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.

I have often said that my least favorite question is “What is the ideal target amount for a nonprofit to have in an operating reserve?” Because there is never a simple answer for the question, I wrote a post a while ago on The Cash Reserves Myth:

Every nonprofit should have a cash reserve equal to three months of expenses.” There’s some truth and some myth to this “best practice.” It is absolutely true that every nonprofit needs to have adequate cash balances available to support the timing of payroll and other expenses, as well as to pay for unanticipated costs or increases. It’s a myth, however, that a single standard applies for all nonprofits. I have two issues with the “three month reserve” standard. One is that different organizations need different amounts of cash on hand. The second is that building a reserve of three months of expenses is not a practical, or even desirable, goal for all nonprofits.

In an article I wrote a couple of years ago, The Yin and Yang of Nonprofit Reserves, I recommended different ranges depending on the stability of incoming cash flow, with reserves as low as one to two months of operating expenses. One reason for my caution about standard reserve ratios has been the business question of whether idle cash is an efficient use of capital.

I take it all back. Well, I take some of it back.

The Value of Cash Reserves

The past 18 months have been a lab test of the value of cash reserves. This isn’t a surprise, I suppose, but it has made me re-think my earlier questions about the focus on reserves. It is clear that nonprofits that have been able to build up a good cash cushion have had options and opportunities in the past year that enabled them to respond to reduced income and increased demand more strategically and carefully than those organizations with few extra dollars in the bank. You know what I mean whether you are affiliated with a nonprofit that has reserves or with one that does not.

In the survey that the Minnesota Council of Nonprofits conducted to prepare the most recent Current Conditions Report, several questions were included about operating reserves. MCN generously shared the survey data with me for an in-depth analysis of these questions. The responses illustrate the differences between nonprofits with and those without reserves.

• How much in reserves? For all respondents, 34% have one month or less, 18% have none, and 6% had a reserve fund but depleted it in 2009.
• Asked if they anticipated dipping into reserves in 2010, 24% of nonprofits replied that they do.
• Not surprisingly, 65% of nonprofits with minimal or no reserves experienced cash flow problems in 2009, and most of them anticipate prolonged cash flow problems in 2010. Nonprofits of all sizes fell into this group, most commonly in arts & culture and social services.

Why does it matter? I sliced the responses further and found that the nonprofits with minimal or no reserves were more likely to have cut budgets, eliminated staff positions, reduced wages and benefits. They were also less likely to have been able to increase services to respond to growing demand.

There’s a caveat that these results aren’t necessarily caused by the lack of reserves. It’s quite likely that other factors are at play, including the broader question of the governance and management practices and business model needed for nonprofits to build reserves over time through operating surpluses.

This survey and the practical cases that we talk with every day have taught me to truly appreciate – to love – operating reserves.

Build the Right Reserve for Your Organization

I still believe that the “right” target for reserves needs to be customized for each nonprofit based on their operating structure, cash flow, and ability to generate surpluses in the operating budget. Building reserves requires an intentional budget strategy and follow through to generate surplus funds. Whatever the target amount, reserves are most useful if there is clear agreement about their purpose and use codified in a written policy. Nonprofits Assistance Fund has developed a new resource, Operating Reserves Overview and Policy Example. If you are interested in a deeper dive on the issues, considerations, and structure for reserves, you’ll love the Nonprofit Operating Reserves Initiative Workgroup White Paper. They answer the “how much” question with a useful chart that sorts through the “it depends” factors.

How many of you have wanted to take a break from the pace and pressure of work and decompress? I have been given this gift in the form of a one-month sabbatical during February. After seeing the positive effects of a similar break on a friend of mine, I made the request and our board quickly agreed. While I didn’t do any other research about sabbaticals, it made instinctive sense that time away would be a good idea for both me and for Nonprofits Assistance Fund. In the year since my request, two other professional colleagues have taken one-month sabbaticals and had very positive experiences for themselves and the staff of their organizations.

Now, just in time for my break, CompassPoint released a study titled Creative Disruption about sabbaticals at nonprofit organizations. This summary of the report is affirming for my own sabbatical and for any of you who’ve been thinking about it.

This study exposes the myth that an executive sabbatical will be a chaotic disruption, finding instead that the creative disruption of a well-planned sabbatical can be productive for the entire leadership of an organization.

Organizational capacity is increased as the second tier of leadership takes on new responsibilities. Governance is strengthened as a result of the planning and learning that goes with a sabbatical process. Executive directors come back rejuvenated, with a fresh vision and innovative ideas, and tend to extend their tenure with the organization. And funders gain a deeper perspective on community needs from the feedback, networking, and innovative ideas that sabbatical alumni bring.

The report is an interesting read, including the results of surveys of executives who took sabbaticals and the interim directors who took on a new role. The subjects of the study were all recipients of funding to support sabbaticals, usually for three months.

I’m eager to see what kinds of experiences and ideas I have during the month. I’ll be kicking back for some of the time and using some of it for reading and discussions about the big issues and ideas for nonprofits in the future. (Although I can promise I will not spend all four weeks of February in Minnesota.) I started this weekend by reading an advance copy of the book Switch How to Change Things When Change is Hard by Chip and Dan Heath. The book addresses the reasons why change is so hard with a well-formed framework that makes the concepts accessible and actionable. They offer three essential components needed for change to happen:

1. Direct the Rider – clarity and direction
2. Motivate the Elephant – emotions and energy
3. Shape the Path – plan and influence the situation

The book will be released on February 16th, but you can read an extensive excerpt in Fast Company.

More reading and thinking to come, but you probably won’t hear much from me this month. We’d love to hear any comments about sabbaticals from other nonprofits – what have you done, or wished you could do?

What amount is the right size of donation for your organization? Most of us would laugh at the question and answer “$1 million, of course.” But ask again, with a dose of both reality and prudence. What is the amount that would have a long term, stabilizing impact on your organization if you could rely on annual gifts from many donors? It’s probably far, far below $1 million. It’s probably even below $1,000. Many nonprofits overshoot this number, though, chasing larger gifts and grants, thinking that bigger dollars are the answer. I’m not sure that’s ever a realistic strategy, but I think it’s too risky in the midst of the recession.

The Value of Smaller Gifts

I’m pleased that smaller gifts are drawing greater attention and wanted to highlight a few noteworthy examples. The article Save Our Ship in American Theatre Magazine describes the efforts of theaters to rebuild from financial struggles:

The hero who emerges from emergency campaigns is the small donor. Practically every artistic leader I spoke with used the words “grassroots” and recounted anecdotes about donated piggy banks. Over and over, artistic leaders said that it was not one single donor that saved them but rather many, many modest donations – gifts of $100 and $150 that added up to serious money.

The value of many, many small donations was proven on November 17th. At the end of the fundraising-palooza of Give to the Max Day, 38,778 gifts had been made totaling $14,000,406. That divides to a $361 average gift. Many of the most impressive Give to the Max Day campaigns yielded great numbers of both donors and dollars with pretty small average gifts. The organizations with the largest numbers of donors had average gifts ranging from $75 to $100. Organizations receiving the most dollars also had modest average gifts between $65 and $325.  Other examples of the power of small donations can be seen in the international response to the recent earthquake in Haiti, such as the American Red Cross raising $3 million as of 9am EST in $10 increments through a text message campaign.

In his book The Art of the Turnaround, Michael Kaiser describes the process of Alvin Ailey Dance Company’s financial recovery. He offers this advice:

Aiming to fill a deficit with one extraordinary gift is usually just a pipe dream. We need to focus on “right-sized gifts,” gifts that make sense given the budget and the profile of the organization. For the Alvin Ailey American Dance Theater, with a $6-million budget and a $1.5-million deficit, $50 was too low and $1-million was too high. At Ailey, while we did receive larger gifts, we focused our fund-raising on $1,000 gifts. Our board felt comfortable asking for this amount from friends and associates, and this was an amount that would make a difference to us.”

If you prefer to hold out hope for large gifts and grants, be aware of the risks. The Minnesota Council on Foundations just released their 2010 Funding Outlook based on a recent survey. The survey found that overall funding by Minnesota’s foundations will stay fairly level in 2010 compared to 2009, for which we should be thankful. There is wide variation, though, in the grantmakers’ forecasts. More grantmakers expect decreases in giving in 2010 than expect increases: 30 percent expect to give less compared to 25 percent who expect to give more. At least 20% of foundations expect to decrease the number of grants awarded, as well.

Keep up the grantwriting, RFP submissions, and lunches with prospective large donors. But take Michael Kaiser’s advice to heart – make the priority for 2010 to build a reliable base of “right-sized” gifts.  They really do amount to something very important.

I have not had the H1N1 flu.  I hope to keep it that way. However, this flu is starting to really affect me because of the number of people who are not so lucky.

As an example, in just the last week:

• I attended two important meetings where key participants were missing in action.
• Three training events and webinars were canceled.
• A professional associate stayed home with his son for several days.

Two days ago we had to scramble to replace the speaker for one of our own training events.  That really brought this home.

Scramble really describes the activities. There were many emails sent looking for a replacement, and the reply often was “I’m already scheduled for another training, meeting, travel…” Fortunately, a replacement was found (who did a great job) and I am grateful for the size and quality of the network of consultants in the Twin Cities.  But it’s clear that none of us have any slack in our schedules anymore. All the reductions in staff and hours in the past year have taken their toll, removing any elbow room (if there ever was any to start with).

Contingency Planning

The whole process got me thinking about contingency planning. This is going to happen again and again this year and we all need to be prepared. We have a Disaster Recovery Plan, but it wasn’t developed to address this situation. We need to have a plan for deciding when to cancel a meeting or training, when to use a backup plan, and who to call on for reinforcements. We might need to look around for some elbow room again by scaling back a little on commitments for the next few months.

How are you adjusting to more and more absences caused by this flu? Do you have a clear agreement on priorities and steps to take when you have multiple staff members all sick at once?  The Nonprofit Risk Management Center has a number of useful resources and tools, including a list of contingency planning resources and a tutorial on business continuity planning.

As with any planning process, agreeing on the priorities and responsibilities is step one. We’re starting today.

Update: Here is an H1N1 Flu Preparedness Toolkit from the National Council of Nonprofits.

Three cheers, at least, are deserved for Grantmakers for Effective Organizations (GEO) new publication On the Money by Nancy Burd. You can download either the executive summary or full report from the website.

As summarized on the GEO website:

This publication highlights the financial challenges nonprofits face and the ways in which grantmakers are both improving the situation as well as perpetuating the problem.

The first section, Assessing the Problems, identifies five problem areas:

1. Restrictions on Funding
2. Misperceptions Around Sustainability and Growth
3. “Too Many Masters”
4. Onerous Grantmaking Practices
5. Knowledge Gaps

The other sections discuss Barriers to Smarter Grantmaking and Ideas for Grantmakers.

It’s impressive how in 28 pages the author distills a variety of ideas, research, and practices about the realities of financial instability faced by nonprofits. The report also provides helpful and realistic suggestions for grantmaking organizations based on practices that have already been developed and implemented by foundations.  The advice and guidance for funders is great, but this guidebook is a must read for everyone in our sector.

I’m pleased that GEO will be focusing on nonprofit finance and encouraging foundations to understand how “many prevailing approaches and practices in philanthropy can unwittingly create problems for the nonprofit sector.” Many nonprofits have experienced these unintended consequences and will welcome a dialogue on this topic.

However, nonprofit organizations also have a lot to learn from the report’s comprehensive overview of grantmaking. Misconceptions about the true cost of programs and capital needs apply equally (or more) at many nonprofits. We can’t expect a seismic shift in foundation practices and investment unless we nonprofit leaders understand and can effectively communicate what it takes to sustain ourselves.

Download this report, read it, and copy it for your board and senior staff.