Better Financial Decision-Making with a Monthly Cash Flow Projection

Many nonprofit leaders equate financial decision-making with passing an annual budget.  The idea is that once the budget is passed, their job is just to implement. Unfortunately, this breaks down when the expectations and assumptions underlying the budget turn out to be inaccurate or incomplete. Ongoing financial choices requires another tool—the Monthly Cash Flow Projection.  

The Monthly Cash Flow Projection (“MCFP”) brings the budget, available financial information and the latest assumptions together in a single document to support effective decision-making. A model MCFP (available to download) and a brief explanation of the how it works can be found here.

The Budget Is Only the Starting Point.

Here’s an example: Our annual budget authorizes the hire of a program manager to start July 1 at an annual salary of $50,000. The budget projects that we’ll be receiving a $25,000 grant from a foundation that has supported this work in past years, and that our annual gala will be bringing in 15% more than usual. In April, we learn that the foundation has a new ED who is reviewing all long term grant relationships before authorizing any new funding. In May, we learn that the annual gala is tracking advanced commitments about 15% below the previous year. Nothing in the budget requires us to change our plans, but given this new information, should we really go forward with the hire on July 1?  

The budget answers the question, “what are we allowed to do,” but it’s less helpful with the just as important question of “what should we do”—

• The annual budget shows total income and total expense over the course of the full year, so that the numbers tally as of the end of the year. But financial decisions must factor in the ups and downs of getting there. Monthly income and expenses won’t  balance the same way that they do on an annual basis.    

• Most budgets are based in accrual accounting, so they often reflect income that is recognized well in advance of when it’s collected. This can be a particular issue for a variety of nonprofits, including those that generate significant income from reimbursement contracts, for which they’re paid after—sometimes many months after—expenses have to be paid.

• New information will come in, but the budget remains static. To the extent this new information undermines the expectations in the budget, following the budget is not likely to result in appropriate financial decisions.

The MCFP takes it from there.

For some nonprofits, the path laid down in the budget is enough. For those with highly predictable income and expenses and with substantial cash reserves, the choices made in the budget may not require adjustment as events unfold. Larger nonprofits will track cash flow, but will be reluctant to adjust financial decision-making from budgeted expectations because of the many challenges of managing those adjustments effectively.  

For nonprofits that experience income volatility, that are growing or shrinking, that must assess new opportunities and that aren’t sitting on a comfortable nest egg, that have to adjust to a changing world—the MCFP can be indispensable:  

Adapt. The fundamental value of the MCFP is to ensure that the organization’s fiscal path continues to make sense, to identify if and when it no longer does, and then to assist in figuring out what the alternatives might look like. Decisions about whether or not to diverge from budgeted plans may not always be primarily financial choices, but they should always be informed by financial implications. The MCFP enables this understanding.

Focus on cash. Accrual accounting ignores when exactly cash arrives or goes out the door in favor of a set of clear rules around when income and expense are incurred. This improves the reliability of longer term financial measures and supports stronger accountability. But if you don’t have the cash, you can’t spend it. And if you don’t know in advance whether or not you’re going to have the cash, you may be facing a big problem.  

Model scenarios. Financial decision-making requires sorting through a number of “what if”s. What if we delay the hire from July 1 to October 1? What if we hire a more junior position at 60% of the salary? What if the gala looks like it will generate 5% less than anticipated? The MCFP can test how these inter-relate and assess their combined impact on available cash. Just be sure to keep a single “master” MCFP that incorporates the organization’s official projections.   

More Inclusive Decision-making. Too often management teams are ill-equipped to participate in financial decision-making because they lack the access to—or understanding of—underlying information and assumptions that the MCFP can provide. Decision quality suffers without their valuable input. 

Promoting Alignment. Financial decisions best support successful organizational management when they are tied to the budget, appropriate under the circumstances and transparent. The MCFP can facilitate this transparency when it is used not just as a decision-making tool, but also to support internal communications, particularly with the Board and with staff (depending on the audience, it may be appropriate to eliminate some of the granularity). 

Stepping Lightly Into the Weeds.  

Each organization will have its own approach to using a MCFP, but most will have to address a couple of the same issues:

Starting amount. While the cash available at the beginning of the year cannot exceed the organization’s total cash, Cash Available Jan 1 can be set somewhat lower in order to maintain an emergency reserve. The choice of whether to separate the reserve from the starting amount will be grounded in the organization’s approach to risk and the ongoing role of the Board in financial management.   

Restricted funds. The interaction of restricted funds and cash flow management can be complicated. Often, restricted funds will not be available to be spent during the year in which they are received and/or they will require that unbudgeted expenses be incurred. In general, only funds that can be spent in the current year should be included in the MCFP. (Four Flavors of Restricted Funds describes the significance of these funds based on what expenses they’re able to cover.) 

There are a host of factors that contribute to financial decision-making being difficult and stressful.  Not all of them will be addressed by using a Monthly Cash Flow Projection. But it might be a good place to start.

Again, here is the link to download my Monthly Cash Flow Projection Spreadsheet.