Balancing the Mission Checkbook

How much are you willing to pay for a ticket to the theater, a management class, or a counseling session? What should other patrons or clients pay for that same service? Does it matter to you whether or not the price that you pay covers the actual costs of receiving that service?

The rapid changes in the availability of government and philanthropic funds to pay for and subsidize services have led many nonprofits to examine their financial structure and realize that they can’t afford to continue to offer their services for free or nearly free. That model may have worked when the grants and contributions were available, but it doesn’t any more.

Nonprofits Assistance Fund offers workshops and webinars for staff and board members of nonprofits on financial management topics. We charge a fee for these training programs. What’s the right price for us to charge? Change the specifics and that same question is being raised at nonprofits of every size and scope. The answer, as with everything, is “it depends.”  It depends on the purpose and goals, both programmatic and financial, of offering the service. Should prices be based only on costs, or does market demand factor in understanding what your clients or audience are willing to pay? Some of the fee-based services offered by nonprofits are more naturally based on market and competition. Others are much more sensitive to the ability of clients to pay. Theater tickets and tutoring for low-income students have different economic models.

When you start this analysis, it’s important to recognize that discussions about starting to charge a fee or making changes to prices often get caught up in emotions about money and organizational and personal values. When the suggestion of requiring a payment from clients first comes up, expect some of your colleagues to recoil in horror. Someone may even tell you that nonprofits are not legally allowed to charge for their services. (Please tell that to the two colleges that I’m currently supporting!) Talking about money is uncomfortable for many people, and offering services for no charge is very easy. Unless you have adequate subsidy dollars from contributions or other sources though, it’s not sustainable.

A recent post on the Stanford Social Innovation Review blog, Nine Tips to Better Nonprofit Pricing, provides a good start with the market approach. I highly recommend the article To Fee or Not to Fee?, published in the Summer 2004 issue of Nonprofit Quarterly for a thorough review of whether or not to charge a fee, how fees and program access can be aligned, and how to set prices. The article makes a strong case that charging fees improves the relationship with clients:

The most powerful argument in favor of charging fees is the discipline of the marketplace – that fees increase accountability to the people receiving services.

They include a summary of research that showed that fees may help clients buy-in to the services more and perceive greater benefits.

For most nonprofits, charging fees and setting prices will depend on a number of factors, but most of these can be addressed with operational capacity, program design, and differential pricing. This topic is worth a thorough review whether you currently charge fees or not as a part of long term financial planning and strategy.

All of us are reading waves of economic information right now – the stimulus, the proposed state and federal budgets – and are trying to sort out which parts have a direct impact on our communities and organizations. Both the stimulus and federal budget are big and bold and pretty overwhelming. There is so much to understand and analyze – thank goodness for some great resources like Minnesota Budget Bites and National Council of Nonprofits. I’m trying to keep up with the general framework and get into specific details when I need to. I hope that all of us who are committed to stronger communities will spend the necessary time to understand what’s needed and work together with the big picture in sight.

Considering the importance, scale and scope of the economic proposals, I am really disappointed that that the number one, highest priority, most important issue for many in the nonprofit world is the proposal contained in the President’s budget that would limit the extent of deductions for charitable contributions for those in the highest tax bracket, reported here in the Chronicle of Philanthropy.

Typical of the outcries in response is a statement from Independent Sector:

Independent Sector believes that this change could be a disincentive to some donors who might further cap their gifts on account of the new limit.

Most of the comments made by our well-known leaders include the phrase “In these hard economic times” and forecast doom if this change comes to pass.

I’m disappointed in this knee jerk reaction that’s just a version of NIMBYism at a time when we really need to pull together and work for the greater common good, which may involve sacrifice. Beyond that disappointment, I’m skeptical that doomsday will come. First of all, the change wouldn’t be effective until 2011, so it won’t impact donors “in this tough economic environment.” And if you really believe that your donors are in it for the tax deduction I think that you need to re-write your case statement. Surveys, like one conducted in 2006 by Center on Philanthropy at Indiana University for Bank of America, report that over 50% of the high net worth people interviewed would not decrease their giving even if there was no tax deduction at all. From what I’ve read, the tax deduction is more likely to impact the timing and form of a gift rather than whether a gift is made. It’s easy to get this form confused with substance. Consider this from Charity Navigator’s blog:

The data that we have seen over the years has shown a big spike in donations through our site during the last several days of the year, especially on December 31st which of course is the last day to make a qualified tax deductible charitable contribution (see our Tax Benefits of Giving article). This data indicates to us that the tax benefits really do motivate people to donate.

This logic needs checking – do the tax benefits “motivate” people to donate, or have we in the nonprofit world trained our donors to give in December regardless of their motivation? The New York Times article Limiting Deductions on Charity Draws Ire quotes several other experts about the relationship between tax deduction and reasons for giving and their confidence that taxes are at the low on the list.

Even if this tax code change would have an impact on total giving, it’s important to focus on the forest, rather than the leaves on the trees. The proposed federal budget blueprint represents a seismic shift in priorities and structure. I agree with blogger John D. Columbo’s comment:

So let’s not turn this into a doomsday scenario, folks. The truth is, if Obama can fix our health care system, charities as a whole (and everyone else, from GM to the local barbershop) are going to be much better off in the long run.

Independent Sector’s statement (quoted above) includes only one other paragraph about the rest of the 140 page blueprint for the federal budget:

The budget outline also calls for winding down spending for the war in Iraq, boosting funding for domestic priorities, and creating a “reserve fund” of $634 billion to cover health care expansion. The President has stated that his outline will cut the deficit in half by 2013.

Well, maybe that doesn’t seem that important to them.

Nonprofit board members are asking what they should do – specifically to help organizations navigate the economic mess. BoardSource recently published Facing the Financial Crisis: 10 Smart Things Your Board Can Do Now. The article offers a solid, strategic perspective for boards. I have some supplemental words of advice for each individual board members – three steps for board members to consider in a downturn.

1. Step out

Step out of the familiar and comfortable role of supporter and cheerleader.

Now is the time to ask important questions about impact, effectiveness, and entrenched practices. Board members can often bring the outside viewpoint required to ask the right “why” and “what if” questions.

Some of the most important questions to ask right now are about budget assumptions. Any significant revenue number in the budget needs to have a good plan and rationale, not a wish and a prayer

2. Step back

Step back and let the staff do their work.

I have seen boards get carried away generating ideas for new reports, analysis, and research without considering how much time it would take the director and staff to complete the work required to follow through on the ideas. The board chair is the moderator of this balancing act, making sure that every new task suggested by the board is weighed against other priorities and internal capacity.

I urge particular caution for board members who suggest that the nonprofit start a new way of raising funds. If you’ve never hosted a fundraising event, or carried out a significant individual donor campaign, this might not be the time to divert staff time and effort. Remember that each type of income is essentially a new business.

3. Step off

Step off of the board if you do not have the time or energy to work hard for the next two years.

This is not going to be easy and nonprofits need to have the right people on the board. It’s nothing personal, but it’s a good time to ask yourself if you can commit to this organization.

Call it what you want – surplus, positive change in net assets, or profit – nonprofit organizations really need to plan for, and embrace, the importance of building financial capacity by generating a cushion. We don’t have a common language for this, and many nonprofit leaders would be uncomfortable using a term like “profit” when describing their financial goals. The word is much less important than the practice of budgeting and managing to build surpluses. Read “Organizational Slack (or Goldilocks and the Three Budgets” by Woods Bowman, published in the Spring 2007 issue of The Nonprofit Quarterly, for a very helpful overview of the topic.

The definition of slack used by Bowman is “a cushion of potential resources which allow an organization to adapt to internal pressures for changes in policy, as well as to initiate changes in strategy with respect to the external environment.” The benefit of a cushion is probably clear to any nonprofit director. Money doesn’t just fall into your lap to build a reserve. Bowman makes it simple and direct: “Where does financial capacity come from? There can be only one place: annual surpluses.”

Planning for an annual surplus, specifically an unrestricted surplus, is a positive, important, beneficial, and necessary practice for all nonprofits. I emphasize the importance of viewing unrestricted operating results, rather than the total of all unrestricted and restricted funds, because of the volatility in results caused by the timing of project and multi-year grants.

One step that could encourage the practice is to add a measure or ratio that defines the annual addition to the reserve or cushion. In the for-profit world, this is communicated in a fundamental ratio:

Net Operating Income = Profitability Ratio
Total Sales, or Revenue

The comparable measure for a nonprofit could be a CINA (change in net assets) ratio:

Unrestricted Change in Net Assets = CINA Ratio
Total Unrestricted Income

Try calculating this ratio for your nonprofit organization for the past few years and you will start to see how well the ratio can communicate the building, or depleting, of financial capacity. How high should the ratio be? On this point a for-profit and nonprofit organization will differ. A for-profit company seeks the highest ratio possible. For a nonprofit the ideal amount of surplus depends on what they need – and that balancing act is complicated. Bowman’s article has a whole section on measuring the right amount of slack needed.

Continuing on this theme, how effective are nonprofits at making the case for unrestricted support? Rather than bemoaning the lack of unrestricted funds, what can we learn? An article in last Sunday’s New York Times, “Here’s My Check, Spend It All At Once”, connects the current financial challenges at the American Red Cross to their Donor Direct policy established in response to the fallout about the use of funds donated after the September 11 attacks. When the Red Cross commits to direct all of your donated funds wherever you choose, what donor wouldn’t take the opportunity to be the master of their own philanthropy? The long-term results, though, may be the kind of deficits that the American Red Cross is facing. Was the Donor Direct policy an extreme reaction – did the Red Cross go too far as a reaction to a communications and PR problem?Following the references in the Times article, I compared the online fundraising messages of the American Red Cross and of Doctors Without Borders. The choice of how to direct donations is the first question for a donor at the American Red Cross. While the option “Where the Need is Greatest” is the first choice offered, specific funds are immediately listed below. The FAQ section even offers more options:

I don’t see the fund that I wanted to donate to. What do I do?
Due to space limitations, we are limited in how many funds we can make available for online donations. If you would like to donate to a fund that is not listed, please contact Donor Services.

Contrast this with the Doctors Without Borders website, which provides a concise summary of how funding is used to carry out their programs. Note that the information doesn’t offer the donor a choice to designate their funds to a specific use. In the FAQ section, in fact, Doctors Without Borders makes the case for unrestricted gifts:

Can I earmark my donation for a certain area/project?
We appreciate your interest in supporting our programs. While it is possible to have your gift directed toward a specific program or country where we are currently working, we ask that you contribute unrestricted funding. By not restricting your contribution for a specific emergency or project, you will enable us to allocate our resources more efficiently and where the needs are greatest.

All of these appeals and messages rely on trust, of course, and donor trust is what the American Red Cross must rebuild. Every nonprofit should care about this, because the public’s perception and confidence in the Red Cross is a good indicator of confidence in all nonprofits.

I find it interesting that I’ve read and heard quite a lot lately about foundation leaders discussing the relative merits and challenges of moving some of their grantmaking from program and project grants to general operating support. The New York Times recently published a re-framing piece on this by Denise Caruso, “Can Foundations Take the Long View Again?” The members of GEO (Grantmakers for Effective Organizations) have been engaged in a long discussion and analysis on this topic. They have published several thoughtful guides (free registration is required to view them). What I don’t think I’ve heard is a comparable discussion from nonprofit leaders about how much impact and long-term value their clients and communities would gain from more general operating support. If you are the director of a nonprofit, you may think that is an obvious statement – but I don’t think that connection is made very well. There are several issues involved, including different terminology and understanding of budgets.

What is a general operating grant? Is it a grant to pay for overhead expenses, or is it funding to provide comprehensive support for the organization’s mission and activities? Too frequently, the term is used as in this excerpt from an article, “General operating money is certainly one of the more difficult categories of funding to secure, mostly because it’s a lot less appealing to the funder. Let’s face it, paying rent is not nearly as sexy as helping people fulfill their potential as human beings.” STOP saying that. This is the kind of thinking and woe-is-me mentality that can’t make the case for general operating support. There is an implicit choice in this article: We have $10,000. Should we spend it on rent, or should we spend it to help people fulfill their potential as human beings? How about this instead: Let’s spend it on rent, salaries, benefits, supplies, and phones to operate our effective, innovative programs that help people fulfill their potential.

Do we need some new terminology to cut through this mess?

• General Operating Grant: Apparently, this is a grant to pay for distracting, hard to justify, and uninteresting expenses (like rent and phones).

• Program Grant: A grant that is restricted for a defined set of activities and outcomes that fit with the organization’s mission. All expenses included in the program budget, including salaries, rent, and supplies, are needed to carry out the program’s goals.

• Core Mission Grant: A grant provided to an effective organization to use as their leaders direct in order to support and achieve their mission. Some of the funds may be spent on immediate program and organizational needs and some on long-term investments, such as program development, staff training, and technology.

According to Caruso’s article, “The majority of foundation leaders polled in the studies acknowledged that unrestricted operating funds were better and more effective for grantees. But they continue to focus their grantmaking on project support, they said, because they prefer its clear-cut results.” Flexibility is the key value of core, or operating, support. Think about how you can make the case that flexibility will enable your nonprofit to be more responsive to community, better prepared for the future, and more effective in all of your programs and activities – that’s results.