Balancing the Mission Checkbook

On April 19th, the Nonprofits Assistance Fund and the Minnesota Council of Nonprofits hosted the inaugural Finance and Sustainability Conference for an impressive group of over 400 attendees. Even before the conference, there was an energetic buzz among nonprofit finance types about a conference specifically tailored to our field, our vocation, and for some, our passion. But as a career-long nonprofit employee, a nonprofit CFO for over 17 years, I looked forward to the conference with a mix of emotions – enthusiasm on one hand and skepticism on the other.

I joined Nonprofits Assistance Fund last fall. Admittedly, I am still giddy with the excitement of working with such a fantastic organization. I joined the staff after I had been a loyal and enthusiastic consumer of the training and technical assistance resources that NAF offers. After I attended two financial management workshops, I requested follow up one-on-one technical assistance to discuss revenue drivers and dashboard reports. The personalized help I received was a great inspiration and confidence boost. I came away with a clear vision for how to integrate financial drivers with program outcomes, and how to better condense financial reports to be of maximum use to our board.

Now that I work with NAF, I remain one of our most fervent promoters. But I continue to wonder how to best help nonprofit executives, staff, and board members translate the knowledge from NAF’s many resources (including the recent conference) into practical gain. From my previous experience, I know that there are lurking practical challenges that come with each breakthrough in understanding. How do financial leaders transform our latest insights gained from an inspirational conference, a training session, a consultation, or a recently-read article into a tangible benefit for our organizations?

Too often, nonprofit leaders leave some of our best insights in the theoretical dust bin. We nod our heads during conference breakout sessions, have animated discussions in the hallways between sessions, and fire off enthusiastic emails to colleagues after the conference ends. But soon after, we come face to face with urgent demands, short-sighted “budget priorities”, and never ending reporting deadlines. We also lose momentum before we can transfer our enthusiasm to executives and board members. Why, we wonder, don’t program managers and finance committee members want to stop for a long talk about the latest thoughts on nonprofit financial sustainability? Most often we lose our commitment to change when confronted by the pace of our jobs. Our newly gained vision for integrating financial acumen with mission success is scrapped before it is even tested.

It might be easy to resign ourselves and believe that there is no hope of introducing new financial strategies into a seemingly immovable organizational culture. We convince ourselves that our emerging nonprofit is too small and green to adopt sophisticated nonprofit financial reporting systems or that the idea of building multiple reserves is the luxury of a few, rare, well-heeled nonprofits. But these are the attitudes of victims, not visionaries. Instead of shrinking from the challenge, we could rise to the occasion. Wouldn’t you rather be seen as a wild-eyed revolutionary than a grousing bean counter?

I realize today that our responsibility as nonprofit financial leaders is to push our organization’s executives, staff, and boards, and the nonprofit sector to understand that any debate that refers to mission and money as two distinct topics must be called out as naïve and misguided. Having strong financial and organizational infrastructure that support program planning and strategic vision must be championed as a basic program activity – a responsibility, a necessity. We must join in the calls for donors and government agencies to abandon the dangerous and short-sighted focus on overhead percentages and an unproductive bias for narrow funding restrictions. There is nothing auxiliary about having sufficient accounting systems and competently-trained personnel to manage an organization’s finances. There is nothing discretionary about investing in board training and development of financial expertise. As nonprofit financial leaders, we have to be the first to give up these attitudes ourselves.

The Finance and Sustainability Conference put in front of us cutting edge information and ahead-of-the-trend perspectives on financial strategy, sustainability, and infrastructure. But did we simply meet as isolated and pigeon-holed finance geeks? Or will we transform this into an energizing event from which to launch our version of a revolution? I trust that you found an outlet for the creative and transformative ideas you gained at the conference. I hope that my initial skepticism is unwarranted – that many of us will put into action what we have learned.

Two weeks have passed, what are your next steps toward financial sustainability? Please share your stories in the comments below.

Money has a strange effect on nonprofit organizations. Well, likely it has an odd effect on nearly any person or group, but the staff at NAF is all about our nonprofit clients, so that is the issue at hand. A nonprofit sets out with a mission to accomplish in the world, and has to create a business model to pay the necessary financial costs to get that mission accomplished. Some nonprofits use a lot of volunteers (one business model – replace hard costs with soft costs), some charge fees to clients, but most will rely on at least some portion of donated revenue to make ends meet.

Some of this money is pure incentive to get the work done. An unrestricted gift is from an individual or institution that loves the work and wants to support that mission in the world. The more of this kind of donation a nonprofit gets, the more likely the organization will stay on the mission-track.

The inverse can also be true, however. The less donated revenue a nonprofit gets for its mission, the greater the chance it might stray in order to chase funding. The former incentive to stay on the mission path has become a disincentive for the original mission.

Nonprofit boards can and should evaluate how donated revenue impacts their mission. If there simply isn’t sufficient support for the mission to generate the revenue needed, than perhaps making a formal change in the mission is required. In the most extreme case, a nonprofit could decide the business model doesn’t work, there isn’t a logical segue to the next mission, and shutting down or merging could be a sensible option.

The intentional change in mission is the best-case scenario. A subtle shift in mission – or drift – is another potential outcome. If the money (incentive) isn’t there for the original mission, perhaps a nonprofit could decide to slightly adjust the mission to get available. Without a formal evaluation of the mission, a creative reading of a request for proposal (RFP) might find any imaginative nonprofit in a bind and therefore creating justifications for a drift.

Falling victim to funding disincentives is just one step further down the path. If philanthropic givers have identified a passion for a new direction (Hey – let’s fund MacGuffins!) and a nonprofit suddenly decides to become a MacGuffin provider, they aren’t responding to financial incentives. They’re really responding to the disincentives in their business model, and that probably isn’t the right solution.

So how do nonprofits align mission and money? When is pay for performance a mission fit versus a mission drift? Some of the best thinkers in the sector are going to be taking these issues on at the Finance and Sustainability Conference on April 19. If you can’t join us in person (please do if you can), watch this space for more conversation, follow the hash tag #npfinance on Twitter, or join in on the comments section below to share your own story of responding to incentives or, perhaps accidentally, reacting to a disincentive. Open conversation can help us all avoid drift and make intentional decisions.

Have you read or heard about Social Impact Bonds, Pay for Performance or Pay for Success Bonds? The concept of service providers in the community might be paid for their results (instead of for delivery) has taken hold in a big way with governmental and philanthropic institutions. The allure is managing tight public dollars by limiting funding for program delivery that doesn’t return sufficient value to the government agency. Nonprofit service providers are interested in the potential to bring in additional private resources that are attracted by a social and financial return. The Pay for Success concept for funding public services – variously referred to as Social Impact Bonds, Pay for Success, or Pay for Performance – has garnered attention over the past several years beginning with the Social Impact Bond pilot in the U.K. Earlier this year, the White House announced a Pay for Success initiative to promote a federal level program to leverage private investment dollars for public services. There are a number of different initiatives and pilots at state, county and local levels around the country. We’ve been paying close attention here at Nonprofits Assistance Fund in our roles as an advisor to nonprofits that may be entering into these contracts and as a potential source of financing for working capital for what could be an extended time before payment.

Here’s an introduction to some terminology, links to some good articles and resources, and an invitation to discuss how it might fit your organization at the Finance & Sustainability Conference.

Terminology

Pay for Success (or Pay for Performance)
A contract in which payments from the public agency is in some manner dependent on successful outcomes. These contracts may combine traditional contract terms with incentive payments tied to outcomes. The contract relationship is directly between the public agency payer and the nonprofit or business service provider. An external evaluator may be involved, usually contracted by the public agency.

Social Impact Bonds
A new type of financing that includes a contract where payment from government agency is tied solely to outcomes. Generally the public agency has few other controls or restrictions on the provider. As currently deployed and designed, relationships for SIBs have three parties: the public agency payer contracting with a third party intermediary for payment based on outcomes. The intermediary contracts with a nonprofit service provider to deliver services and raises funds from investors. The intermediary contracts with the service provider with payment upfront for delivery of services and pays an incentive or bonus payment based on outcomes. The use of the word “bond” is actually a misnomer in this structure. The investment has more in common with venture capital that has a social value.

Minnesota pilot Pay-For-Performance Program
This pilot program, included in the budget adopted in the 2011 Special Session, authorizes a $10 million appropriation bond to be used to fund pay-for-performance contracts. The first step was appointment of an Oversight committee charged with developing criteria and conditions for services to be included, defining outcomes, and selecting service providers. The committee has been appointed and has started to meet regularly. Materials from meeting are available online through the MMB website.

Articles & Resources

If you are interested in a deeper understanding of the concept, structure, and current developments, here are some excellent sources:

• Summary of most recent development: Will Americans Pay-For-Success in 2012? by Centre for Social Impact in Sydney, Australia
• What Are Social Impact Bonds? An Innovative New Financing Tool for Social Programs by Center for American Progress
• Will Social Impact Bonds Work in the US? by McKinsey & Co
• Impact on Service Providers: Opportunities and Challenges of PFS/SIB Participation Recording of a webinar presented in August 2011
• Many articles, webinars, and resources on Nonprofit Finance Fund’s Pay for Success Learning Hub, including the Nonprofit service provider readiness self-assessment questions.

Start the Conversation

The “readiness questions” are especially important for nonprofits that are interested in delivering services in a pay for performance model. Here are a few questions to start your thinking:

• Do you deliver a service focused on prevention or intervention with a well defined group of clients?
• Does the prevention or intervention program result in outcomes that result in either reduction in direct costs or increased revenue for the state, county, or federal government?
• Do you have experience and systems for collecting and managing data related to your program participants?
• Are you in a position to grow you prevention or intervention service delivery program(s)?

Before entering into a pay for performance contract, nonprofits also must analyze some new types of contract provisions:

• Defining outcomes over which the nonprofit service provider has sufficient influence.
• Identifying the data that will be used to calculate outcomes, having confidence in the data sources and the ability to monitor the data during the life of the contract.
• Understanding and gaining confidence in the economics used for outcome valuation calculations.
• Negotiating contract terms that allow sufficient flexibility in service delivery to adapt and change to achieve outcomes.

If you find this interesting please join us at the Nonprofit Finance and Sustainability Conference on April 19^th and attend the afternoon session, “Pay for Performance: Assessing the Fit and Impact for Organizations” to hear more and participate with a great panel of nonprofit leaders on this topic.

Imagine this: Eyes race to the bottom of the page and a negative number between a pair of dreaded parenthesis stares back. Nonprofit staff and board members wonder what happened after they subtracted all expenses from total anticipated income. To many, this may be an immediate red flag. But how do we decide if this deficit is OK for our organization? The decision involves analyzing the balance sheet, assessing staff leaders’ and board’s appetite for a deficit, and forecasting more than one year into the future.

Can we absorb a deficit?
Deficits on our income statement erode our balance sheet’s net assets.

• Have we accumulated sufficient net assets over time to be able to absorb a deficit? If a deficit is planned, it’s important that decision-makers and budget-approvers recognize that the net assets from previous years’ surpluses will be drawn down. Looking further up the rows on our balance sheet, we must consider if our liquidity will allow us to absorb a deficit.
• Do we have sufficient cash and working capital? Or, do we have access to credit and a lender that is on-board with using the credit to fill this year’s deficit?

For more information on analyzing your balance sheet, see our Balance Sheet Cheat Sheet resource. If considering a deficit, pay special attention to Days Cash on Hand and the Working Capital Ratio.

Are we willing to incur a deficit?
Deficits are either strategic or accidental.

Strategic deficits are planned and intentional. Often times, organizations knowingly invest in programming or infrastructure for a future benefit, or perhaps intentionally spend down organizational reserves. In these situations, be careful to consider how a deficit might impact relationships with funders and lenders. Also, be mindful to protect the business model (see below).

Accidental deficits can result in disruptive cash flow crises, restructuring without strategy, or even program termination or dissolution. They are often caused by deferring difficult budget decisions or not having alternative budget scenarios prepared for quick implementation.

Are we protecting our business model?
Deficits are often structural, meaning there’s an inherent flaw to our business model that will repeat itself if left unaddressed. If approving a budget with a deficit, consider:

• Is there something unique that causes this deficit? Is it clear how the condition will change in future years?
• Are we able to achieve a recovery surplus? Net assets will only be replenished following a deficit if an organization is willing and able to incur a potentially significant surplus in a future year. Do your business model and dominant funding sources allow for a profit margin sufficient to recover from the deficit?

I like to think of budgets as “best-guess working drafts” for the future. They are our best guesses given all the information that we can gather and analyze, but they are still filled with risks and assumptions. Budgets are also working drafts, because they must be closely monitored and managed during a fiscal year to assure the desired financial outcome.

To learn more about activating your budget, be sure to attend the “Financial Drivers and Budget Benchmarks” session at the upcoming Nonprofit Finance and Sustainability Conference on April 19. And for further reading on this topic, check out “Nonprofit Budgets Have to Balance: False!” by our conference keynote speaker Jeanne Bell.

And if you find yourself sweaty-palmed and anxious staring at a budget deficit, drop us a line, and we can talk through it together.

March in Minnesota gets the Nonprofits Assistance Fund thinking about spring in Minnesota. It’s what we do here.

The conversation in the office kitchen turned to gardening, and of course, being financial geeks, that conversation turned to an analysis of the profit and loss of planting and maintaining your own gardens. Minnesota is fortunate to have great farmers markets, so if you’re looking for fresh, locally-grown produce and flowers, you can buy a great deal for very little money. If you calculate your true “program” costs of growing your own (mostly your own time, really), you’re better off never turning a shovel to mix in some new peat moss.

But that isn’t why we garden.

We have to look past the financial return on investment and look at the mission intangibles of gardening: Talking to your neighbors as you weed, or running out with the kids to see just how fast cucumbers grow around here. Many Minnesotans find gardening to be rewarding for a change in their labor, getting outside and seeing something green rather than going to meetings or crunching numbers. Variety is important in planting, and important in our work.

Nonprofits are feeling a lot of pressure to make the money work, and sometimes that means a good long look at programs that revitalize us but don’t contribute to the bottom line. One of our clients called for some strategy advice the other day, and said she thought she should cut any program that can’t be fully self-funding. We are the first to stress the importance of financial health – after all, if all we did was garden and we didn’t have a job to pay the bills, we wouldn’t be gardening next year. But not everything needs to show a profit. If some of your programs show a surplus, then other stuff can be done because it fulfills your mission and restores your nonprofit drive to move forward with the other important work.

It’s important to know the difference between what is financially-sustaining, what is mission-sustaining, what is both, and frankly – what is neither. If you analyze your true program costs, you’ll learn which programs are financially-sustaining, but that calculation won’t tell you which programs are mission-sustaining. You may need a strategic advisor to help understand just how much financial loss can you subsidize in a mission-sustaining program (how many hours you can garden) before it starts to impact your organization’s livelihood (not making enough money to pay all the bills due to time lost with a watering can).

Giving up some mission work may sometimes be necessary, but the goal can always be to become stable enough so you can take the time to dig in the dirt every now and then. It may take some tough budgeting or long-term goals, but it’s worth the extra effort to get the change of scenery and revitalize the rest of the work.

We’re an excitable bunch at Nonprofits Assistance Fund. We ring loud bells to celebrate our clients’ successes. We toss homemade confetti when we receive good news from funders. We raise our voices when debating what are the most useful financial ratios. But this spring, nothing puts that excited sparkle in our eyes more than talk of the upcoming inaugural Finance and Sustainability Conference on April 19.

Through our work in lending, training, and providing strategic financial guidance, we work with individuals that serve wide-ranging roles within nonprofit organizations – executive directors, program staff, board members, fundraising staff, and finance staff – and they all have a role in financial leadership.

The broad and diverse skills and knowledge required of these individuals to effectively lead a mission-based organization toward financial sustainability is truly remarkable. Consider these real nonprofit management scenarios that demonstrate the combination of technical and strategic skills necessary in nonprofit financial management.

Scenario 1:

An Executive Director along with her board enters the fiscal year with the goal of an unrestricted operating surplus.  They have different budget scenarios in place to aid in managing the unavoidable uncertainties in their income budget. At mid-year, some program output measures are below projections, and finance staff warn that there’s a risk that a portion of a program grant will not be released from its temporary restrictions before the end of the fiscal year. The E.D. meets with fundraising staff to consider strategies on getting permission from funders to re-purpose the grant funds while also revisiting the aspects of the communications plan that reference the organization’s commitment to financial surpluses.

Scenario 2:

A year-end deficit is keeping an Executive Director up at night, pondering the question, “Why isn’t our business model working?” The E.D. works with program managers and the Finance Manager to develop a comprehensive allocation system. Empowered by an understanding of true program costs, the E.D. modifies grant proposals in order to request funding at a level that fully pays for the services that his agency is providing. The board begins next year’s budget process by discussing the financial expectations of each agency program.

These scenarios and the unique combination of technical and strategic skills that they require are representative of the types of complex challenges that nonprofits face today. To name just a few of the many skills required, leaders must develop competencies in scenario planning, accounting principles, communicating financial information, and engaging others within their organization in financial leadership activities. Financial leadership entails an emerging and evolving skill set that changes with our environment and our organization’s circumstances.

At Nonprofits Assistance Fund, we understand the challenges and requirements that nonprofit leaders face along their quest for sustainability. Accordingly, we’ve worked with our partners at the Minnesota Council of Nonprofits to design the 2012 Nonprofit Finance and Sustainability Conference – a one-day event that will cover a wide gamut of technical and strategic topics that will give you the skills and knowledge necessary to put your organization on a sustainable course.

Our morning keynote will be delivered by a national leader in guiding nonprofits down the path towards sustainability, Jeanne Bell of CompassPoint Nonprofit Services. Our lunch keynote speaker will be Elizabeth Boris, the founding director of Center on Nonprofits and Philanthropy at the Urban Institute, who will highlight resources for nonprofits to navigate the new economy. Morning and afternoon breakout sessions will cover technical topics, such as selecting the right accounting software and ensuring internal controls in an electronic age, as well strategic topics, such as using your budget as a communications tool and managing multiple bottom lines.

Conference registration is open and there are still a few more days to take advantage of discounted early registration. Please join us April 19 for what promises to be a wildly practical gathering.