Changing charity financial leadership strategies
A recent report from the Charities Aid Foundation and the Association of Chief Executives of Voluntary Organisations, Social Landscape: The state of charities and social enterprises in 2015, found that the most pressing challenge for charities is generating income and achieving financial sustainability.
This is then a time for outstanding financial leadership and charities should be able to look to their treasurers and finance teams to contribute to the success of the organisation. Below we will consider the financial leader’s contribution to financial sustainability
Decisions on how to allocate resources are some of the most difficult decisions facing any organisation. For charities, this can mean rationing resources for some beneficiaries while they spend money on building a new IT system – not a palatable choice, but possibly necessary to improve services in the future. So how does a charity make such decisions?
Typically, the annual budget round is how charities make their resource allocation decisions. Managers put together activity plans based on the strategy and cost them.
The role of the finance team may be no more than “adding up” – putting all the budgets together to see what the whole organisational budget would look like. If the total budgeted expenditure is more than anticipated income, then managers are asked to "think again" or arbitrary cuts are imposed.
There are obviously quite a few problems with this approach. Elements of traditional budgeting are fine and necessary – such as costing an activity or a plan. But aspects of the overall organisational budget contain fundamental flaws which financial leaders can address. Thought leaders Hope and Fraser addressed these in their book, Beyond Budgeting: How to Break Free of the Annual Performance Trap, and charity financial leaders can learn much from their case studies and examples.
Whose money is it anyway?
The annual budgeting process encourages a “spend it or lose it” mindset among managers and staff. They consider an allocated budget to be “their” money and will spend it even if the indicators are showing that the activity is not necessarily the best way to achieve the desired outcomes or that strategic priorities need to change in the context of the external environment.
We can see this at the end of every financial year – expenditure is always higher in the last quarter as managers try to use up unspent budgets. While this behaviour is understandable – you may have a cut in the budget the following year if you seem to not need it all - it is encouraging waste.
Why on an annual basis?
Financially, we need to change our approach to allocating resources once a year. This is too inflexible and commits us too far in advance. When your outside environment is evolving and constantly throwing up new challenges, what is the value of a budgeting system that sets rigid targets for the next year to eighteen months? A better approach to allocating resources is to regularly review the resources needed, consider the risks and external environment, and release the resources as they are needed.
In order to undertake regular resource allocation decisions, charities need the right information. This will include forward looking financial information based on up to date actuals and best estimates of future incoming and outgoing resources. Charitiess also need to consider the risks attached to those forecasts. While some elements of the forecast may be fairly certain, other aspects may carry a higher degree of risk. Factor the risks into the appraisal of the resources likely to be available.
Traditional management accounts tend to produce historic accounting information, comparing this to the budget prepared many months ago. The budget is used as a way of expressing expectations and then success is measured by whether the actual results are close to expectation. There are a number of problems with this approach:
- This focuses on “inputs”. Spending the expected amount of money is not actually a measure of success. We are surely more interested in the outputs and outcomes of our activity if we wish to measure success.
- The expectation may have been based on a false premise – in other words the budget was wrong.
- The approach usually assumes that what was done before was acceptable or successful, as budgets tend to build on the previous year´s budget and accounts. It is often taken for granted that core elements of a service will be retained and budget decisions focus on incremental changes. For example, the staffing element of a department’s budget will be a “given”, and discussion revolves around the relatively small amount of the budget that is spent buying in goods or services.
- Ideally, and indeed increasingly so, charities (well, larger charities) have well developed and embedded staff appraisal systems which set and review non-financial performance targets for individuals. They may also have strategic planning systems, with clearly defined objectives, targets and indicators. These systems will be undermined if there is a continuance of a culture that emphasises hitting the budget as the real way in which performance is judged.
- Charities may therefore be giving staff and managers contradictory messages about performance expectations.
Performance targets can help a charity to focus its efforts and achieve desired outcomes. In order for target setting to work, the targets do need to be accepted by the staff teams working towards them. Absolute targets (such as raise £500,000 from legacies this year) can be perceived as too difficult to attain, particularly if imposed on a team, with the result that they are demotivating in their effect. On the other hand, absolute targets can be too easy, such that the manager will “cruise” – just meeting the target but doing no more.
Adaptive performance management methods use relative targets so that you maximise the results given the environment in which you are working. A relative target might ask a team to improve on the results they achieved in a previous period. It might also benchmark against other organisations in a similar field and take into account the general climate in which your charity is working.
Cost control objective
Budgets are also seen as a method of controlling costs, but this is unlikely to be achieved, given "spend it or lose it" mindsets and the sense that a good performance is to come in close to budget. In fact, an expenditure budget is often seen as a floor rather than a ceiling to the level of expenditure. Managers will try to ensure that they spend their whole budget.
This tendency is exacerbated in charities because of restricted funding and project budgets. The legal requirement to return unspent restricted funds incentivises charities to spend all the allocated funds whether they are needed or not.
The annual budgeting round also sets an expectation in managers’ minds that they are likely to be asked to reduce their proposed expenditure at some point. Quite rationally, they therefore inflate initial expenditure proposals – they "bid to be safe". So the initial budget the finance team creates from these initial proposals is grossly inflated. So apparent "cost savings" are nothing of the sort – they merely reduce the planned expenditure to a more likely scenario.
The current behaviour of managers is completely rational and to change the behaviour, you have to change the rules.
What should the rules be?
Organisations would have implemented changes in this area understand that they have to make a cultural shift. You need to stop rewarding "spend it or lose it" behaviour and instead make heroes of colleagues who voluntarily offer expenditure budgets to others because they realise they do not need it. Swedish companies are particular experts in this area and reward managers who are thrifty. Performance is measured by outputs, outcomes and results – particularly in terms of the benefits and gains to service users or beneficiaries.
Role of the financial leader
A financial leader will recognise the cultural issues arising from traditional ways of budgeting and reporting financial performance and work with colleagues to express plans and outcomes in ways that incentivise all staff to act in the interests of the charity and its beneficiaries.