Balancing the Mission Checkbook

Nonprofits Assistance Fund advises its clients to think about financial statements as a way to tell the story of their nonprofit missions. How organizations raise resources (mixes of earned and donated revenue, for example), where they spend money, and what they impact as a result of using resources are the narrative arcs of your financial statements.

The stories are told within a common context. Narratives have rules of grammar, and the financial statements have rules about how we describe resources so we all have a common understanding. These rules (Generally Accepted Account Principles, or GAAP) are periodically reviewed and revised to help make sure we are all still speaking the same language, so our stories are well understood.

Someone has to keep the rule book, and in the case of GAAP, that is the Financial Accounting Standards Board (FASB). Nearly two decades ago, FASB changed the nonprofit rule book, because the stories being told under the old rules were sometimes confused tales the average reader couldn’t always decipher. Rules about how we account for temporarily restricted net assets and more were revised to make things a bit clearer. FASB has had more time to see the stories unfold, and the nonprofit sector has now grown more mature, and it’s time once again to think about how these numbers tell our tales.

FASB is considering changes to net asset categories. The specific changes are not final, but it reflects some thoughts Nonprofits Assistance Fund has been promoting with clients. Nonprofit net assets – what you are worth when you take away everything a nonprofit owes from everything a nonprofit is worth – can be described in better detail and with more narrative heft than just whether the asset has a donor-imposed restriction. A single lump of resources at the end of the day is useful information, but showing board-designated categories within the larger context of net assets helps convey intention about the direction and thoughtfulness of the management over time.

Board-designated categories can come in different flavors depending on the needs of the organization and story it may tell. A group with a building or other expensive fixed assets may want to show a designated reserve for repair and replacement work. A nonprofit with significant ups and downs in cash flow may want to show a specific board designation for a cash-flow management account. A nonprofit considering a merger or acquisition may need to show a designated reserve for one-time expenses related to growth.

Each case will vary, but a few well-chosen designations will help your nonprofit story gain understanding – and therefore more support – with audiences. FASB may soon change the rule book, in which case nonprofits will want to align their narratives with the new guidelines. Stakeholders will appreciate the added information, and designations can help nonprofits keep on their strategic targets. After all, when we tell our stories to others, we hear them again ourselves.

We give lots of business model advice to our clients. It often takes a general form, such as, “improve the financial performance of this program” or “better align that profitable program to your mission.” However, sometimes a more technical analysis is required to really understand how to make a business model work.

Every nonprofit business model has unique business model drivers. These drivers are typically income-generating activities that have a significant impact on an organization’s ability to simultaneously operate at a surplus while achieving its mission. Common examples of business model drivers include: number of clients served, number of projects completed, and amount of grant funding secured. Knowing your business model drivers is essential to managing financial sustainability.

These drivers often consequently correspond to the triggers within scenario budgets.  A scenario planning trigger is a decision point at which an alternative budget scenario is implemented. For example, “if we aren’t at 200 clients served by June 30, we need to switch to our Plan B budget and corresponding expense reductions.” Or, “if contributed income is 20% greater than budget at mid-year, we can consider moving to Plan C and implementing our program growth plan.” Scenario budget triggers are critical, because in a changing environment, action is almost always necessary. (For a scenario planning spreadsheet template, check out the ‘Budgeting and Planning’ section of the Nonprofits Assistance Fund’s resource library.)

Setting the appropriate scenario budget triggers requires a good understanding of an organization’s business model drivers. Nonprofit leaders often wonder, “How exactly do I make this budget work?” Or, in other words, “What is the optimal level of service for our organization?”

The rest of this post will explore how to apply a break-even analysis to a nonprofit business model. A break-even analysis tells us at what level of service we’re able to achieve a net financial result of zero, or break-even. We’re going to get technical and do some math. And, it’s going to be fun and helpful in understanding our organization’s financial health!

Let’s first start with some definitions of concepts and terms key to our example:

• Q – Quantity. This represents the number of clients served.  Depending on the business, it could also represent a unit of production.
• CI – Contributed Income. These are subsidy dollars, such as grants and individual contributions, that do not vary when service levels change.
• EI – Earned Income. These dollars vary in direct proportion to the number of clients served.
• P – Price. Synonymous with variable income, this is the amount of revenue we receive for each client served.
• FC – Fixed Costs. These expenses do not at all vary with the number of clients served. For example, if we pay $1,000 in office rent, that expense line-item won’t change if we serve 50 or 60 clients.
• VC – Variable Costs. These are expenses that vary as the number of clients served varies.

Nonprofit budgets often depend on achieving a certain Q. That is to say, at what level of service does our business model work?

A key premise is that a sustainable organization or a sustainable program operates at a financial surplus.

Sustainability = Surplus

Surpluses occur when:

Income > Expenses

Using the above definitions, we’ll think about nonprofit income as either contributed or earned:

Income = CI + EI

Also using the above definitions, we’ll think about expenses as either fixed or variable:

Expenses = Total Fixed Costs + Total Variable Costs

 So, to achieve a surplus, contributions plus earned income must be greater than fixed costs plus variable costs. We’ll call this our Sustainability Equation:

CI + EI > TFC + TVC

Earned income depends on our variable income and the number of clients served, and our variable expenses depend on the cost per client and the number of clients served:

CI + (P*Q) > TFC + (VC*Q)

Since the purpose of this exercise is to find out what service level makes our budget work, we can do some algebra to solve for the variable Q.

CI + (P*Q) – (VC*Q) > TFC

Q * (P-VC) > TFC – CI

Q > (TFC – CI) / (P-VC)

Now we have a useful equation!  To put the analysis to work, we first need a good understanding (or a good guess!) of the following variables: Total Fixed Expenses, Contributed Income, Price, Variable Costs.

Let’s apply the formula to a simple example to illustrate the analysis.

All Services Nonprofit gets reimbursed $500 for each client served. Current staff has the capacity to serve more clients, so the only variable expenses of adding a client are $100 in transportation expenses.  Most of the budget doesn’t change with the addition of a client; we have fixed expenses of $500,000. The organization expects $300,000 in contributed income next year. How many clients does All Services need to serve to achieve a surplus?

Q > (TFC – CI) / (P-VC)

Q > ($500,000 – $300,000) / ($500 – $100)

Q > $200,000 / $400

Q > 500

The budget breaks even when 500 clients are served. If more than 500 clients are served, and all of the other assumptions are accurate, a surplus will be achieved. This is true because there’s a positive margin per client, so that 500 is a minimum quantity.

For some nonprofits, there is a negative margin per client, meaning that costs per additional client exceed revenue per additional client. In those cases, the quantity that the above analysis yields is a maximum not to be exceeded. Serving too many clients would lead to a budget deficit.

In the short term, we work hard to achieve the service level that makes our business model work. But, what if we can’t achieve this level of service? Let’s think back to our sustainability equation:

CI + EI > TFC + TVC

As soon as we suspect that our earned income won’t make its budgeted goal, it’s time to consider alternatives such as increasing the price, increasing contributed income, or decreasing expenses. (This highlights the important point that fixed expenses aren’t necessary inflexible expenses. All expenses should be considered flexible to some degree.)

Nonprofits Assistance Fund’s scenario planning template can help you to imagine what different levels of income and expenses would mean for your bottom-line.

For almost all nonprofits, service level is a key business model driver. It’s important to understand in which direction it’s driving your organization!

There have been years when I hated to see the year end because of all the wonderful, joyful events that had occurred. This year, though, was pretty mixed in terms of the financial health and sustainability of Minnesota’s nonprofits. While there was a lot to celebrate for nonprofits in 2011, there were also challenges which I’ll be happy to leave behind. I can see some silver linings in these clouds, though, in new practices and trends that will lead to better financial health and capacity in 2012.

So in the spirit of year end lists, here are five goodbyes for 2011 – and hopes for 2012:

Goodbye

1. State budget impasse and shutdown: Without a doubt the low point of the year for nonprofits was the long budget battles, anxious uncertainty, and the twenty day state government shutdown. While many services were maintained by court decision, nonprofit leaders had to divert their attention to preparing, information gathering, planning, and navigating appeals and systems to survive.
   Silver lining: Nonprofit leaders learned a lot about contingency planning and budgeting which has led many organizations to begin more substantive scenario planning for 2012.
2. School funding shift: For three years, the state budget has shifted part of the funds for public schools to the next year in an accounting maneuver to close budget gaps. As of July 2011 the shift is up to 40%. The impact of this shift on charter schools is particularly difficult because of limited cash reserves and financing alternatives.
   Silver lining: Nonprofits Assistance Fund made our first significant public policy effort to provide data and analysis on the impact of the shift on charter schools. We look forward to more policy involvement in 2012.
3. Information overload: So much data, information, analysis and opinion to read, hear and see. I’ve been pretty overwhelmed this year by it all, but I can’t seem to stop myself. Between printed media (yes, I still read daily papers), online journals, broadcast and cable media, Facebook, and Twitter, I should be as well informed as humanly possible. When I found myself standing by the steps of the capital at 11 pm on June 30th, though, listening to MPR on a tablet computer and reading tweets on my phone, I realized I had fallen into the well.  I had to learn to “curate” for myself (new buzzword alert).
   Silver lining: We have amazing journalists in Minnesota through nonprofit and for-profit media outlets that make their reporting available. My hope for 2012 is that the economic models for high-quality reporting and ideas gain stability and support from all of us who rely on them.
4. Financial crises and closures: A number of nonprofits in Minnesota ran into severe financial problems in 2011 which resulted in major program contraction or closing their doors. The prolonged recession was a big contributing factor, but not the only factor.
   Silver lining: Some board members have woken up to the need to to ask better questions about both short term financial information and long term structure and sustainability. We hope in 2012 to see better financial governance that goes far beyond micromanaging budget variances.
5. Unemployment: We all know too many people who have been laid off by nonprofits, government agencies and businesses in the last three years.  It’s been a loss to have talented, experienced, committed workers sidelined and spending long months or years searching for work.
   Silver lining: There are glimmers that nonprofits are finally being recognized as employers and “job creators”.  As reported in this Nonprofit Quarterly article the nonprofit sector is generating jobs at a faster rate than the private sector. A new advocacy organization, CForward, was formed to “champion the economic role of nonprofits”. We are hopeful that a variety of incentives and policies will be adapted to support the nonprofit sector as an economic force.

My final goodbye for 2011 is to thank all of the staff, volunteers, and board members of nonprofits everywhere for your commitment and effort to help people, build community, create magic, and bring us all together. My hope for 2012 – that all of your organizations are productive, effective, satisfying – and well-funded – in 2012.

Brad Kruse, Program Director at Hugh J. Andersen Foundation with Steve Boland, Nonprofits Assistance Fund

The Minnesota Council of Nonprofits’ Minnesota Foundations 2012 conference was another info-packed afternoon, talking about all the news from the latest edition of the Minnesota Grants Directory. Hundreds of grant-seekers gathered to share what they know about philanthropic support in Minnesota, and occasionally to bemoan how funders just don’t get us.

The conversation shifted to ways nonprofits can help granters. One suggestion was to add a good narrative to budgets or financial documents. Financial narratives are brief comments that can accompany grant proposals and can be extremely helpful for potential funders. Nonprofit organizations that use financial narratives have the opportunity to explain unusual or exceptional circumstances and avoid any potential confusion or misunderstanding.

Some possible situations to explain in a financial narrative:

• Is there anything in your document that would stick out as unusual for the first-time reader?
• Are there any unusually large or exceptional sources of revenue requiring explanation, such as receiving a planned gift or one time grant?
• Explain if your organization received a multi-year gift that will be recognized all in one year and expended over multiple years. A simple sentence or two can go a long way in explaining an unusual surplus in one year and then deficits in one or more years after. If applicable, be sure to report temporarily restricted income and explain the restriction.
• Does your organization have an internal, board-restricted reserve or other internally restricted funds as opposed to having cash on hand? If so, does your board have a cash reserve policy? Explain cash reserves and any policies in the narrative.
• If your organization has a deficit or multiple-year deficits, put the situation in context and use the opportunity to explain what the organization is doing to address the situation.
• If your organization has a healthy balance sheet with surpluses, put the situation in context and explain your need. “Why not spend down your resources before seeking more?” You likely have a good answer. Write it down.
• Explain if the special event revenue line. Is this one special event or the totals from several special events?
• Does your individual giving contain special events or are those listed separately?
• Large amounts of in-kind contributions can raise questions. Provide some detail that explains how these donations fit the guidelines for in-kind contributions.
• Does your program budget contain all committed funds or only partially committed funds and the plan(s) to raise the necessary funds?

Obviously, not all of these questions are appropriate for every situation and financial narratives should be kept brief. A financial narrative that goes on for pages and pages is usually not as helpful. A brief, one-page or less narrative can be an important tool in helping your organization tell your story and make your case.

The acronym “CDFI” is a clumsy one for an elevator speech or for a holiday dinner table conversation. Not many know what the letters stand for, let alone what it means to be a CDFI.

A CDFI is a community development financial institution. As a CDFI, Nonprofits Assistance Fund works on the fringes of lending, finding financing opportunities that are credit-worthy but just beyond the reach of more traditional sources credit. Where other lenders see risk, we often see opportunity. In over thirty years as a loan fund, Nonprofits Assistance Fund has built the expertise that allows us to make working capital and real estate loans to nonprofits with a loss ratio of less than 1%. By gaining CDFI designation from the Department of Treasury’s CDFI Fund, we are able to access specific federal dollars and tax credits to increase our impact.

The CDFI industry is broad.  It includes loan funds, community banks, credit unions, and venture capitalists. The common goal of our work, as articulated by our nationwide trade association the Opportunity Finance Network, is “investing in opportunities that benefit low-income, low-wealth, and other disadvantaged communities across America.” While many CDFI products and services are aimed at individuals, small businesses, or a specific type of nonprofit, Nonprofits Assistance Fund is unique in that we lend to a very wide range of 501(c)3 nonprofit organizations. Nonprofits Assistance Fund’s mission “to build financial healthy nonprofits that foster community development” is often times achieved by providing deserving nonprofits with access to credit. (Our mission is additionally accomplished through our training and financial assistance programming.)

Why is access to credit a justice issue?

Opportunity Finance Network hosted their 2011 annual conference November 11-14 in Minneapolis.  Over 1,000 individuals attended to learn more about the work of “aligning capital with justice.”

CDFIs are credit providers. Credit is simply borrowed capital. I invite you to close your eyes and say that word aloud: “capital.” Capital. It drives our world. Here are just some of the reasons why capital matters:

• Capital drives returns. In our world of nonprofits, capital investments can drive both financial returns (i.e. an invested endowment or start-up money for a profitable social enterprise) and social returns related to our missions (i.e. reduced incidence of drug use or increasing youth civic engagement). In many cases, capital investment in nonprofits yields both financial and social returns.
• Capital minimizes disruptive crises. In the case of households and businesses (including nonprofits), access to flexible credit, like cash, is important to successfully manage unexpected events.  For a nonprofit, insufficient access to flexible capital can inhibit our ability to fulfill our mission.
• Capital enables innovation. Individuals, businesses, and nonprofits alike, are often unable to take risks that lead to innovation due to insufficient capital. Without capital, great ideas are often left sitting on the shelf.
• Capital can disrupt the forces that perpetuate low-income and low-wealth environments for individuals and communities. As the well-known model of micro-lending has demonstrated, having a little access to capital can go a long way toward income generation and wealth building.

At Nonprofits Assistance Fund and at other CDFIs across the country, we are motivated every day in our work to align capital with justice in our communities. We place the highest value on our incredible community partners that work for justice while being good stewards of our dollars.

To learn more about the CDFI industry, watch this 4-minute video produced by the Opportunity Finance Network with support from Citi Foundation.

To learn more about other CDFIs based in Minnesota, you can view a directory here.

To support the CDFI industry, you may contact us, or simply purchase a Create Jobs for USA bracelet for $5 at a Starbucks location near you.

Here’s a classic chicken-or-the-egg question. What comes first, creating a system to work together for collective impact, or assessing all of the seismic shifts underway? The article on Collective Impact has generated a lot of conversation and momentum for systems thinking. The United Front event in October introduced the concept and practice to hundreds of nonprofit and philanthropy leaders. The article makes the case for a new approach and describes a practical implementation.

A few weeks ago, the Alliance for Children and Families released a thought-provoking report calling on human service nonprofits to take bold action in order to continue to serve communities. The report, Disruptive Forces: Driving a Human Services Revolution is focused on the future, recognizing that while we don’t know what’s coming, we do know that major shifts are underway. In the report, the Alliance describes the massive challenges facing human services. Adapting to respond to these changes will require much more than new fundraising tactics and hard-working staff. They urge nonprofits to consider themselves as a part of a much larger system and then plan how to participate in new kinds of networks to serve community needs. Similar to the conversations about collective impact, the focus is on impact in the community and not on preserving individual organizations.

At the heart of the report are six disruptive forces that nonprofits need to understand and tackle:

1. Purposeful experimentation: Nonprofits regularly hear about the need to innovate and develop new models, but there isn’t a clear path or pattern to follow. We all need to try things, test new ideas, and take calculated risks.
2. Information liberation: Locked down confidentiality has become a barrier to delivery improvements and consumers will take control of their information to find better services within and outside the systems.
3. Integrating science: Delivering human services can be improved, even revolutionized, by applying new scientific research and crossing fields. The walls between disciplines need to come down.
4. Uncompromising demand for impact: Measuring, verifying, and communicating impact is neither optional nor is it an after-thought to service delivery.
5. Branding causes, not organizations: Marketing and fundraising for individual nonprofits may be effective for raising money and name recognition, but branding a cause can change public perceptions and lead to bigger changes. This force may seem to counter a nonprofit’s individual interests but is necessary for the broader vision.
6. Attracting investors, not donors: This force is part of a growing call to recognize the return on investment of human services and translate these benefits into actual returns, either for the public or for financial investors. This may include long term, patient philanthropy, pay for performance funding, and collaborative investments.

The Big Idea of the report is:

“There must be a shift from an organizational-centric focus to an acknowledgement of the importance of networks and collaboration. … This shift will be difficult and will require many key players to set aside their own egos and become less defensive of their ‘home turf’”.

Unlike the Collective Action articles, the report doesn’t offer a guide for how to build a network. The authors encourage nonprofit CEOs and boards to ask a lot of questions about these disruptive forces and their responsibility to stretch their traditional boundaries, take risks, and build the networks that can create real impact. How should they start?

“Call to Action: In this report, we encourage you to seize the opportunities that contradictory, complex situations create.”