Balancing the Mission Checkbook

Many nonprofits think about the Internal Revenue Service only once a year - when they are filing their 990 return. Since the IRS is the regulator and enforcer of exempt status and activities, you might want to pay closer and more frequent attention. Of increasing importance are questions about the role and scope of the IRS’s watchdog and oversight activity. The IRS website has a section devoted to Exempt Organizations that contains some valuable resources. The article on Governance and Related Topics opens, “The Internal Revenue Service believes that a well-governed charity is more likely to obey the tax laws, safeguard charitable assets, and serve charitable interests than one with poor or lax governance.” Who could disagree? But where does the IRS fit in assessing the quality and effectiveness of your governance practices?

In speeches delivered at a conference on April 23rd and 24th, Commissioner Steven Miller makes clear that the IRS believes that there is no question about whether they have a role, but rather what that role is. In his April 23rd speech as part of a panel on nonprofit governance he addresses the questions by saying, “despite the absence of explicit federal statutory provisions setting forth clear governance standards, what I am calling jurisdictional gaps, we are not interlopers trying to regulate an area that is beyond our sphere.” In other words – the IRS intends to exercise its muscles, real and perceived, in the movement to push nonprofits to more specific standards in governance practices. If you doubt that they can, read the 20 questions contained in the Governance, Management, and Disclosure section in the new Form 990.

The new IRS 990 form is effective in 2009, with a two year transition period for some nonprofits. Most nonprofits I’ve talked with have only a general awareness of it out there in the future. It’s time to pay close attention now. It’s a significant change to the current 990, with several new schedules that may require different record keeping for 2008 activities. The IRS recently released the draft instructions that offer the most detailed view. (Read through Part VI of the new form: Governance, Management, and Disclosure.) You’ll also be seeing more e-newsletters from accounting firms and nonprofit associations with updates and training events.

Regarding the question of whether the IRS should have an enforcement/watchdog role in governance, I think we should take a step back. Let’s consider why the service, and Congress, think that they need to. When there are bad actors and the public feels victimized, regulations often follow.

Following up on questions raised during some training workshops I presented last week, I’ve decided to start an occasional series called Mythbusters – Nonprofit Finance Edition. There are a number of pieces of “common wisdom” that I hear over and over again, and some of them are just not helpful. So starting with this post I’ll be adding my own spin to the Discovery Channel show Mythbusters (is it true that a penny thrown from the top of the Empire State Building will kill a person on the ground?).

Nonprofit Finance Mythbuster #1 – “Every nonprofit should have a cash reserve equal to three months of expenses.” There’s some truth and some myth to this “best practice.” It is absolutely true that every nonprofit needs to have adequate cash balances available to support the timing of payroll and other expenses, as well as to pay for unanticipated costs or increases. It’s a myth, however, that a single standard applies for all nonprofits. I have two issues with the “three month reserve” standard. One is that different organizations need different amounts of cash on hand. The second is that building a reserve of three months of expenses is not a practical, or even desirable, goal for all nonprofits.

First, how much should nonprofits have in cash reserves? A single standard doesn’t factor in some important variables, starting with the stability of the nonprofit’s cash receipts. Organizations that have contracts or fees with regular and reliable payments don’t need as much in cash as organizations that rely on a few big grants, fundraising events or campaigns, or seasonal activities. I’ve reviewed financial reports from large nonprofits with pretty low cash balances. They wouldn’t meet a standard requiring three months of expenses, but they also have regular cash receipts from program fees, contracts, and year-round fundraising. They also have high quality receivables and other short-term assets (which create “working capital”).

The other myth is that nonprofits can go from step one, the board adopts a policy requiring a three month reserve, directly to step two, open the savings account. Somewhere in there, voila, the cash is generated to deposit the required amount. Where do cash reserves come from? Consider a hypothetical agency that provides mental health services with a $2 million annual budget. A three month reserve is $500,000. Starting from zero, they need to generate a 25% surplus of income over expenses to build these minimum reserves. This is unattainable in the near future, and it may be far more cash than this agency needs. If the mental health services are paid for by third party insurance payments and contracts with the county government, cash flow may be stable enough that about one month in operating cash, or $165,000 - $200,000, will be enough.

Bust this myth. Rather than falling back on an easy standard, each nonprofit needs to understand their revenue sources, project month by month cash flow, anticipate any shortfalls, build in some cushion for snags or surprises, and create a workable and customized policy.

My interest in financial mythbusting is inspired in part by a series I’ve enjoyed by Paul Shoemaker at his SVP Blog at Social Venture Partners Seattle. Over the past few months Paul posted a series called “10 Things We’d Like to Tell Every New Philanthropist.” For example, Lesson #3 - “I need to be careful to not let the non-profit get too dependent on my contributions.” Each of the questions that he poses seem to make sense, but he warns that these common misperceptions and mistakes need scrutiny and discussion to avoid the problems they can cause. He’s finished the list of ten lessons for philanthropists and said he would follow this series with “10 Things We’d Like to Tell Every Nonprofit.” I look forward to seeing his new top ten list.

For those of you who are not familiar with Alltop, it’s a place that gathers and posts stories on a particular topic, in this case nonprofits. You can visit Alltop and see the most recent posts from a range of news sources and bloggers, as well as find new sources of information to expand your online resources. In their own words,”You can think of an Alltop site as a ‘dashboard,’ ‘table of contents,’ or even a ‘digital magazine rack’ of the Internet…we are trying to enhance your online reading by both displaying stories from the sites that you’re already visiting and helping you discover sites that you didn’t know existed.”

We’re pleased and honored to be featured on Alltop. We’d like to thank our readers for their support and participation – we would not be a part of this exiting project without you. A special thanks to Guy Kawasaki and Nononina, Nedra Kline Weinrich, and everyone else at Alltop for including us in your site.

For more information on the story behind Alltop, to see their full list of categories, or to browse the latest top stories, visit http://alltop.com/.

I recently had the pleasure of participating in a roundtable conversation with leaders from several Minnesota foundations about the Big Topic of general operating support. The meeting was convened by Minnesota Council on Foundations and published as the feature story in the new issue of Giving Forum. This issue includes the roundtable discussion as well as related stories about trends in types of support, current practices, and additional thoughts from other leading foundations.

I left the roundtable with a sense that this may be a good time to start moving on from this endless discussion/argument. As Juliet remarked, “What’s in a name? That which we call a rose, by any other word would smell as sweet.” Today’s version is “General operating support, by any other name would help as much.” It was notable that the participants didn’t have a “line in the sand” definition of general operating support. The distinction didn’t seem to be nearly as important as you might think with these foundations that understand that program grants have to include all the costs of the programs. The foundations were not very concerned with tossing out gen op requests. They were focused on working with nonprofits doing good work in the community that matched their foundation’s areas of interest, and providing support – program, project, organizational – to help them to do that work. We talked a lot about flexibility, long-term relationships, trust, and shared community goals.

What are the goals? Foundations want and need to understand how the funds they provide are helping to meet needs in the community that match their priorities and interests. Nonprofits want and need funds to support programs that further their mission with some flexibility to respond to the changes that might occur. Both foundations and nonprofits want to help the community. Both also want to have trusting, honest relationships. Too often, unfortunately, these priorities have led to battles in the general operating vs. program grant war. Are the goals really all that different? I suggest that we move the last goal into first position – both foundations and nonprofits want to have trusting, honest relationships. These relationships require clear information, reliable decisions (no surprises on either side), real numbers, and a good match in mission and community vision. I know that you might say that the particular foundations represented at the roundtable are some of the most committed to creating these relationships (and they are). Fortunately they are also leaders in the foundation community.

By the way, it’s interesting to read your own words in a transcript, as I got to do with this Giving Forum. I cringed a little when I read this verbatim excerpt: Barr, “I hear [nonprofits] say that general operating pays the rent and program support pays for the work; that’s the worst accounting I’ve ever heard.” Harsh – but I stand by it.

Last week, I unplugged from email, Blackberry, and voicemail for a nine-day vacation. I’m sure you’ve all enjoyed the times when you change pace, slow down, and relax. It was indeed a great break – but interestingly, I was not taking a break from nonprofits. They’re everywhere – and that’s a wonderful thing. Our trip started with a few days in Virginia in the Shenandoah Valley and the Blue Ridge Mountains and ended with some time in Washington, DC. With that itinerary, I’d expected that our time would be dominated by businesses, like hotels and restaurants, and by the National Park Service for our visits to the Skyline Drive, the National Mall, and other historic sites. What I hadn’t really thought about was how much nonprofits would be woven into the trip. Both Thomas Jefferson’s home at Monticello and George Washington’s Mount Vernon are owned and operated by nonprofit organizations, and are supported by fundraising, fees, and gift shop sales. In DC, the National Mall is a public park, but many of the events and special features are created and supported by nonprofits. We were lucky enough to be there at the peak of the cherry blossoms and the (nonprofit) National Cherry Blossom Festival. I know that this photo looks like a postcard, but I really did take it myself! To round off our nonprofit immersion, we had dinner at the funky Busboys and Poets restaurant, operated by a nonprofit, Teaching for Change.

It’s probably not a surprise that nonprofits are everywhere – and that’s a good thing, right? So maybe we should push back the next time someone brings up the argument that there are too many nonprofits, or that “someone” should prevent new nonprofits from forming. While I was on my nonprofit tour, in fact, there was a blog exchange on this very topic that you can find at Give and Take. I’ll confess that I’ve contributed to this idea on occasion, but my trip and the time I had to reflect on the presence and role of nonprofits has made me re-think this. Come on in! If a group of people have the commitment and passion to help the community, and are entrepreneurial enough to pull together an organization and programs, then I hope they can find their role and support. It isn’t easy. The field may be crowded, and funding is competitive, but important work is being done. Thanks.

I was at breakfast last week with the founding executive director of a nonprofit and he made an off-hand, joking comment about how he supposed that that meant the organization had “Founder’s Syndrome.” It did make it sound like a disease, like Carpal Tunnel Syndrome. This isn’t the first time that I’ve heard this annoyance from a founder about this term that is used so frequently. Is it really fair, or even accurate, to label all founders with a pejorative term? It doesn’t sound very appreciative – like, “Thanks for having the guts and moxie to start this organization.” Most founders who I know didn’t fully realize what they were getting into when they started the nonprofit. Most start nonprofits because they feel deeply about the program and mission. They didn’t anticipate needing to fundraise, recruit and develop a board, manage staff, and make dozens of decisions every day. They did what they needed to – and now they have this Syndrome.

I won’t deny that there are organizational development issues that frequently occur in organizations with a strong founder/leader that impact decision-making, control, knowledge, and direction. When we call it a Syndrome, though, it sounds incurable. I think it needs a better identity as a leadership problem that can be corrected. I also take issue with the description of Founder’s Syndrome since I’ve worked with many nonprofits with all the same poor practices that were led by a second, third, or fourth director. Whoever the director is, these characteristics describe a common leadership problem that becomes an obstacle to effectively sharing responsibility, authority, and building a strong organization.

Does the founder, or strong leader, have to leave the organization to “cure” the Syndrome? I hope not, and I have seen plenty of examples of founder/leaders taking part in an organizational transition. It takes commitment, effort, and lots of trust – and requires that the board and staff respect the leader for what they have done in the past and what they are capable of in the future.