Budgeting for nonprofits is never a simple exercise. Uncertainty about government funding, rising costs, and other economic factors beyond your control only complicate matters. But organizations that use scenario planning as part of their regular budgeting process can increase their odds of making the right decisions — and promptly responding if conditions later shift. Here’s what you need to know to include scenario planning in this year’s budget decisions.

What is it?

Scenario planning is a type of financial modeling that provides nonprofit leaders with valuable guidance during evolving circumstances. It simulates how various assumptions are likely to play out. Nonprofit leaders make the ultimate budget decisions, yet scenario planning gives other stakeholders input.

Members of your board finance committee, your executive director and finance and accounting staff are obvious participants. You’d be wise, too, to include some staff members who are in the daily trenches working with clients and donors. They may notice impending issues that will affect finances long before those higher up in the org chart will.

How do you construct scenarios?

Participants construct budgets for multiple operational scenarios to ensure your nonprofit can cover projected expenses. There’s no rule of thumb for the number of scenarios you should consider. But many organizations use three: best-case, worst-case and most likely scenarios. The variables that change among the scenarios should reflect a handful of factors most likely to affect your revenues and expenses (such as a significant drop in funding levels or a jump in demand for services).

A best-case scenario, for example, might assume a highly successful fundraising campaign, favorable replies to all grant applications and a large gift from a major donor. A worst-case scenario might assume loss of all government funding, a substantial economic downturn and the departure of your long-time development director. The most likely scenario or “base case,” is essentially a regular annual budget based on historical trends, confirmed grants and similar factors.

For each scenario, you’ll determine the impact on the underlying budgetary assumptions. You can also identify indicators that trouble might be brewing and metrics that suggest it’s time to re-evaluate and adjust (for instance, a 5% increase in operating expenses or a 10% drop in corporate giving).

What do you do with the results?

From there, you can begin to brainstorm the types of measures you might implement in response — such as increasing annual dues or delaying a planned technological upgrade. You’ll also want to test these assumptions for viability and effectiveness. The last thing you want is to discover in the middle of your budgetary period that your plan is inadequate.

Once you’ve determined the optimal response to a particular scenario, you can develop an appropriate budget for it. This gives the ultimate decision-makers a wealth of information from which to develop the budget’s final figures.

Why use modeling?

Scenario planning may seem like an added layer of budgeting burden for resource-strapped nonprofits. However, it facilitates more informed decision-making and long-term strategic planning. Rather than risk being driven by overblown fears or misplaced optimism, your decisions will be grounded in reality.

Moreover, scenario planning can be persuasive when making your case to those who hold the purse strings, reassuring stakeholders that you’re keeping your eye on the horizon and preparing action plans for different developments. For example, if rising costs or loss of a major donor threaten operations, you’ll be able to respond with greater agility.

Your nonprofit likely has an operating reserve fund. So you might think you’re already prepared to handle financial emergencies. Scenario planning, however, is different. It positions you to act from a solid, thought-out foundation rather than react haphazardly.

Getting started

If you’re just beginning to explore scenario planning, you don’t need to go it alone. We can help you, your executives, and your board identify appropriate scenarios, develop and validate response plans, and craft budgets that will support them.

Sidebar: Another useful tool: Rolling forecasts

Like scenario planning (see main article), cash flow forecasting should be an integral part of your budgeting process. Some nonprofits handcuff themselves by using traditional forecasts that cover only the budget year. These static forecasts can become outdated quickly. Organizations that instead opt for a dynamic rolling forecast typically have a better handle on funding their organization’s operations.

Built on real-time data, rolling forecasts are generally more reliable than static forecasts. As conditions change, budget figures are revised, typically at the end of each interim period within a year (monthly or quarterly). As each interim period expires, a new and equal period is tacked on to the end of the cash flow forecast.

For example, when October 2027 ends, October 2028 is added to the annual forecast. At that point, figures for the entire year can be revised to account for current information, including changes in economic conditions, funding, demand and other factors.