FINANCIAL REPORTING

Forecasting

Inevitably, as the year progresses, things will happen that your budget did not predict. Of course, there are always funding cuts and unanticipated expenses to worry about, but you might receive a “bank error in your favor,” like a bequest or other large donation, or an increase in third party insurance billing rates. As the actuals diverge from the budget, you will want to consider modifying your income statement presentation either by revising the budget or adding a forecast.

REVISED BUDGET VERSUS FORECAST

A revised budget replaces the original budget, reflecting the information that has become available since the original budget was approved. A revised budget may be called for if an event occurs early in the year that significantly impacts revenues and/or expenses. For example, an organization I worked for was once awarded a $1 million grant late in the year that was for the subsequent year—too late to include in the budget that had already been approved by the board. In this instance there was no question that we would start working on a revised budget on January 2. Once completed and approved the revised budget will replace the original budget on the financial statements.

Like the original budget, the revised budget is a static document; it functions like the original budget in that:

  • It is a plan based on the best available data at the time of preparation.
  • Its purpose is to track performance based on past events.
  • It does not respond to new events as they occur.
  • The process to create it is similar to the original process, and will require board approval.

In my example, preparation of a traditional revised budget was needed, but more typically, changes to the budget assumptions occur gradually, and the variances in the budget-to-actual reports pile up as the months go by. By the time you are halfway through the year, board and management are primarily interested in predicting how the year will end. A year-end forecast incorporates revised budget data, but by combining revised budget data with actual data it becomes a powerful tool whose purpose is to predict the future rather than set a benchmark for performance. The forecast does not replace the budget, but is provided on the financial statements to provide insight into the year’s financial activity as it unfolds.

The essential components of a forecast calculation are year-to-date (YTD) actual numbers as of the most recent closed month, and revised budget numbers for the remainder of the year. A forecast prepared after June has closed would combine six months of actuals and six months of revised budget.

A year-end forecast is superior to a revised budget because it reflects what actually happened (actual data) and it reflects new information (revised budget data) about the remainder of the year. Each time the forecast is prepared the percentage of actual data embedded in the report increases. The revised budget component is also improved because the further we get into the year the more we know about what is going to happen.

In Budget Variance Analysis Example 4 we looked at Farm Haven’s (FH) animal care program and its six-month budget-to-actual report along with proposed strategies for addressing the variances from budget. Now let’s add a forecast calculation worksheet and see how it provides additional insight and guidance.

In Budget Variance Analysis we showed how budget variance analysis informs the reader of the program’s progress in following the plan that the budget laid out before the year began. The forecast in Example 5 above builds on the budget-to-actual data as of June 30 to provide a realistic estimate of revenues, expenses and bottom line for the entire year. The forecast is predicting a deficit of $168,923, close to the actual deficit of $172,610 shown in The Income Statement Example 2), and significantly higher than the budgeted deficit of $146,327. (Budget Variance Analysis Example 4).

Preparing a forecast can be time consuming. An organization with many programs may not have the resources to manually prepare and maintain worksheets such as Example 5 above for every program. For some, a software product specializing in budgeting, reporting, and forecasting may be a worthwhile investment. With only two programs, Farm Haven may be able to prepare forecasts by program at least quarterly.

Why go to the additional trouble of forecasting?

  • To keep board and management informed. The forecast column in Example 5 above is added to the budget-to-actual report. The board will continue to monitor performance against the budget, but the forecast answers the all-important question: “How will we end the year?”
  • To build on variance analysis. Variance analysis tells us the good and bad news, but forecasting takes us to the next step of predicting the effect of the variances. As numbers are plugged into the “budget revision” column, their effect on the estimated year-end bottom line is calculated.
  • To facilitate year-end purchasing. Although FH’s animal care program is looking at deficits, nonprofits surprisingly often find themselves with surpluses, either from unexpected revenues or underspending. Let’s assume that in a different year the September’s year-end forecast is predicting a surplus due to underspending of salaries. FH would like to purchase replacement computer equipment. By this time the forecast will be founded on nine months of actual data. With only three months left to guess at the unknown, FH should have a good idea of the amount available to spend, and has time to contact the funder, if necessary, for permission to reallocate expenses from the personnel line to the equipment line. In my book, assessing computer equipment replacement needs and placing the order in November is far superior to the mad dash to the office supply store on New Year’s Eve to spend up unused grant funding.

TO CONCLUDE

Forecasting is a powerful governance tool that benefits nonprofits of every size. When I was working with a $20 million budget, my team used sophisticated (and expensive) software and we spent many hours each month maintaining the forecast. Now, in my retirement, I am treasurer for a $20,000 community orchestra. The hour I spend each month manually updating the forecast spreadsheet gives the board a level of comfort that they appreciate.