Balancing the Mission Checkbook

Imagine this: Eyes race to the bottom of the page and a negative number between a pair of dreaded parenthesis stares back. Nonprofit staff and board members wonder what happened after they subtracted all expenses from total anticipated income. To many, this may be an immediate red flag. But how do we decide if this deficit is OK for our organization? The decision involves analyzing the balance sheet, assessing staff leaders’ and board’s appetite for a deficit, and forecasting more than one year into the future.

Can we absorb a deficit?
Deficits on our income statement erode our balance sheet’s net assets.

• Have we accumulated sufficient net assets over time to be able to absorb a deficit? If a deficit is planned, it’s important that decision-makers and budget-approvers recognize that the net assets from previous years’ surpluses will be drawn down. Looking further up the rows on our balance sheet, we must consider if our liquidity will allow us to absorb a deficit.
• Do we have sufficient cash and working capital? Or, do we have access to credit and a lender that is on-board with using the credit to fill this year’s deficit?

For more information on analyzing your balance sheet, see our Balance Sheet Cheat Sheet resource. If considering a deficit, pay special attention to Days Cash on Hand and the Working Capital Ratio.

Are we willing to incur a deficit?
Deficits are either strategic or accidental.

Strategic deficits are planned and intentional. Often times, organizations knowingly invest in programming or infrastructure for a future benefit, or perhaps intentionally spend down organizational reserves. In these situations, be careful to consider how a deficit might impact relationships with funders and lenders. Also, be mindful to protect the business model (see below).

Accidental deficits can result in disruptive cash flow crises, restructuring without strategy, or even program termination or dissolution. They are often caused by deferring difficult budget decisions or not having alternative budget scenarios prepared for quick implementation.

Are we protecting our business model?
Deficits are often structural, meaning there’s an inherent flaw to our business model that will repeat itself if left unaddressed. If approving a budget with a deficit, consider:

• Is there something unique that causes this deficit? Is it clear how the condition will change in future years?
• Are we able to achieve a recovery surplus? Net assets will only be replenished following a deficit if an organization is willing and able to incur a potentially significant surplus in a future year. Do your business model and dominant funding sources allow for a profit margin sufficient to recover from the deficit?

I like to think of budgets as “best-guess working drafts” for the future. They are our best guesses given all the information that we can gather and analyze, but they are still filled with risks and assumptions. Budgets are also working drafts, because they must be closely monitored and managed during a fiscal year to assure the desired financial outcome.

To learn more about activating your budget, be sure to attend the “Financial Drivers and Budget Benchmarks” session at the upcoming Nonprofit Finance and Sustainability Conference on April 19. And for further reading on this topic, check out “Nonprofit Budgets Have to Balance: False!” by our conference keynote speaker Jeanne Bell.

And if you find yourself sweaty-palmed and anxious staring at a budget deficit, drop us a line, and we can talk through it together.

March in Minnesota gets the Nonprofits Assistance Fund thinking about spring in Minnesota. It’s what we do here.

The conversation in the office kitchen turned to gardening, and of course, being financial geeks, that conversation turned to an analysis of the profit and loss of planting and maintaining your own gardens. Minnesota is fortunate to have great farmers markets, so if you’re looking for fresh, locally-grown produce and flowers, you can buy a great deal for very little money. If you calculate your true “program” costs of growing your own (mostly your own time, really), you’re better off never turning a shovel to mix in some new peat moss.

But that isn’t why we garden.

We have to look past the financial return on investment and look at the mission intangibles of gardening: Talking to your neighbors as you weed, or running out with the kids to see just how fast cucumbers grow around here. Many Minnesotans find gardening to be rewarding for a change in their labor, getting outside and seeing something green rather than going to meetings or crunching numbers. Variety is important in planting, and important in our work.

Nonprofits are feeling a lot of pressure to make the money work, and sometimes that means a good long look at programs that revitalize us but don’t contribute to the bottom line. One of our clients called for some strategy advice the other day, and said she thought she should cut any program that can’t be fully self-funding. We are the first to stress the importance of financial health – after all, if all we did was garden and we didn’t have a job to pay the bills, we wouldn’t be gardening next year. But not everything needs to show a profit. If some of your programs show a surplus, then other stuff can be done because it fulfills your mission and restores your nonprofit drive to move forward with the other important work.

It’s important to know the difference between what is financially-sustaining, what is mission-sustaining, what is both, and frankly – what is neither. If you analyze your true program costs, you’ll learn which programs are financially-sustaining, but that calculation won’t tell you which programs are mission-sustaining. You may need a strategic advisor to help understand just how much financial loss can you subsidize in a mission-sustaining program (how many hours you can garden) before it starts to impact your organization’s livelihood (not making enough money to pay all the bills due to time lost with a watering can).

Giving up some mission work may sometimes be necessary, but the goal can always be to become stable enough so you can take the time to dig in the dirt every now and then. It may take some tough budgeting or long-term goals, but it’s worth the extra effort to get the change of scenery and revitalize the rest of the work.

We’re an excitable bunch at Nonprofits Assistance Fund. We ring loud bells to celebrate our clients’ successes. We toss homemade confetti when we receive good news from funders. We raise our voices when debating what are the most useful financial ratios. But this spring, nothing puts that excited sparkle in our eyes more than talk of the upcoming inaugural Finance and Sustainability Conference on April 19.

Through our work in lending, training, and providing strategic financial guidance, we work with individuals that serve wide-ranging roles within nonprofit organizations – executive directors, program staff, board members, fundraising staff, and finance staff – and they all have a role in financial leadership.

The broad and diverse skills and knowledge required of these individuals to effectively lead a mission-based organization toward financial sustainability is truly remarkable. Consider these real nonprofit management scenarios that demonstrate the combination of technical and strategic skills necessary in nonprofit financial management.

Scenario 1:

An Executive Director along with her board enters the fiscal year with the goal of an unrestricted operating surplus.  They have different budget scenarios in place to aid in managing the unavoidable uncertainties in their income budget. At mid-year, some program output measures are below projections, and finance staff warn that there’s a risk that a portion of a program grant will not be released from its temporary restrictions before the end of the fiscal year. The E.D. meets with fundraising staff to consider strategies on getting permission from funders to re-purpose the grant funds while also revisiting the aspects of the communications plan that reference the organization’s commitment to financial surpluses.

Scenario 2:

A year-end deficit is keeping an Executive Director up at night, pondering the question, “Why isn’t our business model working?” The E.D. works with program managers and the Finance Manager to develop a comprehensive allocation system. Empowered by an understanding of true program costs, the E.D. modifies grant proposals in order to request funding at a level that fully pays for the services that his agency is providing. The board begins next year’s budget process by discussing the financial expectations of each agency program.

These scenarios and the unique combination of technical and strategic skills that they require are representative of the types of complex challenges that nonprofits face today. To name just a few of the many skills required, leaders must develop competencies in scenario planning, accounting principles, communicating financial information, and engaging others within their organization in financial leadership activities. Financial leadership entails an emerging and evolving skill set that changes with our environment and our organization’s circumstances.

At Nonprofits Assistance Fund, we understand the challenges and requirements that nonprofit leaders face along their quest for sustainability. Accordingly, we’ve worked with our partners at the Minnesota Council of Nonprofits to design the 2012 Nonprofit Finance and Sustainability Conference – a one-day event that will cover a wide gamut of technical and strategic topics that will give you the skills and knowledge necessary to put your organization on a sustainable course.

Our morning keynote will be delivered by a national leader in guiding nonprofits down the path towards sustainability, Jeanne Bell of CompassPoint Nonprofit Services. Our lunch keynote speaker will be Elizabeth Boris, the founding director of Center on Nonprofits and Philanthropy at the Urban Institute, who will highlight resources for nonprofits to navigate the new economy. Morning and afternoon breakout sessions will cover technical topics, such as selecting the right accounting software and ensuring internal controls in an electronic age, as well strategic topics, such as using your budget as a communications tool and managing multiple bottom lines.

Conference registration is open and there are still a few more days to take advantage of discounted early registration. Please join us April 19 for what promises to be a wildly practical gathering.

Nonprofits Assistance Fund is sometimes called in to help nonprofits when they have financial problems that have been building for a long time. Fortunately, financial turnarounds are possible and we’ve seen some incredible work at nonprofits that resulted in financial recovery. Whether the outcome is positive or negative, though, in every case the situation would have been more manageable if it had been identified and addressed sooner. At some point, the question comes up: why didn’t someone, including board members, see the red flags and call attention to them sooner?

There are hundreds of reasons, of course, including disengaged boards, weak fiscal controls, misunderstanding of roles and responsibilities, and lack of timely information. I’ll offer one technical reason: boards miss the red flags because they don’t know where to find them.

But red flags should be obvious on the financial reports, right? Not really.

Some background: there are two standard financial reports that should be provided to the board of directors regularly, the income statement and balance sheet. From all the training workshops we’ve delivered over the years we know that the income statement makes sense to most people, especially when the report includes a comparison to the budget for the same period. With some basic training board members can get comfortable reviewing how much income is coming in, what the expenses have been, and where the actual performance varies from budget. Balance sheets, on the other hand, are not easy to read or interpret. They are based on accounting terminology and standards that require more training and experience to make them useful. Nonprofit accounting rules for restricted funds make balance sheets complex even for experienced finance professionals from the business sector. It’s hard for board members to get a handle on what’s important on the balance sheet or feel comfortable asking questions.

So, why do board members miss the financial red flags?

Boards pay too much attention to income statements and budgets.
The periodic income statement is useful for tracking progress and expense controls, but this report is very limited because it is covers such a short time period. Big variances are useful to alert boards to questions. Deficits are cautionary signs that deserve analysis. A surplus or a deficit in one month, or even one year, is usually not the sign boards need. What matters is the cumulative financial condition over time, signs that indicate a big problem that threatens a nonprofit’s future.

Boards don’t pay enough attention to balance sheets.
Many (most?) board members pass over the balance sheet or skim it, at best. That’s too bad, because the balance sheet is the key for seeing the problems. The balance sheet reports the cumulative effect of all of a nonprofit’s financial activity over the years and signals financial health or problems. Healthy nonprofits build up assets, cash reserves, and unrestricted net assets, and maintain reasonable amounts of debt. Nonprofits with serious financial problems report diminishing cash, insufficient working capital, restricted funds diverted to current operations, negative unrestricted net assets, and creeping debt levels. Those are the red flags that should make board members jump up and down and shout – look over here.

Yellow flags are on the income statement. Slow down, look both ways. Red flags are on the balance sheet. Stop – now!

Resources:

• For a quick review of how to read nonprofit financial reports, watch these very short video primers.
• For a more extensive review of the marvels of balance sheets, refer to our Balance Sheet Cheat Sheet and the article Why Do Balance Sheets Matter by Rodney Christopher.
• I’ll dig into these flags and indicators at a session at the Nonprofit Finance and Sustainability Conference on April 19^th. Register now!

It’s been gratifying to hear and read the great feedback about An Executive Director’s Guide to Financial Leadership published in the current issue of The Nonprofit Quarterly. I enjoyed writing the article with co-author Jeanne Bell from CompassPoint Nonprofit Services. We have very similar approaches to finance as a tool for mission and community impact. Nonprofit managers and directors have posted online comments and given me direct feedback that they appreciate the practical guidance that goes far beyond bookkeeping basics. These principles help to build strong infrastructure and capacity, and break some habits that aren’t serving our organizations very well.

I encourage you to read the full article (and subscribe to the magazine!)  Here is the brief “Executive Director’s Finance Cheat Sheet” of the eight key business principles that we believe are essential for financial leaders.

1. Develop your annual budget with a commitment to its net financial result—whether surplus or planned deficit—and then adjust spending during the year if income is not coming in on pace to yield that net result. Then, complement your annual budget with rolling financial projections that incorporate your most current information about probable future financial results.
2. Diversify your income cautiously, ensuring you have the capacity to develop and sustain the programmatic and operational requirements of attracting each new resource type well.
3. Develop cash flow projections along with the budget and rolling projections so that you can anticipate any cash flow problems well in advance, when you have more options.
4. Plan goals for financial reserves based on your typical cash flow cycles and risks and incorporate reserves into all financial plans and policies. Be sure to foster a financial culture for staff and board that understands the importance of a regular operating profit or surplus.
5. Pursue restricted funding from those foundations and corporations that understand and value your organization’s mission and particular strategies for achieving impact. When pursuing restricted funding, develop proposal narratives and accompanying budgets that link staff development to program design to superior outcomes, including all related costs as direct.
6. Ensure that your finance function is always properly staffed; if necessary, use a mix of staff and expert contract consultants to achieve this.
7. Discuss expectations for financial roles and responsibilities with board leadership to create accountability and information flow that matches the size and life stage of the organization. Make sure to invest time to develop meaningful financial report formats for the board that reinforce organizational strategies and goals and supports the board in fulfilling their responsibilities.
8. Introduce the concept of enterprise risk management to your team and initiate an internal assessment of a full range of risks.

Read the article and let me know what you think and what other principles we should add. For those of you in Minnesota, we’ll have a chance to hear directly from Jeanne Bell at a conference coming up in April that Nonprofits Assistance Fund is co-hosting with Minnesota Council of Nonprofits. Watch for more information soon!

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.