Posts tagged with "financial sustainability"

Sustainability to Survivability: 5 Nonprofit Finance Must-Do’s in the Time of COVID

In the nonprofit sector, the fragility of life is always very present. Likewise, for nonprofit leaders, the fragility of our organizations is also always present. Fears of an impending recession and the decline in the percentages of individuals donating to nonprofits have made the sustainability of organizations a top concern for executive directors for quite some time. But none of us expected the sudden disruption of our lives and society brought on by a pandemic.

As nonprofit professionals scramble to devise new operating plans designed to serve as many as possible while protecting and caring for employees, the thought of sustainability seems almost quaint. All revenue streams, from foundations to individuals and even fees for service, are under extreme pressure. Indeed, for many executives, thoughts today are not on sustainability but survivability—and, as always, it is at these times our constituents need us most.

The initial steps to respond to the pandemic have varied by type of organization with the focus, rightly so, being on humanity—serving our clients—as well as safety and protection. Arts and culture organizations, educational institutions, and other community organizations have closed their doors for extended periods while several social service organizations continue to operate, balancing constituent service with social distancing. One constant across the sector has been the cancelling of spring fundraising events and the upheaval of development plans. As organizations struggle to maintain operations, payrolls, or both while revenue is decreasing, there are steps they can take to increase likelihood of success:

  • Understand your cash position.
  • Assess damage to revenue streams.
  • Look at the dual bottom line.
  • Include everyone in the discussion.
  • Communicate consistently.
Understand Your Cash Position

Cash is king. With expenses continuing and revenue on hold, knowing your cash position serves as a foundation for action. Certain common ratios like the quick ratio or current ratio calculate whether the organization has enough cash to pay its bills today, but they don’t provide guidance on how long it can weather this disruption. The best ratios for that help with understanding your liquid reserves:

This ratio calculates how many months of savings the organization has if it operates at its current rate and receives no additional income. The numerator subtracts restricted cash and receivables, assuming the organization will not be able to perform the work necessary to release those revenues. The denominator is simply the annual budgeted expenses divided by 12 months.

This is the purest form of a reserve. It allows leadership to understand how much time they have to stabilize the organization. For many organizations, this is somewhere between two weeks and four months.

For organizations that have ceased operations but are committed to maintain payroll as long as possible, a separate calculation that only includes essential expenses such as payroll, health insurance and occupancy-related costs in the denominator may be useful:

This formula lets leadership see how long their current position allows them to maintain these basic expenses. In this ratio we have excluded receivables, but they can be included if the organization believes there is a high likelihood of collecting them.

These formulas are the simplest way of calculating and monitoring the organization’s savings. A more strategic approach would be to prepare or update the organization’s cash flow projections for the next six months showing expected inflows and outflows of cash. With the ratios as a foundation and the cash flow projection as a tool, leadership can work with the board to build out scenarios if they have time. At the very least, leadership can monitor the urgency of the situation and make informed decisions about how to continue.

Assess Revenue Streams and Damage

The formulas above focus on the organization’s expense side, assuming no additional income. Attention should also be paid to revenue. Many foundations are attempting to continue grantmaking, and many local government agencies are seeking to fund expanded social service activities for vulnerable populations with emergency dollars. Therefore, revenue projections based on the updated development plans and budget, which take into consideration our new reality, can be inputted into the cash flow projection for a more realistic picture. While it is conservative to assume your organization will not receive any new income, acting on a worst-case scenario does not necessarily lead to strategic or beneficial decision-making.

Revisiting revenue streams also allows leadership the opportunity to discuss revised plans and to focus on those efforts where the organization has the strongest relationships and greatest likelihood of securing funds. For example, some special events have already moved online, with operas livestreaming performances and social service agencies holding online auctions and sending recorded messages to supporters. While less revenue has been raised, there may have also been fewer expenses. This is also the time to identify areas where board members might have relationships and could meaningfully engage in sharing the fundraising workload.

Look at the Dual Bottom Line

When cash gets tight, the financial bottom line becomes readily apparent. But in stressful times, it is important to consider both bottom lines: impact and financial. Especially if challenging decisions need to be made about where to focus, consider the impact of each program and fund the highest impact programs first. This is often a difficult discussion. Everything an organization does has value, but given the current situation in which we find ourselves, which aspect of the organization has the most value today? Are there longer-term programs or projects that could be put on hold? Could unrestricted resources and staff be transferred to those efforts with the highest impact, such as direct services? Could reducing expenditures on lower impact programs allow the organization to build cash reserves?

This is especially helpful if cuts need to be made. One common response to crisis is to implement a straight percentage cut across all activities; however, this is not the most strategic decision. Yes, it avoids conflict, but focusing on those programs where there is an intersection of organizational strength and pressing constituent need is essential. Not only does this allow the organization to most effectively have impact and accomplish its mission given the resources it has available, but it also helps make the case for increased support to funders.

The matrix map visual is a helpful way of highlighting both the impact and profitability of an organization’s programs and looking holistically at how each program of an organization contributes to its impact and financial viability. While the process of completing a detailed map can take some time, a rapid version can be created in an afternoon. Remember, the map is a representation of the business model used to inform decision-making, not a 100-percent-accurate picture. In some cases, some information is better than complete information, especially when the goal is to bring others along in the discussion and make decisions. This is one of those cases.

Include Everyone in the Discussion

Speaking of bringing others along, there are no “right” answers to these challenging questions, and ideas for sustaining the organization know no positional boundaries. Engaging everyone in these candid conversations can often surface new approaches or meaningful strategies. That said, programmatic staff may be overwhelmed and overworked responding to the crisis, and leadership will need to decide whether it is appropriate to add to their workload by bringing them into the conversation. However, our default position is that nonprofits are community organizations responding to a community challenge and they benefit from the input of close community members during these difficult times. Our desire is for everyone to have a voice.

Determining the organization’s cash position, described above, will inform how much time leadership has to meaningfully engage a broad group of people in discussion. At a minimum, however, board and senior leadership should be involved in surfacing potential solutions. Ideally these positions will be informed by staff and constituents. Especially for social service organizations, it is important that the needs of those being served are well known and represented in the discussions.

Again, the easy solution in these times is for a small group at the top of an organization’s leadership to come together and make decisions, but this group may not be as well informed about constituent needs as others. By opening the discussion, unexpected opportunities might surface. Additionally, by sharing the complexity of the decision to be made and the options to consider, leadership helps to build community and buy-in for implementation.

Communicate Consistently

Our last point may be the most important. Often, in times of crisis when leadership is busy trying to serve constituents and make informed decisions to save their organization, communication can lapse. Leaders may feel they have “nothing new” to say or they might not yet have a “path forward” or solution for the organization and therefore don’t communicate to key stakeholders. Unfortunately, while understandable, this is the wrong course of action.

Nonprofit organizations are expressions of our humanity—people coming together to build stronger, more enriching and more equitable communities. By expressing the hardship that our organizations are experiencing and the difficult choices that must be made, we invite others to participate in the process. We are all joined together in this time, living through a pandemic the likes of which none of us have ever seen.

This is especially true of donors. Helping donors understand firsthand what your constituents and the organization face allows them to support you in the most effective manner. We cannot only talk with stakeholders when things are going well. Helping everyone understand that the organization is maximizing impact and leading with its values—with the needs of our constituents and staff front-of-mind—strengthens the connection and relationship donors feel with the mission. This connection will be necessary for organizations to survive this shock and ultimately be able to thrive once again.

Time is of the Essence

None of the steps here are easy—especially in a time of crisis. Given this rapidly evolving pandemic, it is tempting to put off decision making to see how the situation progresses. One lesson from the Great Recession, however, was that those organizations that assessed their situation earlier were able to make strategic decisions which resulted in less severe measures later. Nonprofit leaders face competing demands and priorities as they deliver on their missions. By inviting others in, communicating clearly, looking at the organization holistically, and understanding where we’re starting from financially, leadership can attempt to spread the workload, build commitment, surface strategies and implement solutions to help their organizations—and our communities—survive and, once again, eventually thrive.

Beyond Financial Oversight: Expanding the Board’s Role in the Pursuit of Sustainability

This article is reprinted from NPQ’s spring 2011 edition, “Governing amid the Tremors.” It was first published online on April 26, 2011.

Throughout the ten years prior to the recession, it seemed that whenever anyone talked about boards and finances in the same sentence they were making a point about accountability. They were warning us that our Form 990s were now on GuideStar, so we’d better make sure that our boards were reading them. They were telling us to have an audit committee and a “Conflict of Interest” policy. They were telling us that we should study Sarbanes-Oxley and apply whatever we could to our own boards. They were making constant reference to a handful of nonprofit fraud cases, suggesting that this was what awaited us if our boards did not get very serious about oversight and accountability.

Now, as community-based organizations continue to weather the severe, and in many cases permanent, shifts in their operating environments caused by the recession, those accountability concerns seem downright quaint. The truth is that one of the roles that most decently functioning boards play quite well is providing financial oversight. Compared to other board functions, financial oversight is relatively clear: there is a dedicated officer role, the treasurer; nearly all boards have a finance committee; and there are tangible products such as an annual budget to approve, financial statements to distribute, and an auditor to select.

The problem is none of those tangible products in and of themselves has anything to do with nonprofit sustainability. And it is sustainability that is keeping executive directors up at night, not financial oversight. In a new book I coauthored, Nonprofit Sustainability: Making Strategic Decisions for Financial Viability, my colleagues and I define sustainability as being both programmatic and financial:1

Sustainability encompasses both financial sustainability (the ability to generate resources to meet the needs of the present without compromising the future) and programmatic sustainability (the ability to develop, mature, and cycle out programs to be responsive to constituencies over time).

In other words, board finance committees can look at annual budgets, financial statements, and audits forever, but if some group of board members is not considering those financial results in light of the organization’s programming mix and its results, then their efforts are very unlikely to contribute to sustainability.

Our boards, not unlike many of our staffs, are artificially siloed into groups that consider financial results, groups that consider programmatic results, and groups that consider fundraising results. Yet, for those of us without an endowment or many wealthy annual donors, program results in large part drive financial results. It is how many clients we case-manage that yields a particular contract reimbursement. It is how many units of housing we build that yields a particular developer’s fee. It is how popular our new play turns out to be that yields a particular box office revenue. And just as critically, it is how many people respond to our direct mail campaign and to our special event invitation that determines how much subsidy we can raise for programs that don’t cover their own costs. Put another way, if the board finance committee doesn’t like the financial results it is seeing as it provides oversight, what is it going to do about it? It has to look to the programs and the fundraising activities of the organization to yield different financial results; that’s the only way to make the financial statements say anything better.

So while financial oversight is absolutely critical, it is hardly sufficient. Boards of directors charged as stewards of an organization have to be fundamentally knowledgeable about and actively engaged in the business models of the organizations they govern. And nonprofit business models are typically the antithesis of siloed; they are instead a very interdependent mix of programs and fundraising activities that work together to achieve a set of impacts and financial results. How engaged are most boards in that interdependence? And if they are not engaged, how can they meaningfully assist with the dogged pursuit of sustainability in which so many of their executives find themselves?

The complex challenges facing community-based nonprofits require that we shift our mental model from boards being primarily about financial oversight and accountability, to boards being concerned in an ongoing way with the financial sustainability of their organizations.

Is Your Board Sustainability-Focused?
If you are considering making the pivot from an oversight orientation to a sustainability orientation, consider using these discussion questions to start off the conversation at your next board meeting:

  1. How financially literate are we as a group? If we have knowledge gaps, how will we work together to close them, and by when?
  2. Is our finance committee engaging in the key business-model questions facing our organization, or is it focused primarily on monitoring budget variance and preparing for the audit?
  3. What major sustainability decisions are before us as an organization, and how will we structure our board and committee-meeting agendas over the next three to four months to ensure we make those decisions effectively?
  4. Overall, how healthy is our organization financially? Is it healthier today than it was three years ago? Why or why not? When our board terms end, where do we want to leave the organization financially?
  5. How strong is our partnership with staff leadership around issues of sustainability? Are we sharing information and ideas across staff and board in a way that truly leverages our individual and collective strengths and networks as board members in the sustainability pursuit?

When pivoting a board of directors from a strictly oversight orientation to a sustainability orientation, there are a number of things to consider. For instance, a board with a sustainability orientation requires board members who are financially literate. By this I mean that everyone has, or is actively developing, an understanding of the financial statements they receive. They have the fluency, for instance, to ask how a core program is performing both financially and programmatically. If only two or three people on the board can read the financial data, the board is unlikely to have holistic conversations that take both mission impact and financial return into account. With a sustainability orientation, financial statements become a useful tool in the ongoing discussion of where the organization should go next rather than merely reports that the treasurer assures everyone she has reviewed on their behalf.

Practically, this means that board chairs and executives need to team up in creating a board culture that expects and supports financial literacy from all members. During the recruitment and orientation of new board members, thorough and transparent discussion of the organization’s business model and its current financial challenges and opportunities should be central. A board with a strong sustainability orientation will most likely pass on the potential recruit who uses stale language such as, “I am not a numbers person. I leave that stuff to the treasurer.” The response should be, “Our board is focused holistically on the sustainability of this organization, so everyone engages with our financial results. We will train you and support your development as a financial leader, but you have to be committed to our stance on this point to be successful on this board.” In addition to this kind of strategic recruitment and orientation, board chairs and executives should prioritize financial training opportunities and consider mentoring among board members to support members who are in active development of their financial literacy. Once a year, all board members should receive a one-hour refresher on how to read and interpret the organization’s particular set of monthly financial statements.

To signal and reinforce this sustainability stance, chairs and executives should consider renaming their finance committees and adding nontraditional members—folks who are financially literate but who have program or fundraising as their primary orientations, for instance. A board committee called “Finance and Sustainability” that is composed of both finance experts and programmatic folks actively engaging with the business model’s concerns will support the pivot to a “beyond oversight” board. When a diverse group of members is reviewing and discussing the numbers, not only can it go beyond merely reporting to the full board how close to its budget the organization is or is not, it can also frame for the board the questions of “why?” and “what might we do about it?” With this approach, the treasurer role evolves from that of a CPA, who is among the only people able and willing to review financials, to a full leadership role that supports the full board’s meaningful focus on the complex questions and difficult decision making of the sustainability pursuit.

Another key shift required for a sustainability orientation is the normalizing of profit. Profit, like program impact, is fundamental to sustainability. A board of directors that is uncomfortable budgeting for surplus and unwilling to face the brutal facts about the prospects for profitability of core activities is not operating with a sustainability orientation. It is important not to conflate profitability with earned income, however. Many community-based nonprofits achieve profitability—that is, consistent annual surpluses—through a mix of earned and donated income. A special event can be just as profitable as a fee-based service to the community. The key is for boards to be looking for profit wherever it can be generated in the model, and to be ensuring that, as a set, the organization’s activities yield more than they consume.

Through the recession, many leaders have had to face the reality that they can no longer subsidize core activities that do not cover their own costs. The fact that an activity is core to an organization’s mission and very needed by its constituency does not necessarily mean that the organization can afford to keep it in its business model. So many executives I talk to now lament not having faced those realities sooner. I attribute this reticence to act on unsustainable deficits in part to boards of directors not deeply engaging in why and how their organizations were incurring deficits. That is, they didn’t deeply understand which activities in their business models were losing money, and how much; instead, they talked in macro terms about the organization’s overall “not hitting budget.” Part of pursuing sustainability is determining the desired profitability of every core activity—programmatic and fundraising. While most community-based organizations will elect to subsidize a handful of money-losers—allow the profits from an annual event to offset the losses in the government-funded job training program, for instance—the board should be very clear on these decisions and ensure that those subsidy decisions do not result in deficits for the organization overall.

The nature of financial plans and reports shifts too with a sustainability orientation. Ironically, the classic tools of annual budget, monthly financial statements, and an audit can actually keep a board focused on oversight rather than business model sustainability. When boards focus too much on annual budget variance, for example, I find that they are often not sufficiently engaging in projection. Rather than focusing all of their analytical energy on how close the organization is to numbers it predicted six or eight months ago, members of the Finance and Sustainability Committee want to be anticipating the next several quarters’ results, too. We spend too much time providing oversight on things that already happened, and not enough time considering the financial road ahead. For-profits engage in rolling projection, and I believe that nonprofits should do this as well.

Rolling projection moves the board of directors away from the silly obsession with “hitting the year-end budget” and toward the capacity to make earlier and better decisions given the economic forces happening in real time. Fiscal years are artificial time frames. All major decisions will have economic impact far beyond the current fiscal year. Put another way, it is just as important to have a good July as it is to have a good June. When boards focus only on predicting the coming twelve months (annual budget), monitoring variance from that increasingly outdated prediction (monthly financial statements with budget variance), and reviewing the past year’s statements (audit), they risk not actually engaging in the pressing and emerging business issues facing their organizations right now. Again, financial oversight is critical but insufficient for sustainability.

A board that is focused on sustainability will be working a handful of key business-model issues all the time. In this economic climate, very few community-based organizations do not have to rethink some aspect of their business models. The Finance and Sustainability Committee members will partner with staff leadership to articulate those issues and find meaningful ways for the full board to understand them and, where possible, contribute to their resolution. For instance, the committee may come to the realization that the organization needs to close or transfer its drop-in program for teen dads because, while valued by the community, it has lost money for three years in a row, and its government contract is unlikely to survive the next round of county budget cuts. A committee member can partner with the executive director to craft a presentation to the full board, laying out the data and framing the key questions for board decision making: Are we prepared to end this program, and if so, by what date? Are there elements of this program that we can transfer to a collaborator or competitor? Are there financial implications of closing this program that we need to understand (for example, laying off staff, alienating a key funder, or losing the contract’s modest contribution to defraying overhead costs)? One board member can be engaged in reaching out to another community organization about the potential for program transfer; another board member can join the executive director in breaking the news to the government funder; and so on. In this fashion, the full board is actively engaged in decision making and execution on a business-model issue essential to the organization’s sustainability.

For too long, too much of our boards’ finance focus has been on reviewing the past. For many nonprofits, this meant decision making was too slow in the face of the mounting recession. Modest reserves were depleted, and organizations were left exceedingly vulnerable during a time of great community need. The lesson of the recession is that boards must engage not only in financial oversight but also in the pursuit of sustainability. To do this well, boards have to be composed of financially literate members who engage in real-time analysis and focus on answering the complex business-model questions their organizations face today.

Notes

  1. Jeanne Bell, Jan Masaoka, and Steve Zimmerman, Nonprofit Sustainability: Making Strategic Decisions for Financial Viability. San Francisco: Jossey-Bass, 2010.

Budgeting must be more flexible in uncertain times

By Jim Simpson, CPA and Director, Financial Technologies & Management

A strong budget is an essential element for any nonprofit organization to achieve financial leadership. Superior budgets, though, have written plans about the core activities to include strategic, organizational, and program goals and how they will be financed.  A superior budget must be monitored and managed in light of the political and economic realities and the increased uncertainties we are all facing.

Most financial leaders focus too much time on budget variance analysis and not enough time on anticipating or planning for the future. By anticipating or planning, organizations can focus on what’s upcoming regardless of its budget cycle or fiscal year-end. A budget can be complemented with rolling forecasts to better anticipate upcoming financial results.

Budgets also need to include cash flow projections, which maybe outside of the finance departments capacity or capabilities. Financial leaders must have a direct role in developing useful cash flow projections and assumptions with frequent, detailed analysis.

Financial sustainability can only be achieved with a well-prepared and continuously monitored budget. Conversely, a poorly developed budget can diminish mission focused activities opportunities and threaten long-term success.

It is important that each of the following budget process practices is used to develop the budget.

  • Draft revenue and expense budget to attain strategic, organizational and program goals. It is important to break expenses into variable expenses, fixed expenses, incremental expenses and indirect expenses for administration and facilities.  It is important that any new initiatives are approved and deadlines established before they are undertaken.
  • Modify budget with budget team input to ensure everyone understands and approves the revised draft budget.
  • Implement budget to communicate budget, assign management responsibilities, implement in accounting system, monitor and respond to changes to the budget. It is important that you document budget decisions including writing down all budget assumptions.
  • A budget should be implemented with monthly distributions to anticipate the changes to monthly revenues and expenses based on timing and seasonal program activities.
  • A budget may need to be broken out for donors without restrictions and donors with restrictions to insure that there are sufficient resources to actually fulfill the donor restrictions.
  • A budget should add a contingency or cushion to take into consideration the unknown.   The less predictable your budget it, the more contingency you may need to have.    A contingency of 5% of your non-personnel costs is typical and may need to increase if your funding or costs are not predictable.

Any unfavorable budget deficits need to be evaluated to determine if it is just a timing difference or an actual deficit. Shortfalls created by deficits need to be solved by budget adjustments or strategic choices to absorb a shortfall. An organization can determine timing or actual deficits by reviewing the budget to see if it had planned for or not.

Your budget deficits should consider what funding may become available, whether to utilize reserves, utilize unrestricted funding, or reduce expenses.  If funding is disappearing, can we replace the funding, should we reduce or eliminate an ineffective program, or can we reinvest into more effective or sustainable programs.  You should create various budget scenarios so you have various options about how to meet budget deficits.

In contrast to traditional budgets, a flexible budget may include a range of scenarios or a shorter time frame, or both. Three scenarios at a minimum should be prepared: best, worst and expected cases.

A bare bones worst-case budget will show you exactly which expenses are crucial to your organization.  Prepare your flexible budget in shorter or longer time increments from the annual budget cycle.

It is important the you strike the right balance in your development of flexible budgets.

  1. Worst-case budget – It will include realistic income and your core expenses.  The realistic income is committed funds and conservative fundraising estimates.  The core expenses would include essential expenses with no expansion of services.
  2. Expected-case budget – It will include optimistic income and incremental expenses.  The optimistic income will include uncertain funding estimates.   The incremental expenses would be the additional expenses to be incurred if new funds are secured.
  3. Best-case budget – It will include the fundraising goal revenue and projected expenses.  The fundraising goal revenue includes the combination of the realistic and optimistic income.  The projected expenses includes the combination of he core and incremental expenses.

It is important that an accompanying cash flow projection be developed to accompany the accrual based budget.  A cash flow projection will help to foresee cash flow problems a plan for solutions even if an organization has a balanced or surplus budget.  It is generally helpful to do a mid-year deep review to include anticipated year end projection and forecast.

Flexible budgets and Cash Flow Projections will provide you with additional tools to help ensure your organization remains financial stable despite an uncertain future.

Key Goals for Financial Stability

  • Diversify Revenue so you are no too dependent on any one funding source and look for ways to accelerate cash flows
  • Allocate indirect costs to programs to insure all program costs are covered
  • Develop Staff versatility and adaptability to work in different program areas
  • Develop and maintain an Endowment to support financial operations
  • Maintain one to three months reserves to allow for program growth and cover short-term deficits
  • Keep track of financial results and how you are doing to keep organization financially stable
  • Monitor cash flow projection at least monthly to determine how long the organization can survive without additional funding

Let us know how we can help your organization develop the financial tools it needs to grow and remain financially stable.