The Core Funding Approach—For Better Financial Management
Restricted income is the lifeblood of many nonprofits. Smart organizations steward that income carefully, making sure that funds are allocated only to appropriate expenses. Knowing whether funds are restricted or unrestricted is a critical accounting distinction. But from a financial management perspective, that distinction is far less meaningful and may even be confusing. As previously discussed, restricted funds can have entirely different financial impacts, depending on when they can be spent, what they can be spent on, and how that conforms to budgeted expectations.
The core funding approach addresses challenges created by restricted fund accounting by downplaying the distinction between restricted and unrestricted funds. Rather, it emphasizes whether income is available to meet budgeted expenses or must be used for other purposes.
For any budget year, budgeted core expenses are equivalent to total budgeted expenses. These include both program and overhead expenses whether or not those overhead expenses are allocable to programs.
Actual core expenses consist of all overhead expenses and all budgeted program expenses that are incurred during a financial period. To ensure an accurate assessment of actual core expenses, only program expenses specifically identified in the budget are considered core expenses, even if other program expenses are “substituted” during the course of the year.
Budgeted core income is equivalent to budgeted core expenses. It consists of two parts:
a) The carry-over, which is the sum of funds accrued in prior years and available to fund budgeted expenses in the current year.
b) The core income requirement, which is the balance to be raised during the budget year.
The core income requirement may differ from income projections in the budget since the budget may anticipate either a net gain or loss for the year.
Actual core income will be the sum of the carry-over and income acquired during the budget year that is either (i) unrestricted or (ii) restricted and available to cover budgeted core expenses.
Unbudgeted expenses incurred during the fiscal year and funds raised either to cover those expenses or for use during subsequent periods are both considered non-core. The portion of income for unbudgeted programmatic work during a budgeted year that is allocable to G&A (and so covering budgeted costs) is core funding.
Benefits of the Core Funding Approach
In a for-profit business or in a nonprofit that does not utilize restricted funds, it can be relatively easy to understand the relationship between income and expenses during a fiscal period. Understanding that relationship is essential to strong financial management. For nonprofits with restricted funds, the core funding approach can help:
Enhance the utility of the budget. All too often, a nonprofit budget is like a shiny new car, losing value even as you drive it off the lot. In a rapidly changing, uncertain environment, a budget can quickly become obsolete—sometimes before the fiscal year is even underway!
That’s unfortunate, because the budgeting process is a critical moment of alignment, where Board and staff agree on a united path forward. A good budget links programmatic aspirations to allocations of resources. Approval of that budget affirms a shared understanding that certain work will be done and a shared belief that adequate funds can be raised to support that work.
The core funding approach helps keep the specific work that the budget anticipates front and center. It maintains clarity throughout the fiscal year both about what was planned and what changed. In particular, the complexity that results from the acquisition and expenditure of restricted funds is substantially reduced. The idea here is not that things shouldn’t change—opportunities should be seized and plans going nowhere should rightfully be scuttled. Rigid adherence to the budget may or may not be a good thing. But clarity about the degree of adherence means that changes can be both more intentional and transparent. Among other benefits, the core funding approach:
Honors the shared expectations established by the budget and provides greater accountability to those expectations.
Clarifies organizational priorities and performance against these.
Provides a clearer view of the effectiveness of the planning process.
Enhances a nonprofit’s ability to learn from its results, to plan more effective strategies, make improved forecasts and understand its fiscal environment.
Alignment on income goals. Looking at core and non-core funding rather than restricted and unrestricted funds offers a better approach to an often difficult problem—how to ensure the Development team is focused on raising the funds that are most critical to the organization. Defining fundraising needs in terms of core funding aligns the Development efforts explicitly with the work that your organization aspires to do. Success in raising the core income requirement will result in the nonprofit being able to fund its planned programmatic work.
Of course, the Development team should alsoreach for non-core funding. Good things come from exploring non-core funding possibilities. And non-core funding this year can be next year’s core funding. But there can be no doubt that the priority must be to secure core funding.
I’ve never met a Development Director that wasn’t passionate about meeting income goals. It is absolutely critical that the goals we set are the right ones. The core funding approach enables this.
Better Decision-Making. Closely related to a more useful budget and better alignment on income goals is the potential to strengthen organizational decision-making. The core funding approach is intended to make understanding and communicating about essential financial information easier. That underlying clarity supports better discussions about risks and opportunities, hopes and fears. That clarity contributes to accountability for choices that are made and for learning after the fact.
The core/non-core distinction is not important to every organization. Those funded primarily with unrestricted funds and/or with adequate unrestricted reserves may not particularly benefit from the perspective this approach provides. For the rest of us, though, this may prove to be a helpful financial approach. Try it and let me know how it works for you.