Balancing the Mission Checkbook

Earlier this year, I proposed Accountability Lesson Number 1: Questions Must Be Asked to encourage directors of nonprofits to overcome their hesitancy to ask questions. In particular, when financial or governance issues are unclear or incomplete, they should continue to pose questions until they get answers. In some ways, asking questions is one of a board member’s primary jobs. What comes next, though, after the questions are answered?

Next lesson: Action must be taken. One of the most interesting dynamics in nonprofits is the relationship and shared authority of executive directors/CEOs and their board of directors. We could debate infinitely the question of who is really in charge. In day to day life, most nonprofits find a way to make it work if they have assembled and hired the right people, agree on roles, and know how to share and use information. There are times, though, when the board needs to assert its real and legitimate authority to make a big decision – to take action in the face of urgent needs for the nonprofit and its mission. In Lesson Number 1, I said that asking questions is one of the board member’s most important roles. I will state here that I think the primary role for board members, especially board chairs, is to know when they need to take action, and then to do it. I think this is an urgent issue right now because I have often seen the sometime dire consequences of reluctant, slow decisions. Too often, board members who have been expected to be good supporters and cheerleaders can’t seem to change gears and be the leaders they need to be. If the board’s practice has been to ask for more information and then defer decisions to the next meeting, and then the next, then real problems can grow while the options shrink.

The need to step up and take action is always applicable, but it seems to be more urgent right now. If income sources are less reliable, or costs are harder to identify and match with impact, then boards simply must ask questions and then follow up with real decisions – and real governance.

What do you think about these Accountability Lessons?  Do you have an example where asking tough questions and then taking action led to positive change? Or do you have lessons learned that may be helpful to others?  I invite you to share your experiences in the comments section.

I’m pretty sure that every nonprofit would love to have enough money that some of the funds can be invested for the future. In the past month, though, nonprofits may have seen their investment portfolios buffeted by the markets. If that wasn’t enough of a concern, this week we read about losses for some local nonprofits from investments related to the Petters Company fraud case. News reports this week in both MinnPost and the Star Tribune describe the negative impact on organizations that may lose millions from investments that were made to provide short-term loans to companies for inventory purchases. As Scott Russell said in the MinnPost article, these cases are “a wake-up call for other nonprofits to review their investment policies and portfolios.”  As an outside observer, it’s easy to say that these investments seem like an unlikely fit for a nonprofit organization, but we don’t know what standards or criteria those boards were using to evaluate and select investments. This is a good time, though, to review some fundamental guidelines for investments by nonprofits.

• Time Horizon – Funds that may be needed within a few months must be invested in highly liquid, safe investments. This is the most common type of investment fund for most nonprofits, composed of operating funds and reserves. In order to be assured that the funds will be available as needed, the investment choice must be readily available. The recent financial news has even raised red flags about some short-term investments – see my earlier post It’s 10 AM, do you know where your cash is?.

• Risk Tolerance – One of the fundamentals of investing is the balance of risk versus return. Investments with a higher return almost always also come with higher risk. The key question for nonprofit leaders and boards is to understand how much risk is involved and to decide if they can accept the risk. As an example, if the funds to be invested represent the balance of a large program grant that will be spent over the next year, then the organization can’t afford to risk the loss of any of the funds. A permanent endowment fund, on the other hand, is usually invested in a diverse portfolio that includes more risk in return for a higher long-term return.

• Responsibility – The nonprofit’s board of directors is responsible for overseeing this balance of risk and return for the health of the organization and any legal requirements. In order to fulfill this responsibility the board must act as prudent and loyal stewards of the organization’s assets. The board may decide to employ professional staff or outside advisers to manage the investments if the amount if large enough.  At minimum, the board needs to adopt and follow an investment policy. I highly recommend a booklet from BoardSource, Minding the Money: An Investment Guide for Nonprofit Board Members.

In this economic environment, every nonprofit needs to take a look at their investments and understand any risks that may have been taken for granted. It’s better to spend some time now and avoid surprises later.

Unfortunately, the news has been full of stories of struggling nonprofit organizations. Every nonprofit is grappling with budgets and growing community needs in the face of economic pressures. Fundraising is mixed right now, with individual giving as the biggest concern for many organizations, and corporate giving still an open question. Meanwhile, utilities and transportation costs are up and programs are trying to serve more clients. Balancing mission and money is always hard work.

It seems that every article includes a comment by either the director or board chair that identifies the current economic downturn as the cause of the financial problems. The next time you read something similar, consider the possibility that, in some cases, “it’s the economy” might be a masking a different story.

By doing a little financial detective work, I’ve found that some of the nonprofits that identify the current economy as their problem have actually been operating with deficits for several years. They spend more than they bring in – and eventually it catches up with them. Checking this out requires a few steps. Access to IRS 990s on Guidestar is a gift for this kind of research. Page 1 (Part I) of the 990 reports all income and expenses and the resulting surplus or deficit. Because this section consolidates all unrestricted, restricted, capital, and endowment activity, though, it isn’t helpful in reporting the operating results. Page ahead to Part IV, the balance sheet, and look at Line 67 – Unrestricted Net Assets. If the organization had an operating surplus, this balance will increase from the beginning to the end of the year. If they had an operating deficit, then the balance will decrease.

There are a wide range of reasons and circumstances that result in operating deficits. Recurring and unmanaged operating deficits are the number one red flag of financial problems and raise questions about ongoing viability. If deficits recur, the management and board must take the time to understand the causes and make needed changes in income and expenses. Raising money is challenging in every economic environment, especially during a downturn. Make sure you can distinguish between the economic, management, and program considerations that result in deficits and take the steps needed to address each one.

Jeanne Bell at CompassPoint wrote a wonderful column about surplus and deficit planning, Nonprofit Budgets Have to Balance: False!. She asks strategic questions about budgets:

Instead of “How can we make the budget balance?” the annual budgeting cycle should begin with the question, “What financial outcome does our organization want or need this year?”

I can’t think of a single nonprofit that would answer that question by saying, “Our desired financial outcome is to run out of money and close our doors.”

How do you know what you don’t know? Someone asked this question last week in a workshop on the topic of board oversight and some high-profile problems. It’s such a great and critical question. There’s been a swirl of conversations in the last week or so about financial problems and governance issues at a number of nonprofits, both local and national. No matter what the details are, questions have been raised in every situation about the board’s role – what did they know, when did they know it, and what did they do? But what’s the first step for the board, since they are relying on reports from the staff and have little or no access to the raw information. Boards that ask for lots of details are accused of micro-managing and not trusting the staff. So how do you know what you don’t know? There has to be a balancing act between accepting reports at face value and asking questions that go beyond the information presented. I think that there’s an art to asking good questions – my favorites generally start with either “Why…?” or “What if…?” (I actually have those two words up on the wall in my office). Speaking last night to a group of people who had recently joined boards of nonprofits, I suggested that asking questions is their primary job. It’s great if they get an answer that makes sense. However, the role of governing requires further action and follow up when the answer doesn’t make sense, or when the answer is “Don’t worry about it,” or “I’ll find out later.” The distinction between hyper-questioning and prudent questioning depends on circumstances, but in every one of these recent governance and financial situations there were some “why” questions that needed to be asked and then carried through.

This complex balancing act between supporting and governing is discussed in the article Why Boards Don’t Govern available from CompassPoint. One point raised in this article is the importance of creating an atmosphere and culture at board meetings that encourages questions and disagreements. I know in financial matters, many board members feel like second-class citizens because they are not the “financial” board members. The fact is that if they have a question, or if something doesn’t make sense, they need to feel free and encouraged to ask the question. It just might be the question to unlocks the truth.

There was no telling what people might find out once they felt free to ask whatever questions they wanted to. (Joseph Heller, Catch 22).

Eight years ago, ACORN, a national grassroots community organizing nonprofit, was the victim of an embezzlement of almost $1 million from an employee who was the brother of the organization’s founder. The fraud was never reported to their board of directors or legal authorities, but a small internal group negotiated a restitution agreement and then kept the perpetrator on staff. The situation just became public after pressure from a whistle-blower and was reported this week in The New York Times. Quoted in the article, ACORN’s president said, “We thought it best at the time to protect the organization, as well as to get the funds back into the organization, to deal with it in-house.”

Can we make a list of the problems with this scenario? Among other reactions, I want to thank the whistle-blower, though I would like to know why it took eight years for anyone to think this was not OK. Yesterday, ACORN released a statement from the president apologizing for their handling of the situation and announcing that the founder (brother of the embezzler) had stepped down. The most alarming phrase in the statement is that “The ACORN Board recently learned …” How comfortable would you be if you sat on that board – with fiduciary responsibility – and learned that you had been sitting for years on this ethical powder keg?

The statement says, “We want to assure our many friends and supporters that ACORN’s Board has taken additional steps to ensure increased transparency and accountability” (emphasis mine). It seems to me that they need to start with basic transparency and accountability. They can start with a basic accountability overview from Independent Sector.

There is a lesson here for every nonprofit organization. Public trust really is the most important asset for each individual nonprofit and for the whole sector. It’s too easy to mess it up, which is why we all get asked to answer questions and fill out forms and certifications by donors, foundations, the IRS, state Attorney General, etc, etc, etc. As long as these kind of egregious situations occur, and especially when they are mishandled, nonprofits will be subject to deeper scrutiny and misgivings about trustworthiness.

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.