Alison Coleman 6 Mar 2019 03:43pm

What not-for-profits can teach business

Alison Coleman investigates what not-for-profits can teach business about managing a budget in the age of austerity

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Caption: Illustration by Cami Dobrin

In times of austerity, financial planning and budgeting at any organisation can be fraught. However, complexity around grants and funding, greater board demands, and generally smaller finance teams mean that those in charge of budgeting within the public and non-profit charity, community and cultural sectors face even greater demands, and higher stakes.

They have ambitious targets, public interest remits to fulfil, and increased demand for services, as well as reductions in some traditional funding bases. As a result many not-for-profit organisations have to be creative in seeking new funding and in making the most of the resources they have. And for private sector businesses with whittled-down budgets, there may be some lessons to learn from them. To make effective budgeting decisions in a climate of austerity, organisations in the not-for-profit sector need a detailed understanding of their income and cost base, as the challenges they face are often different to those that profit-making organisations contend with.

As Steve Harper, senior audit manager at chartered accountancy firm haysmacintyre explains, fund accounting presents a specific budgeting challenge for the not-for-profits. He says: “These organisations also have to consider how to manage financial volatility, with sudden increases and decreases in income. Specific income streams such as legacies, are unpredictable and can lead to significant fluctuations. Techniques that can be used to manage this include developing an approved wish list of projects that are ready to implement if sufficient funds are available, with the planned spending based on longer-term averages, and ‘excess’ funds set aside in one year to cover a potential shortfall in the next.

“Even relatively small not-forprofits have to develop a strong understanding of the risks they face to budget and manage risk effectively,” says Harper. “The risk assessment should inform the budgeting process and the terms of the reserves policy. When it comes to financial planning and budgeting, not-for-profits are often more advanced than comparably sized commercial organisations and in some cases can be more effective at managing their funds.”

An era of austerity measures in the UK has seen many public sector organisations face enormous budget cuts, and they are far more restricted than private sector organisations in terms of what they can do to manage the situation. A significant difference between the public and private sectors is that public sector entities receive annual budget control totals, annually managed expenditure (AME) and departmental expenditure limits (DEL), each divided into Resource and Capital, then further subdivided into cash and non-cash through the Parliamentary Supply process.

They do not have legal authority to exceed, even by a pound, any of those control totals. Consequently almost the whole focus of budgeting and in-year management is on spending control. If the overall budget is cut, or as is far more likely, just doesn’t grow at the same rate as expenditure, then the usual response in most departments is simply to reduce all sub-budgets proportionately.

The charity sector is huge and diverse, and the challenges of predicting and managing income streams can vary enormously. Some charities are reliant on donations, while others have contracts to deliver services that are renewed on an annual basis, so management of financial risk is critical. On the other hand an endowment charity or a charity with large trading subsidiaries, while never being complacent, can be reasonably confident about the level of income they will receive.

Jane Marshall, partner at chartered accountancy firm BHP and head of the firm’s specialist charity team, says: “For many charities the budget process is looked at bottom up, so they look at what it costs to carry out their charitable activities and then where the funding will come from to support this. “For example, some hospices receive less than 30% funding from the Clinical Commission Groups (CCGs) and have to raise the majority of their income each year from other sources. With cutbacks in government funding and an increasing number of charities competing for donations, legacies and grants from the same sources there has to be a focus on diversification of funding sources.”

Charities also need well-thoughtout reserves policies to allow them to continue if a funding stream dries up. Many are not in the fortunate position of having sufficient reserves, so if funding does reduce they may need to cut costs. In some cases this means frontline services have to be cut.

“The most successful charities are the ones that are able to react quickly to changing circumstances,” says Marshall. “Some fail because they don’t see the writing on the wall and don’t take those critical decisions soon enough.”

The charity sector is also much more regulated than many of the commercial sectors, and the level of complexity of accounts that a tiny charity has to prepare compared to big companies can be staggering.

However, one of the biggest challenges for many organisations in this sector is receiving funds that can only be spent on specific activities, as the funds have been restricted by the donor. Where a significant proportion of funds are restricted it can be challenging to simply cover core costs, including essential overheads, Gillian McKay, ICAEW’s head of charities, explains.

“For many charities this can include the finance, HR and IT functions,” she says. “Many are under pressure to skip on investing in those areas, because their funders can specify how much of their funding, if any, can go towards overheads,” she says.

“You could find yourself in the position of needing to invest a lot more in finance but simply not having the funds. The reality is that it is hard to get charitable work done without incurring some costs.” For some charities the differences between private and not-for-profit sector financial management are not as stark.

Finance, adult health and social care charity Making Space competes against other charities and some private sector organisations to win tenders to provide services. To that end, executive director Wyn Jones believes they face exactly the same challenges as a private provider. “The only difference is that we don’t have shareholders who require returns, so a charity should be able to continue to operate at a lower fee level,” he says.

“Charities also have the option to use reserves to subsidise service delivery, even where this does not make commercial sense, so charities may choose to run deficit-making services because this is in the best interest of service users, whereas a commercial organisation may choose to end service delivery on purely financial grounds.” While he doesn’t see a huge amount of difference between the third and private sectors in terms of their budgeting and financial planning processes, Jones believes the biggest difference is that charities have to consider what commercial organisations may view as unthinkable.

“Charities should always keep the best interests of service users in mind so may decide a service is best delivered by someone else even if this is at a financial detriment,” he says. In dealing with financial pressures, charities will see other charities and third sector organisations as potential collaborators as well as competitors.

Jones says: “For example, charities may look to share back office costs but will also look to work with partner organisations to deliver services at a lower cost or better quality than each charity could deliver independently.” In times of austerity, organisations in all sectors look to their finance teams and accountants to keep things running smoothly. Rick Smith, managing director of business recovery firm Forbes Burton, believes that those running businesses in the private sector have plenty to learn from the third sector, and advocates more cross-sector recruitment of financial professionals.

“Third sector organisations are well practised in cutting back costs in times of austerity and their budgets are more accountable as they can be open to public scrutiny,” he says. “Private businesses can be archaic and inflexible; often budgets are not updated quickly enough, even though they have greater resources and the ability to respond more quickly than a third sector business. They could benefit from hiring an accountant with third sector experience, someone who can look at a private business budget in a different way and identify areas where savings or adjustments can be made that might have otherwise been missed.”

Cultural sector case study: V&A Dundee

Securing funding can be a challenge for third sector organisations, particularly those in the cultural sector. So it was inspiring to see last September’s opening of Scotland’s first design museum, V&A Dundee, the first museum in the UK by architect Kengo Kuma, who is now designing the Tokyo 2020 Olympic stadium.

As an exciting new institution with a global profile, it has attracted a great deal of interest, but it came at a total design, construction and fit-out cost of £80.11m, requiring the most ambitious capital funding programme of its kind in Scotland. Barry Ferguson, director of philanthropy and partnerships at V&A Dundee, says: “We are not in London, where the vast majority of corporate and individual private funding still goes, or in the central belt of Scotland between Edinburgh and Glasgow, and there has never been a project on this scale in this area before. There is competition for limited funds and there can sometimes be a misunderstanding about how culture is funded. Most cultural bodies, V&A Dundee included, are charities that have to raise significant sums from private sources.”

The capital costs were met by support from several major funders. They include the Scottish government (£25m), Growth Accelerator Funding (£12.61m), Heritage Lottery Fund (£12.5m), egovernment (£5m), Creative Scotland (£4.5m), and Waterfront Dundee (£4m).

There was also a contribution of £10m from a fundraising campaign. The funding is split broadly into thirds, a third from public sector, a third from the museum’s commercial activity, and a third from private fundraising, including individuals, corporates and trusts. “The capital fundraising campaign achieved a record for a cultural project in Scotland,” says Ferguson.

“The biggest proportion of that, at over £6m, came from Dundee and the surrounding area, precisely because of where the project is based and the wider impacts on Dundee’s regeneration. There has been substantial national support too, given the profile and nature of the project.” The V&A Dundee has an ambitious but well-developed business plan covering the initial years of the museum’s operation.

“Funding needs are clearly an important element to this and programmes have to be tailored to our resources,” says Ferguson. “This means our fundraising team and the organisation more generally need to work hard to continue bringing in new supporters at all levels while ensuring existing funders stay on board.”