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.

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!

A large percentage of nonprofits view their strategic plan as an essential part of managing the organization. The process of developing a strategic plan clarifies the purpose of the organization in a mission statement, and gets the staff and board on the same page by setting goals and priorities. The most commonly used tool for financial planning, on the other hand, is the annual budget. For many nonprofits, the financial goal represented by the budget boils down to this: “we hope we can raise enough money to pay for programs and overhead this year. We’ll work really hard to get this done.” Unfortunately, that’s a lousy way to plan.

What nonprofits need is the financial equivalent of the strategic plan that sets goals for programs and organizational development. This kind of financial plan is not for one year. It includes big goals, a clear path to accomplish goals, resource and capacity needs, and benchmarks for monitoring progress. Just as the process of strategic planning brings everyone together to set goals and sort through options and priorities, developing a strategic financial plan reveals the strengths and weakness of the current financial structure and sets goals that are more than annual revenue targets. What’s the right cost structure for delivering programs with measurable impact: paid staff, volunteer, intern, national service corps? These decisions will determine program, management, and financial structure. This idea is illustrated well in the article about Nonprofit Business Model Statements published on Blue Avocado last year.

Most nonprofit strategic plans that I’ve read give limited attention to the financial structure that will be needed to be successful. Some include some projections in an appendix, but most include a short set of financial goals such as “increase fundraising”, or “implement new individual donor program.” Our resource article Transforming Nonprofit Business Models describes the four components of business models: mix of revenue sources, cost of effective programs, infrastructure, and capital structure. A strategic financial plan needs to address each inter-related element of the model both now and what will be needed for the organization to achieve its goals over the next three to five years.

The steps followed in developing a strategic plan include agreeing on the vision and mission, gathering internal and external information to assess community needs and organizational capacity, establishing three to five year goals, and describing more specific objectives for implementing the plan. Strategic financial planning requires similar steps:

• Agree on a vision for financial sustainability
• Analyze financial history and trends
• Conduct a SWOT assessment of the business model
• Identify the current business model
• Evaluate the financial requirements to fully implement the strategic plan
• Assess the external community and market drivers and internal capacity for changing the financial structure
• Describe the business model that will be needed in five years
• Create a three to five year implementation plan

Strategic planning needs the commitment and participation of many skills and perspectives from inside and outside the organization. In the same way, strategic financial planning requires technical expertise for analysis and projections, strategic thinking about structure and alternatives, and creativity to weave together vision, mission and business models.

I’ll be presenting a more thorough session on the need for financial strategy and strategic financial plans at United Front 2011 on Thursday morning. This is going to be a great conference with lots of bold topics about strategy, leadership, and impact. Join us if you can!