Balancing the Mission Checkbook

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.

Some choices that nonprofit leaders have to make are really tough. Others are tougher. Right now, there are many nonprofits in Minnesota that need to make some of these choices in the next few weeks because of the strong possibility of a state shutdown. In the recent post When the Worst Case Scenario is Really Soon we advised all nonprofits that rely on payments from the state to start working on cash flow contingency plans. As reports are trickling in about notices and conversations with grant and contract managers at state agencies, it’s clear that these plans will need to go beyond cash flow. That’s when questions go from tough (can we pay the staff and bills?) to tougher (can we continue to provide services in our community?).

State agencies are developing their own plans to suspend operations if necessary, and they are dealing with uncertainty just like the rest of us. Many state grant and contract managers are contacting their nonprofits contractors to alert them to possible disruptions in payments or the risk that any services provided during a shutdown may not be eligible for retroactive payment. How much impact would a state shutdown have on your organization, and what kind of plans to you need? The answer (as always) is “it depends”. This very fluid situation demands multiple versions of “what if … “

• What if … a state agency pays funds to the nonprofits from a source other than the state general fund budget, including federal funds or a designated source? A worst case state shutdown could either stop or slow down payment processing of contracts and grants – you need to create a conservative cash flow plan.
• What if … the nonprofit has a long standing state contract or grant? Even with an active contract or grant, a shutdown would stop payments for the near term, and could cause a longer payment lag due to backlogs and other disruptions. Review the contract terms, or check with the grant manager, to confirm whether or not payments are certain for services provided during a shutdown. You need a plan for cash flow delays including both immediate term and some lag time.
• What if … the nonprofit has an established contract with the state that is signed annually with a start date of July 1st or later? This situation poses more risk to the nonprofit because of uncertainty whether a new budget will include a provision allowing retroactive contracts. The budget passed in July 2005, the time of the last shutdown, included such a provision (thanks to Minnesota Council of Nonprofits). You need to take this risk into consideration as you plan – is this a cash flow delay, or a possible loss of some revenue? Could your organization absorb the reductions if you provide services without retroactive payments?
• What if … the nonprofit has a new state grant or contract that begins July 1st or later, or is waiting for a final approval or announcement for state funds? These funds are at the highest risk as long as there is not a budget in place. Be very cautious about assuming that the terms will be untouched and retroactive once a budget is in place.
• What if … your nonprofit doesn’t rely on state funds, or receives small amounts from the state? Rather than feel relieved, think about the impact a shutdown may have on your clients, other organizations with whom you partner, and other community services. You may see a ripple effect in new requests for service, higher demand, or service disruptions elsewhere. Spend a little time brainstorming how your organization might be affected and how you could respond.

The what ifs could go on and on. The only way to answer any of them, and many nonprofits have more than one state contract or grant, is to systematically review the terms, check with grant managers (while they’re still available) and consider the options. In some cases, the options may fall into three categories: tough, tougher, and toughest. The Minnesota Council of Nonprofits is communicating policy information, news, and resources through email and a page on their web site. Nonprofits Assistance Fund is working with MCN to sponsor six free Government Shutdown Emergency Briefings around the state that will include background of how we got to this point, crisis communications techniques, financial planning, and open discussion with your peers. Register through the MCN web site.

For the last six weeks or so there have been quiet conversations and meetings at nonprofits to prepare contingency plans in case of a state shutdown. As with all contingency plans, no one wanted to have to use them. Now that the May 23^rd legislative adjournment date has passed, and the governor vetoed the budget bills as expected, the likelihood is much, much higher. The conversations have moved from private conference rooms to big meetings and headlines, including Shutdown Looms in the Star Tribune, and MPR’s post Get to Know a State Shutdown. The State of Minnesota must have a budget in place by July 1^st or the money to operate the state’s activities runs out.

How concerned should you be? I think that we’re probably all concerned about the broad policy question and impact on the state. How worried should you be in your role as a nonprofit staff or board member? If you receive funds that flow from the State of Minnesota, you should be very worried. There are a lot of variables to consider and information to sort out, and it’s hard to accurately predict exactly how the state government would manage the shutdown if it happens. At the time of the shutdown in 2005 some services were declared “essential” as described in the MPR article, but don’t rely on those decisions made by a different administration. Budget Commissioner Jim Showalter has said that a shutdown this year could be “much, much more extensive.”

We are urging all nonprofits that rely on payments from the state to develop a worst case contingency plan as soon as possible, with an emphasis on one thing: CASH.

Here are our recommended steps:

1. Do you have revenue that comes to you directly from the State of Minnesota? Do you have revenue that is indirectly from the state, even if it is paid to you through another entity, such as a county, a collaborative, or partner?
2. If you do receive state funds, how much do you expect to receive in July and August? What would be the impact if you do not receive any of these payments in July and August?
3. Now is the time to update your cash flow projection or create your first one. We have two good resources, the guide to Managing Cash Flow and the cash flow template (Excel) that you’ll find in the Nonprofits Assistance Fund resource library. If you need some help developing your projection, Contact Us to talk with one of our staff.
4. Do you have internal cash accounts or reserves that could handle the cash flow gap?
5. Do you have a line of credit available that could cover the cash flow gap? Would the loss of state payments affect your ability to access your credit line? If you don’t know, find out.
6. If nonpayment would impact your agency’s ability to maintain services, meet payroll obligations, or sustain basic operations, you need a cash plan fast. To be prepared, consider managing cash flow starting now to accumulate a temporary cash cushion even if you don’t have reserves.

If the cash flow projection gives you bad news, be prepared. There may be very tough choices to make about temporary service reductions, staff furloughs, or expense reductions or delays. There may be ways to lessen the impact with advance planning. That’s what contingency planning is for. Don’t wait.

There have been many columns and editorials about the dangers of state governments using budget strategies that are no more than accounting gimmicks. Transfer reserves from one fund to another. Use bond financing for current expenses. Shift payments from one fiscal year to the next. Voila, problem solved. Bill Gates, in this TED Talk on state budgets and education funding, took a jab at these state accounting schemes by observing, “Enron would blush.” He believes that state governments should be required to follow the same accrual Generally Accepted Accounting Principles (GAAP) as businesses and nonprofits. The new governor of Connecticut, Dan Malloy, is implementing his priority campaign pledges to move the state to GAAP standards. I know this sounds incredibly uninteresting to most people, but it’s actually a huge leap. In Connecticut, for example, taking away the accounting sleight of hand of shifts and transfers will add $1.2 billion to the state’s deficit.

I find this all fascinating on a policy level, and I’m happy to talk about these kinds of questions over a glass of wine (yes, I know how to have fun).  What happens, though, when theory about state policy meets daily reality at nonprofits that deliver public services? It’s not theoretical anymore. In Minnesota we have a very real case study as a result of an accounting shift for the state public education budget. Charter schools, a type of public school, have been scrambling for two years to manage the cash flow crisis caused by one of the shifts. State aid to public schools is paid beginning in July in even amounts over the year based on the number of students enrolled and attending school.  The state started “shifting” some of the education aid payments to future years to reduce the budget hole. What had been a 10% shift, called the holdback, has been increased twice in the last two years to help address the state’s budget problems. In the 2009-2010 school year 27% of state aid was deferred to the next year. For the current school year the shift is 30% of state aid.  Because of the state’s continuing budget difficulties, the payment shift seems likely to stay in place for years to come.

Earlier this year Nonprofit Assistance Fund, Minnesota Association of Charter Schools and Charter School Partners conducted a survey of Minnesota’s charter schools to understand how charter schools responded to the funding shift, including the availability of credit, the cost of borrowing, and impact on school operations and education services.  This week we released a report on the results of the survey to bring attention to this clash of policy theory and cash flow reality.

Highlights

• Charter schools have used every tool available to them to manage their cash flow, including internal fund balance reserves, renegotiating lease terms, budget cuts, loans from commercial banks, nonprofit loan funds, outside supporters and affiliates, and sale of receivables.
• Given that traditional school districts have taxing authority and a state guarantee of any loan, districts can typically receive loans with a 1% or less interest rate. Charter schools, who do not have these financing mechanisms in place, have faced obstacles to accessing credit and must pay between 6% to as high as 23% in loan fees (includes interest, fees and legal expenses).
• A gross inequity exists between traditional school districts and charter schools as to how the holdback impacts their respected operations.
• A 30% holdback is unsustainable for many charter schools in Minnesota and unless this is addressed, solid, high-performing charters will be at risk of ongoing financial instability.

Recommendations to reduce the inequity

The report recommends three possible policy changes that could address the inequity and help resolve cash-flow gap financing issues for charter schools, including:

1. Reduce the holdback for charter schools from 30% to 15%.
2. Provide a state-backed, low-interest loan pool.
3. Improve access to private capital (market rate loans) via a state-authorized ‘written assignment’ to banks.

You can read the release and the State Education Funding Shift Has a Disparate Impact on Minnesota Charter Schools report here.

This is just one case of the impact of state accounting schemes. There are many others all over the country. The solution isn’t simply a matter of GAAP accounting. If not through accounting, Minnesota, Connecticut, and 46 other states still have a hole to fill. It’s important to remember that theory quickly becomes reality when it hits the ground.

There are some recurring terms that I’ve been hearing over and over in meetings, conferences, and articles intended to help nonprofits, including arts organizations, respond to the serious challenges created by the recession. From what I hear we all need to be resilient, learn to innovate, and adapt to a new normal. It sounds good, but is there some substance that we can use behind these words?

Resilience: Frankly, the people who lead and work for arts organizations have always been about as resilient as you could be, if resilience means the ability to improvise with what’s at hand and bounce back.

Innovation: How about innovation? The arts shine as innovators in creating art, but much less so on the organizational side. Most nonprofit arts organizations are structured using a management and financial model that’s been around for a long time. More and more questions have been raised about the model that will eventually lead to some more options. On his great blog The Artful Manager Andrew Taylor frequently writes about these questions including here and here. There are other interesting developments in helping arts organizations to innovate for long-term structural change. The James Irvine Foundation states that “we define innovation as instances of organizational change that stem from a shift in underlying assumptions and provide new ways to fulfill the mission.” Incremental change isn’t enough for arts organizations to confront their long-term challenges.

Adapting to the new normal: I’m not so sure that we ever had an “old normal”, or that change is a new dynamic. Regardless of the current terminology, though, arts organizations are facing deep and sustained changes to their funding sources, audiences, and role in the community. There is a lot to learn about becoming more adept at identifying the questions and leading the necessary changes. The article Leadership in a (Permanent) Crisis describes adaptive leadership as the capacity to sort out and balance the short and long term issues. Facing immediate problems, many managers will hunker down and nibble around the edges of problems.

People who practice what we call adaptive leadership do not make this mistake. Instead of hunkering down they seize the opportunity of moments like this one to hit the organizational reset button. They use the turbulence of the present to build on and bring closure to the past. In the process, they change key rules of the game, reshape parts of the organization, and redefine the work the people do.

The time is critical for many arts organizations to understand their current situation, envision the extent of changes, and learn to truly and continually adapt.

What if? Last week I was sad to read that the Harlem School of the Arts closed its doors. The school was an institution in the neighborhood for over 40 years. The news report paints a case story of their failure to adapt – years of financial, management and governance problems and attempts to address them with short-term cuts, emergency fundraising efforts, and fingerpointing. If we don’t want to see this happen elsewhere we need to learn some new approaches.

Yes, they’re the buzz words of the day, but I can’t argue with the importance of resilience, innovation and adaptive leadership.

This blog was cross-posted at Springboard for the Arts’ Springblog.

This guest post was written by Carol Berde, nonprofit consultant.

Live Heart Healthy

Have you noticed the articles that accompany tax season each year, with advice about which financial records to keep and which to toss out? That inspired a little file purging in my office, or, as I thought of it, clearing the clots out of the office arteries. One item I found (and kept) got me thinking that nonprofit organizations also have to keep their arteries clear – not just once a year, but continually.

I found notes from a philanthropy conference I attended in 2002, in which the speaker urged his audience to “get comfortable with the new reality” following the post-9/11 economic downturn. Sounds a lot like the “new normal” we hear about today, doesn’t it?

In July 2009, the Pohlad Family Foundation made grants totaling almost $5 million to more than 70 nonprofits that provide housing for the homeless, human services, and community health care in the metro area. I had the privilege of being part of the team that assisted the Foundation and MAP for Nonprofits in making these funding decisions. As Scott Russell reported in a MinnPost piece about the Pohlad initiative on August 13th last year, “waiting lists and overstretched services are commonplace” at these organizations:

Many foundations and philanthropists have focused on meeting basic needs. The federal stimulus package has helped in some cases. Yet clearly money is tight from both government and givers.

Are tight funding, waiting lists, and overstretched services the “new reality” for nonprofits working to meet essential human needs? If it is, how can nonprofits keep their arteries healthy even as they serve more people with fewer resources?

Insight into the first question comes from our review of reports six months later from organizations that received these Pohlad funds. Among other things, grantees were asked to assess whether their financial condition had changed in the last six months of 2009. Of the 68 organizations reporting, 43% said their financial condition was better, 37% said it was unchanged, and 21% said it was worse. Operational efficiencies, expense controls – often including staff layoffs and elimination of retirement contributions – and Federal stimulus funds contributed to “better” financial positions. On the other hand, changed priorities on the part of public and private funders were the chief reason for “worse” financial positions. Huge increases in uncompensated care for people without health insurance or resources to pay deductibles and co-pays was another major stress on community-based providers of health and mental health care. “While we are effectively managing the downturn, we have been less successful stemming the tide of declining revenues and changing [funder] priorities,” wrote one grantee.

This anecdotal evidence suggests to me that settling into the “new reality” or “new normal” is not a one-time event for nonprofits. Cutting budgets, the work of 2009 for many, was necessary but insufficient. Rather, keeping a nonprofit’s arteries clear is a continual process of assessment and adjustment, just as watching our diets, exercising, monitoring cholesterol, and, if necessary, taking medication is for people who want to keep their arteries healthy. Here’s a three-part prescription for nonprofits’ heart health.

1. Scan the environment – both inside and outside the organization – continually. Planning for change is preferable to being surprised. Staying ahead and in touch is an added responsibility for executive directors who are already more than busy, but it is essential in the “new normal.”
2. Monitor priorities and strategies and make course corrections. Change is happening too fast for the old-style strategic plan that was adopted and treated like a fossil to still be useful. But that doesn’t mean that the whole idea of strategic planning has become irrelevant. To the contrary, having a clear strategic direction, overarching priorities, and well thought-out goals and strategies to realize them is more important than ever. Organizations that remain effective and use scarce resources efficiently do so, in large part, because they have a plan. What’s different in the “new normal” world is that a strategic plan must be dynamic, re-calibrated every 6 to 12 months in response to progress (or lack of it) and changes in the environment in which the nonprofit operates.
3. Confront the gnarly issues. Programs rarely operate in isolation; organizational problems tend to be intertwined; and changes in funding streams often affect multiple aspects of a nonprofit. Loss of support for a particular program or service, for example, may also mean a reduction in administrative funds or ineligibility for a different funding source. Understanding each program’s true costs and financial contribution can be empowering. Data, no matter how discouraging the story they tell, often pinpoint decisions that can no longer be postponed. If most discussions in an organization end by circling back to the same complex issues, it’s time to unravel them.

We know from our personal behavior that maintaining a healthy heart takes effort and discipline; so too with nonprofits that want to be healthy. But just as there are websites and coaches for personal fitness, there are great resources on the internet to help nonprofits stay healthy. One of the best is the site you’re on now, www.nonprofitsassistancefund.org. Another of my favorites is The Bridgespan Group,  especially an article written for the Harvard Business Review, Delivering on the Promise of Nonprofits, that includes a useful matrix for analyzing mission relevance and financial contribution or cost of each program.

About Carol Berde

Carol Berde has worked with nonprofits for 30 years from both sides of the desk: a long career at The McKnight Foundation and, more recently, as a consultant to nonprofits and foundations. She can be reached at carolberde@comcast.net.