Which Budgeting Approach Is Right for Your Nonprofit?

A nonprofit budget should be more than a spreadsheet that gets approved by the board and then filed away.  A good budget is a financial plan that connects an organization’s mission, programs, staffing, fundraising and available resources.

But how do you actually build that budget?

There isn’t one right approach. Different budgeting methods can be useful depending on the organization’s size, circumstances and goals. In fact, most nonprofits use a combination of approaches rather than relying on a single method.

Here are five approaches worth understanding.

1. Prior-Year Actuals + Adjustments

This is one of the simplest and most common approaches.  Start with what the organization actually spent and received during the current year, rather than what it originally budgeted. Then make adjustments for what you expect to change.

For example:

• Salaries increase by 3%
• Insurance premiums are expected to increase
• A new program will add $50,000 of expenses
• A one-time expense from the current year will not recur
• Program participation is expected to increase
• A major grant will expire

The advantage is that you’re starting with what actually happened rather than an old budget that may no longer reflect reality.  The danger is assuming that because you spent it last year, you should spend it again next year.

This approach works particularly well for relatively stable organizations, but it should always be accompanied by a review of what is changing.

2. Incremental Budgeting

Incremental budgeting starts with an existing budget and adjusts it for the coming year.

For example:

Current budget: $2 million
Expected salary increases: +$60,000
Inflationary increases: +$40,000
New initiative: +$100,000
One-time expense eliminated: −$25,000

Proposed budget: $2.175 million

This approach is efficient and relatively easy to administer. It can work well when the organization is stable and the existing budget is reasonable.  But it has a weakness: it can perpetuate the past.  If a program was over-budgeted last year, incremental budgeting may simply carry that excess forward. If an expense is no longer necessary, it may remain in the budget because “that’s what we’ve always spent.”

A good budget process should therefore include the question:  Do we still need this, or are we simply continuing it because it was in last year’s budget?

3. Zero-Based Budgeting

Zero-based budgeting takes a very different approach.  Instead of starting with last year’s numbers, you start with zero and ask:  What do we need to accomplish our goals, and what will it cost?

Every significant expense is reconsidered.  For example, rather than automatically budgeting $75,000 for a fundraising event because that’s what was spent last year, the development team might determine:

• Expected attendance
• Venue requirements
• Food costs
• Marketing
• Technology
• Staffing
• Sponsorship strategy

and build the event budget from the ground up.

Zero-based budgeting can be particularly useful when an organization is:

• Restructuring
• Experiencing financial difficulty
• Adding or eliminating programs
• Trying to control costs
• Going through a significant strategic change

The downside is that it takes considerably more time.  And “zero-based” doesn’t necessarily mean that every single line item has to be rebuilt from scratch every year. It can be used selectively for areas where the organization needs a fresh look.

4. Program or Activity-Based Budgeting

This approach starts with the organization’s activities and goals rather than its accounting departments or expense accounts.  The question becomes: What are we trying to accomplish, and what resources will it take?

For example, a food pantry expects to serve 10,000 households next year.  The budget can be built around the resources required to do that:

• Food
• Program staff
• Transportation
• Warehouse space
• Technology
• Client assistance
• Administrative support

The budget becomes much more meaningful because it connects dollars to outcomes.   A donor may want to provide $100,000 to expand a program. Before accepting the gift, the organization should understand what it actually costs to deliver that program.  If the true cost is $125,000, the organization has a $25,000 funding gap.  The fundraiser may have secured a $100,000 gift, but the organization has not necessarily secured enough funding to accomplish what it promised.

5. Driver-Based Budgeting

Driver-based budgeting asks: What factors actually cause our revenue and expenses to change?  Instead of simply increasing expenses by 3%, identify the underlying drivers.

For example:

Childcare program – Number of children × cost per child = program costs

Food pantry – Number of households served × average cost per household = food costs

Fundraising event – Number of attendees × cost per attendee = event costs

Membership revenue – Number of members × average membership fee = revenue

This approach makes the budget easier to understand and easier to adjust.  If the food pantry expects to serve 15% more households, the budget can reflect the expected impact on food, transportation, staffing and other costs.  Instead of saying, “Food expense is increasing 15%,” you can explain why.

So Which Approach Should You Use?

The answer is usually: more than one.

A nonprofit might use prior-year actuals as the starting point for routine expenses, zero-based budgeting for a new program, driver-based budgeting for program costs and activity-based budgeting for major initiatives.  The most effective budgeting process combines these approaches with the organization’s strategic priorities.

Think about the process this way:

Strategic priorities

What are we trying to accomplish?

What resources will we need?

What will those resources cost?

What revenue can we realistically generate?

What’s the resulting surplus or deficit?

What choices do we need to make?

That last step is important.  A budget isn’t finished when the numbers balance. If expected expenses exceed realistic revenue, the organization has decisions to make. It may need to increase fundraising, reduce expenses, modify programs, use reserves or reconsider its priorities.  Simply making the spreadsheet balance doesn’t solve the underlying problem.

Where Fundraisers Fit

Fundraisers are an important part of this process because revenue assumptions are just as important as expense assumptions.  If the organization budgets $2 million of fundraising revenue, there needs to be a realistic plan behind that number.

How many major gifts are expected?

What is the grant pipeline?

What is the donor retention rate?

How many new donors are needed?

What will events generate?

What will corporate partnerships produce?

And perhaps most importantly:  What resources will it take to raise that money?

Staff time is one of the most overlooked costs of fundraising. An event might generate $100,000 after direct expenses, but if staff spend hundreds of hours planning, soliciting sponsors, coordinating volunteers, managing the event and stewarding donors afterward, that time is an important organizational resource.

The goal isn’t necessarily to eliminate those costs. The goal is to understand the return on the organization’s investment of money and staff capacity.

A Budget Is a Set of Choices

Ultimately, budgeting isn’t about finding the right formula.  It’s about making informed choices.

Prior-year actuals help us understand where we’ve been.

Incremental budgeting helps us adjust for what’s changing.

Zero-based budgeting challenges what we’ve always done.

Program-based budgeting connects resources to mission.

Driver-based budgeting helps us understand what causes revenue and expenses to change.

The strongest nonprofit budgets use the approach, or combination of approaches, that best fits the organization’s circumstances.  And perhaps the most important principle is this:

A budget should tell the story of what the organization intends to accomplish, the resources required to accomplish it, and how it plans to pay for those resources.

When finance, program leadership and fundraising work together to build that story, the budget becomes much more than a financial document. It becomes a tool for making better decisions about the organization’s mission.