Balancing the Mission Checkbook

Worrying about cash shortfalls is, without a doubt, at the top of the list of stressors for nonprofit directors and finance managers. In this situation, everyone’s dream is to have a stash of cash - a cash reserve account set aside to tap at a moment’s notice to solve the problem. I’m reluctant to endorse a universal standard for reserves, but there are “rules of thumb” and accepted practices calling for nonprofits to hold reserves of three to six months of operating expenses. Well it turns out that this “best practice” is a practice in theory only for many nonprofits.

A study by the Urban Institute, reported in the Washington Post this week, Nonprofits Imperiled By Low Reserves found that 57% of the Washington area nonprofits studies had less than three months of reserves, and 28% had none. The June 2009 Nonprofit Current Conditions Report published by Minnesota Council of Nonprofits found new cash flow concerns caused by slower payments from county and state agencies. Surveys in Minnesota have found that at least 35% of nonprofits anticipate cash flow problems this year and 30% have one month or less of operating reserves. Low reserves and cash flow problems are not restricted to small or struggling nonprofits - it’s a widespread management challenge. The Urban Institute study contained an interesting finding, according to the Post article:

According to the study, larger groups were less likely to have sufficient operating reserves than smaller ones, a finding that surprised researchers. Seventy percent of charities with expenses over $5 million had low operating reserves, compared with 50 percent of groups with less than $100,000 in expenses.

This shouldn’t be that surprising when you do the arithmetic. Imagine that you run a nonprofit with an $8 million annual budget. Maintaining a three month reserve would require a $2 million cash account. That’s (a) a big number and (b) very difficult to build up in the low surplus, service delivery model of most nonprofits. Rather than dwelling on the best practice or target for designated cash reserve accounts, maybe nonprofits need to learn to be more sophisticated managers of cash and its relative, working capital. This financial concept was described well by Ben Cameron of the Doris Duke Charitable Foundation last week in a Chronicle of Philanthropy live online discussion, The Changing Role of Foundations.

Ben Cameron:
Most businesses recognize the need for ongoing working capital–it’s the heart of funds that allow a business to make strategic decisions around launching a new program or line of business, investing in a new facility, etc. I have been in discussions with some business executives who have been adamantly opposed to general operating support for arts organizations–thinking it gives organizations free license to be unstrategic and undisciplined–but instantly supportive of flexible working capital. In essence, the purposes are the same–the difference is in how the two terms are heard.

I’ve been advocating for better understanding of Nonprofit Capital for years. In the “nonprofits should be like business” debate, this is the one area where we do have a lot to learn. There aren’t many businesses that strive to hold a three month cash reserve account. That would be viewed poorly, in fact, because it’s an inefficient use of capital.

For peek at how the very largest and most sophisticated nonprofits solve a cash flow problem, read about how Dartmouth Joins Harvard, Princeton in Tapping Credit Markets. Because of the drop in endowments, Bloomberg reported that Dartmouth College just issued $250 million of 10-year notes “for liquidity and general working capital,” according to Julie Dolan, associate vice-president for fiscal affairs at Dartmouth.

Learn to love these words: Working Capital.

We’ve heard a lot from nonprofit clients in the last week or so about cash - too little, too restricted, or just right. Maybe the right amount, but the wrong timing. Maybe the right timing, but too risky or some other problem that results in cash on the balance sheet ending up as only “cash” on paper.

Here are three stories:

• Organization 1 has been holding a nice balance in a money market investment account for the last two years. The funds were earned from a special grant-funded project but no one ever figured out whether there was an ongoing restriction on the earnings. Now they wonder if they can use this idle cash as an operating fund.

• Organization 2 has a substantial balance in a building reserve fund and no money in operating reserves. There are no improvements planned and the building has been well maintained, but the policy keeps this cash out of reach to address immediate needs.

• Organization 3 has operating reserves invested in a bond fund and realized that the value of the account has dropped with the market. The treasurer thought that the fund was like a money market account and didn’t realize there was risk of market fluctuations.

In all three cases the nonprofit was accurately reporting the asset balance on financial reports. Beyond verifying an accurate number, though, it’s important to have a solid grasp of all the strings and restrictions that might hinder your ability to use that cash when you need it. Some restrictions are external, such as temporarily restricted grants. Other strings on cash result from internal decisions related to investment decisions, reserve policies, or overly-complex designations and conditions.

Thomas McLaughlin addresses the problem of illiquid cash in this week’s Streetsmart Financial Manager column in The NonProfit Times.

How Liquid Are We, Really? Cash is king, or queen, depending on the realm. As long as you have sufficient cash you can outlast most blows the environment delivers. But you need to be sure that the things listed as cash really are cash.

Nonprofits Assistance Fund has created a quick cash analysis resource to help nonprofits easily distinguish cash that’s liquid and available from other types of restricted, designated, or hard-to-access funds. You can download this Cash and Investment Analysis worksheet now.

I have a New Years Resolution suggestion that has nothing to do with exercise or diet. Resolve to learn more than you already know about economics, markets, and personal finances.

It’s a matter of self interest for you and for the nonprofits that you serve, now more urgently than ever. Think in hindsight of all the financial choices that have been made about questionable mortgage terms, high home prices, risky investments schemes, and un-diversified retirement portfolios. Could some of the pain have been avoided if consumers, and nonprofit leaders, were more educated about the basics of economics and personal finance? I think so.

In his New York Times article, Contemplating the Boobs We Were, Peter Applebome recounts financial mistakes and asks:

“Are we doomed forever to be the fleeced or is there anything we can learn from this latest round of financial catastrophe? In fact, there are plenty of lessons to be learned. So here’s a revolutionary idea: Maybe it’s time we even start thinking about ways to teach them.”

Freakanomics author Stephen Dubner was even more direct last summer in his blog, asking Are We a Nation of Financial Illiterates? Included in his post, Dubner recites this list of suggested financial basics:

1. Basics of how markets work.
2. Time value of money and the working of interest compounding.
3. The concept of risk and the working of risk diversification and insurance.
4. Basic accounting (very basic).
5. Rights and responsibilities of consumers and institutions.

Read the full post for more detailed descriptions.

I’m sure that if individuals who work at, or serve on boards of, nonprofits were to gain more financial literacy that the nonprofits would also benefit. At Nonprofits Assistance Fund we see many problems that could have been avoided with better understanding of topics such as supply and demand, investment risk, and the difference between cash and income. Resolve to learn more this year, no matter whether you’re starting at Econ 101 or financial analyst level.

If you are a young professional in Minnesota, consider working on a Citizens League Action Group on this topic that is starting soon.

Cash is cash, right? Then why are so many nonprofit directors and board members suddenly so concerned about the safety and security of their bank accounts?  All it takes is one alarming story, such as today’s report that some Minnesota private colleges couldn’t access all of their short-term funds. It sounds like the funds will be available, and how would you feel if you couldn’t arrange a transfer of some funds that you consider to be “liquid?”

So how concerned should you be? In general, you shouldn’t panic, but you also can’t make assumptions that all is well just because you haven’t had a problem before. It depends on how your short-term cash accounts are actually invested or deposited. Many nonprofits have balances of funds that are needed for payroll and regular expenses, for reserves, and to hold funds that are restricted or designated for a specific program or purpose. It’s common to have a checking account, other bank accounts, and some money market funds or short-term investments.

However, over the last 20 years the distinction between keeping funds in a bank account and a range of other investment options has gotten pretty fuzzy. We’ve become a little lazy about using terms - like money market account, money market fund, and short-term investments - interchangeably. But they are not the same.  Your first priority is to find out where, in fact, your nonprofit’s cash balances are - do you have a bank account or a mutual fund? If it’s a bank money market account deposit, what is the FDIC insurance coverage? Some banks offer a service to provide additional coverage or work with other banks to enhance the coverage by exchanging funds within a network. If your funds are invested in a money market mutual fund, it’s wise to read the prospectus or other information from the fund manager to learn about the types of investments that are owned by the fund. Money market funds range from ultra-conservative investments in treasury bills to investments with a little more risk. If you have made direct purchases of short-term investments, read up on what you have and how those investments are valued or affected by the current market.

Again, know what you’ve got and then have a discussion with the finance committee about any risks, concerns, or restrictions. Then you can decide whether to make any changes. This might also be the trigger for you to re-visit or create an investment policy and educate yourself and the finance committee on fiduciary duties and nonprofit investment practices. I highly recommend a short book published by BoardSource, Minding the Money: An Investment Guide for Nonprofit Board Members.

I was explaining audits to a group the other day and one person asked if audits were really worth anything. After all, he said, the big financial companies that are in trouble all have “clean” audits. So what’s an audit really worth  -  beyond meeting a legal requirement?  First, you have to understand what an audit is, and what it isn’t. An audited financial report contains standard financial information, supplemental footnotes, and the all-important opinion letter. The letter expresses a professional opinion on the accuracy of the financial information. The opinion is not an assessment of the financial condition or future prospects of the organization.

To answer the person who doubts the value of an audit, it’s helpful to understand how the auditor forms the opinion that the information is accurate.  In the process of conducting the audit, financial information provided by the organization is scrutinized and verified. Verification relies heavily on the auditor’s ability to determine the value of the assets and liabilities. It’s pretty easy to verify the value of the asset called “checking account balance” or even the asset called “foundation grant receivable.” Consider, though, how the auditor values an asset without such a concrete answer. If the organization owns 100 shares of Target Corp. stock, the value can be checked against the market, but what about assets that don’t have a simple or ready market? This includes assets like privately held companies, real estate projects, and investments in hedge funds. All the auditors can do is use whatever information sources are available. Clearly, the values of mortgage-related assets were based on faulty information and assumptions. Auditors use a lot of judgment and research  -  it’s not absolute. Audits are worthwhile and they are worth the paper they’re printed on, but be aware of their limitations and use them with caution.

If you are interested in understanding the crazy assets that got us here  -  CDOs, CMOs, and credit defaults  -  invest $1 for the podcast of This American Life’s radio show on the topic, “The Giant Pool of Money” from May 2008. Jointly produced with NPR News, the 60 minute report explains how the mortgage business changed with subprime loans, new capital sources, and new, indecipherable investments. Well told through stories and understandable questions, it’s illuminating for all.

Wouldn’t every nonprofit, and the nonprofit sector overall, love to be able to increase contributions by 50%? No problem!

I don’t actually have the magic trick to make more dollars come in the door. The big increase in contributions is already in our hands in the form of volunteer labor. It’s a fact. When the value of volunteer labor is included, the total amount of contributions to US nonprofits increases by over 50%.

Here’s the data in a nutshell: The Corporation for National and Community Service just released their annual Volunteering in America study. They report that 61 million Americans volunteered in their communities in 2007, donating 8.1 billion hours of service worth more than $158 billion. The recent Giving USA survey for 2007 reported that cash contributions exceeded $300 billion for the first time. This includes individuals, bequests, corporations, and foundations. The actual value of charitable giving, when donated labor is included, is over $450 billion.

Think about that – 8.1 billion hours is roughly equivalent to 4 million full-time employees. Wow.

Where does this $158 billion calculation come from? Every year, Independent Sector calculates an hourly equivalent for volunteer time. The current value is $19.51 per hour, which is reportedly based on the average hourly earnings of all production and non-supervisory workers on private, non-farm payrolls as determined by the Bureau of Labor Statistics. Independent Sector takes this figure and increases it by 12% to estimate for fringe benefits. (I will leave for another discussion the fact that many employees of nonprofit organizations earn less than this amount.) I encourage every nonprofit with volunteer labor to calculate this value for themselves.

Unfortunately, it’s too easy for this important economic information to be lost because of accounting rules. Most of this economic value is never reported in audited financial statements or IRS 990s. The applicable accounting rule, FASB 116: Accounting for contributions, limits the recognition of the financial value of volunteers to a very narrow definition. Because of this, the actual economic profile of many nonprofits is skewed. When comparing nonprofits to for-profit enterprises, we usually dwell on the role of contributed income and subsidy. The importance of contributed labor is easily lost. I understand why the accounting profession is concerned about accuracy and reliability when recognizing the value of volunteers. However, it’s time to revisit these accounting rules. We’ve been willing to overlook this financial under-reporting for years, but I think the importance and value of volunteers is becoming too significant to ignore for much longer.

End note: There’s a bit of local pride to be found in the new volunteering study. Minnesota ranks #3 by state and the Twin Cities is #1 for large cities in the percentage of the adult population who volunteer. Learn more about how to make the most of volunteers from Hands On Twin Cities.