This is the area we call “below-the-line.” The idea is to project an operating surplus large enough to contribute to – or pay for – all your organization’s longer-term financial items. You will see in the graphic below that I have inserted a Non-Operating Section at the bottom of HTH’s budget that includes the following line items:
- Pay back of debt principal
- Repairs/replacement of fixed assets and/or addition to equipment reserves
- New fixed asset purchases
- Set aside for savings
When nonprofits budget for their full costs and communicate their full capital needs to funders, they put themselves in a better position to avoid crises and provide uninterrupted services for their communities. Covering full costs (as both a nonprofit budgeting practice and a philanthropic strategy) will allow leadership to stay focused on mission and outcomes.
In addition, it may be helpful to include some revenue below-the-line as well. For budgeting purposes, we want to be able to predict and count on reliable, recurring operating revenue. Sometimes when we receive a larger, one-time donation, if we leave it in operating revenue (above the line), stakeholders may mistakenly believe that, once there, it will always be repeated. For example, let’s say that Jordan receives word that HTH will receive a bequest of $100,000. This is something she could consider including below-the-line in the Non-Operating Section. Why? This is a significant gift to HTH, representing more than 10% of total revenue, and we don’t want stakeholders to assume that this gift will be repeated in the future. Please note, however, that being placed below-the-line does not mean that a larger, one-time grant or donation cannot be spent on operating expenses — that is, as long as it’s received without restrictions.
It should also be noted that some organizations raise money through planned-giving programs, the core of which could be a simple bequest program. In this case, that planned-giving program is considered an essential part of the organization’s business model, and as such, any bequest coming in under this intentional program would be included in operating revenue, above the line.
On the other hand, I encouraged Jordan to include a small $2,000 one-time donation that she anticipates receiving in operating revenue. While it is one-time in nature, $2,000 does not meaningfully add to HTH’s overall budget.
However you decide to categorize this revenue, be consistent. Here are some other one-time revenue categories that we suggested Jordan consider segregating:
- Capital grants (e.g., a $15,000 grant for the purchase of a van; see the example in the graphic above)
- Bequest(s), if you do not have a planned-giving program
- Large, one-time special grants/donations
While Jordan felt pretty good about her budget this year, like many of you, she is uncertain about the years to come. In particular, she sometimes finds it really challenging to forecast contributed revenue. So, she asked, “Does NFF have any tips on forecasting contributed revenue?”
*Note, all names of people and organizations are fictitious and any resemblance to others is purely coincidental.
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