Building Financially Strong Nonprofits

Ensuring organizational strength during troubled economic times.

Ron Mattocks | posted 3/13/2009

Nonprofit organizations have an insatiable appetite for revenue. For the past 25 years, new nonprofit organizations have incorporated at twice the rate as for-profit corporations, and existing organizations have continued to expand.

Disproportionately few nonprofits have filed for dissolution, even as for years, one of three nonprofits has operated in financial distress, what is known as "the zone of insolvency." The economic turmoil we currently face may well prove a tipping point that forces re-organizations, mergers, and dissolutions in the nonprofit sector at a scale not seen before.

Faith-based nonprofits depend on revenue from some combination of sources including fees-for-service, charitable contributions from individual income, planned gifts from accrued equity, grants from foundations, government contracts, corporate sponsorships, and earnings from endowments or investment funds. 2008's perfect economic storm impacted every one of these revenue sources.

Near the end of last year, in an address to a national gathering of nonprofit board members, Rebecca Rimmel, CEO of the Pew Charitable Trusts, said she found it impossible to believe that this turn of the economy would not reduce revenue to nonprofits in 2009. While there is some evidence that in previous downturns charitable giving proved remarkably resilient, there is also evidence that giving generally equals 2.1 percent of the Gross National Product (GNP), and that if GNP takes a significant hit, giving will also decline.

Some of the Christian Leadership Alliance member organizations are quite dependent on grants from foundations. There is some chatter among nonprofit managers who believe that foundations should just take money from their principal if necessary to continue giving at previous levels. Sounds nice, but the harsh reality is that most foundations are endowed with very specific legal parameters requiring that they protect the principal and provide funding out of investment earnings. Since the average portfolio lost 30 percent or more of its value in 2008, and since the remaining investments are earning at a lower percentage rate than in recent years, foundation funding will have to decrease. Likewise, high-net-wealth individuals who give out of their investment earnings will reevaluate commitments to balance personal budgets.

At the same time that charitable gifts and grants revenue may decrease, fee-for-service revenue may also decrease as consumer confidence levels stay at all-time lows and consumers slash discretionary spending. The consumer gets to define discretionary, not the selling organization. Decisions will vary from household to household, but you can be certain that the basic needs of food and housing will take priority, while expenses such as camp, private school, books, music, and conferences will be viewed as discretionary, depending on each consumer's unique situation.

Decreases in revenue will not automatically decrease expenses. In fact, in some sectors, such as rescue missions providing food and shelter, demand for services may jump dramatically, increasing expenses as revenues fall. Other organizations may find that they are locked into high fixed overhead, making it challenging if not impossible to significantly reduce expenses. Organizations that decide to ramp up requests for charitable giving in order to sustain expense budgets at current levels may find a frosty reception from donors who are changing lifestyles and slashing personal budgets and will expect the organizations they support to do the same.

However, there are ways to create financial strength for your nonprofit organization in tough economic times. Here are some models and ideas to help your nonprofit navigate the year ahead.

Here are the best practices of financially strong nonprofit organizations:

• Manage cash flow: Strong performing nonprofits discipline cash flow projections and management. The board finance committee insists on a process and sets parameters for minimum cash reserves, lines of credit, and seasonal deficit spending.

• Monitor receivables: In financially strong organizations, the boards are not just rubber stamping the balance sheet, but are actively engaged in understanding the details and establishing policies to ensure that receivables are not artificially inflating the asset side of the balance sheet.

• Keep payables current: While it is easy to assume that payables are current, the boards of financially strong nonprofits have great understanding and discipline in this regard, and do not allow payables to get out of control.

• Manage donor-restricted funds: Financially strong nonprofits have specific board policies regarding the acceptance and management of donor-restricted funds. They are intentional about accepting only those gifts in alignment with the organization's mission, and ensure that restricted funds solve more problems than they cause.

• Utilize board designated funds: Financially strong organizations back up board initiatives through budgeting, and often use board-designated funds to ensure implementation. In contrast, financially weak organizations often find that non-budgeted board initiatives drive deficit spending, or that these initiatives are not implemented due to lack of funding.

• Fund research and development: The visionary board understands the need to set aside funds to encourage research and development of new programs or products. Most nonprofits are very innovative at the start, but due to budget pressures over time, the innovation that fuels development of programs and products is given low priority.

• Review insurance coverage: Boards of strong organizations insist on regular reviews of all risk, and ensure adequate insurances in all areas. They acquire the expertise to ensure not just that they are insured, but also that they are insured at the right levels for the right cost.

• Own real estate: Many nonprofits have built significant stability through real estate holdings. Now is a great time to buy, if the organization can purchase and still achieve key ratios, such as: current assets divided by current liabilities equals 2.5 or more, and total net assets divided by total expenses equals 60 percent or more.

• Establish equitable executive compensation: Boards of financially strong nonprofits are very intentional about establishing executive compensations and reviewing performance, seeking to pay fair market rate, and establishing and monitoring executive reimbursements to protect the organization's integrity, comply with IRS regulations, and garner donor respect.

Immediate action steps for financially challenged nonprofits:

• Project and manage cash flow: If you are not projecting your cash flow needs each month for 18 months out, start now. If you are projecting monthly, consider shortening the intervals and projecting weekly or daily, depending on your level of distress.

• Project credit needs, develop backup plan: If you depend on short-term borrowing or lines of credit, assume for a moment that credit is no longer available to you, and develop a backup plan.

• Reduce contribution-revenue expectations: Be conservative and reduce your contribution expectations.

• Reduce expenses: Based on your reduced revenue projection, reduce expenses to balance the budget.

• Review pricing strategies: If you depend on fee-for-service revenue, be creative and remember that pricing must relate to what the market can bear. This is not a good year to raise prices, but may be a great year to strategically re-price by changing the offering, thereby improving your net.

• Adjust sales projections: Assume that some of your customers will determine that they cannot afford to purchase your programs or services at the same level as in previous years. Adjust revenue projections accordingly.

• Modify demand for services projections: Is demand for your service going to increase or decrease in the current economy? Define your assumptions and adjust your expense budget accordingly.

• Avoid deficit spending: We do not know how long the economic downturn will last, so this is not a time to accrue deficits. Insist on break-even budgets regardless of the pain to position your organization for the future.

• Delay major expenses: If you had planned major expenses for 2009, seriously consider delay. Better to be liquid until the economy turns.

• Manage debt ratio: Do not increase debt load during the downturn. Review your ratios based on the decreases in asset values to determine if your debt ratio is out of line as a result of the downturn.

The current economic situation is challenging, but prudent organizations will use these challenges to change business processes, seek collaboration partners, and develop new service lines. They will take the long view on fundraising, and reduce expenses in the short term. This is a time to be bold, a time for all hands on deck, including board members and managers. At the end of the day, if constituency needs take priority over organizational wants, we will strengthen the nonprofit sector for the future.

Ron Mattocks is a management consultant dedicated to building financial strength for nonprofit organizations, and author of Zone of Insolvency: How Nonprofits Avoid Hidden Liabilities and Build Financial Strength. You can reach Ron at Ron@MattocksConsulting.com.