Balancing the Mission Checkbook

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.

We’ve worked with several nonprofit organizations during the difficult period leading up to closing the organization. Sometimes the decision is internally driven and intentional, and sometimes it’s after fighting it, kicking and screaming. How do you know if it’s time to close, and how to make such a monumental decision? I can think of three specific instances with very different characteristics and outcomes. The first is an arts organization that carefully and systematically paid their obligations and closed their doors after several difficult years of declining earned and contributed income; the second a youth-serving nonprofit that stayed in denial for too long before filing bankruptcy and leaving both students and creditors uninformed; and last is a small organization that remains in operation, though their relevance in the community and support from both donors and volunteers dropped off years ago. They stay alive as long as the director is willing to work with little compensation and little support. In another situation, though, I worked with an organization whose executive director repeatedly suggested closing the doors because fundraising was so difficult. The board realized that the mission was as vital as ever, though, and the solution was a different, less burned-out, director to bring new energy and ideas. These are important organizational questions that touch on financial, governance, fundraising, and mission questions. There aren’t easy answers or absolutes when it comes to closing or changing structures. Come participate in an ongoing discussion of these questions in an online discussion at Nonprofit Quarterly’s Web site - see the invitation from editor Andrew Crosby below.

Find out how one organization weighed the decision about whether it should close, and contribute your own analysis of whether they made the right decision in the Nonprofit Quarterly Online Forum.

Beginning today you can join Mark A. Hager of the University of Texas, San Anton, and Kate Barr of the Nonprofits Assistance Fund in the Twin Cities, to discuss “The Ultimate Question,” authored by Mark and published in the Fall 2007 issue.This will be a great discussion for executives, consultants, board members, and funders interested in how such decisions are made — and may be considering such decisions themselves.Just register on NPQ’s Web site to access the Forum and join us for a thought-provoking exchange where you can offer your experience, pose questions, and comment on those of others.

Once you have registered, a link to the NPQ Forum appears under the User Menu. Inside you’ll find a reprint of the case, financial background material, and some starter discussion threads that you can add to, comment on, or create your own.

So register on the NPQ Web site today to participate. Andrew Crosby, Editor

p.s. If you have any technical questions, contact webmaster James Morgan. For any questions regarding content, please contact Andrew.

Do you grit your teeth when an acquaintance tells you about a nonprofit and adds a comment like “well, they’re just a nonprofit, so what do you expect?” The implication is that nonprofits can’t be expected to be well run, but we put up with it because of the mission. “Perception is reality” is a communication fundamental. If a perception that nonprofits are poorly run is widespread, it doesn’t just damage the nonprofit being discussed, it hurts us all.

I read an article in a local Saint Paul newspaper this week that really drove this home. The paper has been following a story about financial problems at a local community organization, the Highland District Council. In May, the council’s new board discovered that payroll taxes and IRS 990s have been unpaid and un-filed for quite a while (maybe since 1998). The result is, of course, a messy and expensive problem that threatens the council’s ongoing work. The part of the story that bothers me the most, though, is this quote from a board member, “It’s not at all uncommon for nonprofit organizations to have these problems. They usually get worked out because the government wants nonprofits to stay around.” I don’t want to accept this version of low expectations for nonprofits. The reality, in my experience working with nonprofits, is that this IS uncommon. Most nonprofits, even small organizations with one or two staff members, pay their payroll taxes (often by using a payroll service), file their required reports, and stay on top of bookkeeping. Nonprofits Assistance Fund has worked closely with 1600 nonprofit organizations on financial issues. Less than 20 of them have had this kind of long-term payroll tax or IRS reporting problems. The quote in the article continues with, “This problem is a bit more uncommon in terms of how much it has been publicly discussed.” This has been a very public story with a variety of complicated local issues. I wish the board of directors and community members served by the Highland District Council the best. They have a lot of work ahead of them and I hope that they work through this situation and continue to serve the community. Because it is so public, though, it’s essential to fight the image of poorly run nonprofits elsewhere. We can’t accept low expectations.

This is just one story, but NYU Professor Paul Light’s Organizational Performance Initiative has been researching public confidence in charitable organizations for several years. The finding of the 2006 Survey reports that 71% of Americans said that charitable organizations waste a great deal of money, a synonym in my book for poor management. The report states, “Asked which problem facing charitable organizations is bigger – the wrong priorities or spending money wisely – only 17 percent of Americans answered that charitable organizations have the wrong priorities, while 73 percent said charities have the right priorities, but do not spend money wisely.” According to the report, confidence in organizations is strongly related to discretionary giving and volunteering.

Let’s not accept low expectations for nonprofits. In addition to the work you are continually doing to improve management within your organization, become an ambassador for high expectations of nonprofit management. Start talking about qualified and accountable nonprofit management as the reality that we expect and that we believe.

If you’ve ever felt that your executive director, program managers, and board members just don’t “get it” when you talk about financial reports, maybe it’s because you gave them the wrong information. I don’t mean that you are using inaccurate financial reports, but that you may be providing the wrong information all together. There is no such thing as one size fits all in financial reports, but most of the advice and guidance on nonprofit financial reports cover the same generic materials – how to read a balance sheet, income statement and audit. Does this mean that reading a financial report is the best preparation for financial decisions? Is that what you need the executive director, program manager and board members to do – to understand how to read the report? Or do you need them to know how to use the information to develop plans, monitor progress and make decisions? If you want the latter, then you need to take a look at what financial information is provided and how it’s provided.

I think there are six distinct steps in using financial information well. Each step is necessary and follows a clear sequence.

1. Produce accurate reports
2. Understand the information
3. Analyze the information through variance review, comparisons and ratio analysis
4. Interpret the information in the context of the organization’s situation, plans and goals
5. Communicate the information
6. Use the information for decisions and planning

Think about how your organization uses financial information – most of us jump directly from step one to step six. Without discounting the importance of the first two steps (a big accomplishment for most small nonprofits), the analysis, interpretation and communication are essential for really wise decisions. So who should be responsible for these different parts of the process? Are you expecting your board members and program managers to complete their own analysis and interpretation? I shared this concept with a CFO the other day and he stopped suddenly and said “what you’re saying is there is a difference between data and information”. Yes – the financial staff should strive to provide valuable information, not just accurate data. Ideally, the financial staff is responsible for the first three steps, and the fourth and fifth are completed in coordination with management and program staff.

If you take the time to really evaluate how you provide and use financial information – and diagram these six steps – you can easily create a better process for providing exactly the financial information needed for the organization. For a longer article about how boards need to use financial information, read Reporting Financial Information to the Board from the Nonprofits Assistance Fund’s financial management resource library.