One of the board’s primary roles is to direct the organization. The main way that the board can direct the organization’s financial performance is by setting budget parameters before the management team and staff even start budgeting for the coming fiscal year.
The first step in an ideal annual budget process is for the board to determine what financial performance is desired in the next fiscal year. The board might select 3 to 10 financial statement elements or financial performance indicators that it believes to be critical to the organization’s success, and indicate what those numbers should be. Some examples are:
Gross Revenue ≥$5,000,000
Net Income ≥10% of Gross Revenue
Administrative Salaries and Benefits ≤$400,000
Gross Margin ≥30% of Gross Revenue
Capital Purchases ≤ $60,000
Debt to Equity Ratio 1.5:1 to 2.5:1
Return on Equity ≥12%
The appropriate numbers depend on many variables such as the industry, the size of the organization, the organization’s mission and goals, and the risks investors are willing to take. As the senior decision maker of the organization, the board has the job of wrestling with the realities of the organization’s current situation and the business environment in which it functions, and determining which financial parameters will most likely move the organization towards its goals. This work can be done most effectively when the CEO and CFO are available to answer board members’ questions on current financial strengths and weaknesses and operational realities.
When the board has decided on the specific financial expectations for the next year, it provides these parameters to the CEO. The CEO then tasks the CFO and the senior management team with developing a detailed budget that aligns with these budget parameters. If the first detailed budget doesn’t satisfy all of the parameters, it is the job of management to explore ways of changing operations to bring the numbers in line.
Once management has completed an operational budget that senior staff believe is doable, allows the organization to achieve its goals, and is aligned with the budget parameters, it is presented to the board. After reviewing the budget to assure that all the budget parameters have been met, the board simply passes a motion such as “The 20XX budget satisfies all of the board’s budget parameters.” The board is noting in its meeting minutes that an appropriate budget is in place but is not approving each line item. The board will hold management accountable to staying within the budget parameters, but management has the authority to adjust line items as the year progresses. For example, the organization may spend more on telecommunications if it will offset that by spending less on printing and postage, as long as net income meets the board-set parameter.
The board has directed the organization’s finances for the year and monitored that the CEO has a plan to work within board direction to fulfill the organization’s mission and goals.