I joined Nonprofits Assistance Fund last fall. Admittedly, I am still giddy with the excitement of working with such a fantastic organization. I joined the staff after I had been a loyal and enthusiastic consumer of the training and technical assistance resources that NAF offers. After I attended two financial management workshops, I requested follow up one-on-one technical assistance to discuss revenue drivers and dashboard reports. The personalized help I received was a great inspiration and confidence boost. I came away with a clear vision for how to integrate financial drivers with program outcomes, and how to better condense financial reports to be of maximum use to our board.

Now that I work with NAF, I remain one of our most fervent promoters. But I continue to wonder how to best help nonprofit executives, staff, and board members translate the knowledge from NAF’s many resources (including the recent conference) into practical gain. From my previous experience, I know that there are lurking practical challenges that come with each breakthrough in understanding. How do financial leaders transform our latest insights gained from an inspirational conference, a training session, a consultation, or a recently-read article into a tangible benefit for our organizations?

Too often, nonprofit leaders leave some of our best insights in the theoretical dust bin. We nod our heads during conference breakout sessions, have animated discussions in the hallways between sessions, and fire off enthusiastic emails to colleagues after the conference ends. But soon after, we come face to face with urgent demands, short-sighted “budget priorities”, and never ending reporting deadlines. We also lose momentum before we can transfer our enthusiasm to executives and board members. Why, we wonder, don’t program managers and finance committee members want to stop for a long talk about the latest thoughts on nonprofit financial sustainability? Most often we lose our commitment to change when confronted by the pace of our jobs. Our newly gained vision for integrating financial acumen with mission success is scrapped before it is even tested.

It might be easy to resign ourselves and believe that there is no hope of introducing new financial strategies into a seemingly immovable organizational culture. We convince ourselves that our emerging nonprofit is too small and green to adopt sophisticated nonprofit financial reporting systems or that the idea of building multiple reserves is the luxury of a few, rare, well-heeled nonprofits. But these are the attitudes of victims, not visionaries. Instead of shrinking from the challenge, we could rise to the occasion. Wouldn’t you rather be seen as a wild-eyed revolutionary than a grousing bean counter?

I realize today that our responsibility as nonprofit financial leaders is to push our organization’s executives, staff, and boards, and the nonprofit sector to understand that any debate that refers to mission and money as two distinct topics must be called out as naïve and misguided. Having strong financial and organizational infrastructure that support program planning and strategic vision must be championed as a basic program activity – a responsibility, a necessity. We must join in the calls for donors and government agencies to abandon the dangerous and short-sighted focus on overhead percentages and an unproductive bias for narrow funding restrictions. There is nothing auxiliary about having sufficient accounting systems and competently-trained personnel to manage an organization’s finances. There is nothing discretionary about investing in board training and development of financial expertise. As nonprofit financial leaders, we have to be the first to give up these attitudes ourselves.

The Finance and Sustainability Conference put in front of us cutting edge information and ahead-of-the-trend perspectives on financial strategy, sustainability, and infrastructure. But did we simply meet as isolated and pigeon-holed finance geeks? Or will we transform this into an energizing event from which to launch our version of a revolution? I trust that you found an outlet for the creative and transformative ideas you gained at the conference. I hope that my initial skepticism is unwarranted – that many of us will put into action what we have learned.

Two weeks have passed, what are your next steps toward financial sustainability? Please share your stories in the comments below.

Some of this money is pure incentive to get the work done. An unrestricted gift is from an individual or institution that loves the work and wants to support that mission in the world. The more of this kind of donation a nonprofit gets, the more likely the organization will stay on the mission-track.

The inverse can also be true, however. The less donated revenue a nonprofit gets for its mission, the greater the chance it might stray in order to chase funding. The former incentive to stay on the mission path has become a disincentive for the original mission.

Nonprofit boards can and should evaluate how donated revenue impacts their mission. If there simply isn’t sufficient support for the mission to generate the revenue needed, than perhaps making a formal change in the mission is required. In the most extreme case, a nonprofit could decide the business model doesn’t work, there isn’t a logical segue to the next mission, and shutting down or merging could be a sensible option.

The intentional change in mission is the best-case scenario. A subtle shift in mission – or drift – is another potential outcome. If the money (incentive) isn’t there for the original mission, perhaps a nonprofit could decide to slightly adjust the mission to get available. Without a formal evaluation of the mission, a creative reading of a request for proposal (RFP) might find any imaginative nonprofit in a bind and therefore creating justifications for a drift.

Falling victim to funding disincentives is just one step further down the path. If philanthropic givers have identified a passion for a new direction (Hey – let’s fund MacGuffins!) and a nonprofit suddenly decides to become a MacGuffin provider, they aren’t responding to financial incentives. They’re really responding to the disincentives in their business model, and that probably isn’t the right solution.

So how do nonprofits align mission and money? When is pay for performance a mission fit versus a mission drift? Some of the best thinkers in the sector are going to be taking these issues on at the Finance and Sustainability Conference on April 19. If you can’t join us in person (please do if you can), watch this space for more conversation, follow the hash tag #npfinance on Twitter, or join in on the comments section below to share your own story of responding to incentives or, perhaps accidentally, reacting to a disincentive. Open conversation can help us all avoid drift and make intentional decisions.

Here’s an introduction to some terminology, links to some good articles and resources, and an invitation to discuss how it might fit your organization at the Finance & Sustainability Conference.

Terminology

Pay for Success (or Pay for Performance)
A contract in which payments from the public agency is in some manner dependent on successful outcomes. These contracts may combine traditional contract terms with incentive payments tied to outcomes. The contract relationship is directly between the public agency payer and the nonprofit or business service provider. An external evaluator may be involved, usually contracted by the public agency.

Social Impact Bonds
A new type of financing that includes a contract where payment from government agency is tied solely to outcomes. Generally the public agency has few other controls or restrictions on the provider. As currently deployed and designed, relationships for SIBs have three parties: the public agency payer contracting with a third party intermediary for payment based on outcomes. The intermediary contracts with a nonprofit service provider to deliver services and raises funds from investors. The intermediary contracts with the service provider with payment upfront for delivery of services and pays an incentive or bonus payment based on outcomes. The use of the word “bond” is actually a misnomer in this structure. The investment has more in common with venture capital that has a social value.

Minnesota pilot Pay-For-Performance Program
This pilot program, included in the budget adopted in the 2011 Special Session, authorizes a $10 million appropriation bond to be used to fund pay-for-performance contracts. The first step was appointment of an Oversight committee charged with developing criteria and conditions for services to be included, defining outcomes, and selecting service providers. The committee has been appointed and has started to meet regularly. Materials from meeting are available online through the MMB website.

Articles & Resources

If you are interested in a deeper understanding of the concept, structure, and current developments, here are some excellent sources:

• Summary of most recent development: Will Americans Pay-For-Success in 2012? by Centre for Social Impact in Sydney, Australia
• What Are Social Impact Bonds? An Innovative New Financing Tool for Social Programs by Center for American Progress
• Will Social Impact Bonds Work in the US? by McKinsey & Co
• Impact on Service Providers: Opportunities and Challenges of PFS/SIB Participation Recording of a webinar presented in August 2011
• Many articles, webinars, and resources on Nonprofit Finance Fund’s Pay for Success Learning Hub, including the Nonprofit service provider readiness self-assessment questions.

Start the Conversation

The “readiness questions” are especially important for nonprofits that are interested in delivering services in a pay for performance model. Here are a few questions to start your thinking:

• Do you deliver a service focused on prevention or intervention with a well defined group of clients?
• Does the prevention or intervention program result in outcomes that result in either reduction in direct costs or increased revenue for the state, county, or federal government?
• Do you have experience and systems for collecting and managing data related to your program participants?
• Are you in a position to grow you prevention or intervention service delivery program(s)?

Before entering into a pay for performance contract, nonprofits also must analyze some new types of contract provisions:

• Defining outcomes over which the nonprofit service provider has sufficient influence.
• Identifying the data that will be used to calculate outcomes, having confidence in the data sources and the ability to monitor the data during the life of the contract.
• Understanding and gaining confidence in the economics used for outcome valuation calculations.
• Negotiating contract terms that allow sufficient flexibility in service delivery to adapt and change to achieve outcomes.

If you find this interesting please join us at the Nonprofit Finance and Sustainability Conference on April 19^th and attend the afternoon session, “Pay for Performance: Assessing the Fit and Impact for Organizations” to hear more and participate with a great panel of nonprofit leaders on this topic.

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.

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.

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.

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!

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!

The stories are told within a common context. Narratives have rules of grammar, and the financial statements have rules about how we describe resources so we all have a common understanding. These rules (Generally Accepted Account Principles, or GAAP) are periodically reviewed and revised to help make sure we are all still speaking the same language, so our stories are well understood.

Someone has to keep the rule book, and in the case of GAAP, that is the Financial Accounting Standards Board (FASB). Nearly two decades ago, FASB changed the nonprofit rule book, because the stories being told under the old rules were sometimes confused tales the average reader couldn’t always decipher. Rules about how we account for temporarily restricted net assets and more were revised to make things a bit clearer. FASB has had more time to see the stories unfold, and the nonprofit sector has now grown more mature, and it’s time once again to think about how these numbers tell our tales.

FASB is considering changes to net asset categories. The specific changes are not final, but it reflects some thoughts Nonprofits Assistance Fund has been promoting with clients. Nonprofit net assets – what you are worth when you take away everything a nonprofit owes from everything a nonprofit is worth – can be described in better detail and with more narrative heft than just whether the asset has a donor-imposed restriction. A single lump of resources at the end of the day is useful information, but showing board-designated categories within the larger context of net assets helps convey intention about the direction and thoughtfulness of the management over time.

Board-designated categories can come in different flavors depending on the needs of the organization and story it may tell. A group with a building or other expensive fixed assets may want to show a designated reserve for repair and replacement work. A nonprofit with significant ups and downs in cash flow may want to show a specific board designation for a cash-flow management account. A nonprofit considering a merger or acquisition may need to show a designated reserve for one-time expenses related to growth.

Each case will vary, but a few well-chosen designations will help your nonprofit story gain understanding – and therefore more support – with audiences. FASB may soon change the rule book, in which case nonprofits will want to align their narratives with the new guidelines. Stakeholders will appreciate the added information, and designations can help nonprofits keep on their strategic targets. After all, when we tell our stories to others, we hear them again ourselves.

Every nonprofit business model has unique business model drivers. These drivers are typically income-generating activities that have a significant impact on an organization’s ability to simultaneously operate at a surplus while achieving its mission. Common examples of business model drivers include: number of clients served, number of projects completed, and amount of grant funding secured. Knowing your business model drivers is essential to managing financial sustainability.

These drivers often consequently correspond to the triggers within scenario budgets.  A scenario planning trigger is a decision point at which an alternative budget scenario is implemented. For example, “if we aren’t at 200 clients served by June 30, we need to switch to our Plan B budget and corresponding expense reductions.” Or, “if contributed income is 20% greater than budget at mid-year, we can consider moving to Plan C and implementing our program growth plan.” Scenario budget triggers are critical, because in a changing environment, action is almost always necessary. (For a scenario planning spreadsheet template, check out the ‘Budgeting and Planning’ section of the Nonprofits Assistance Fund’s resource library.)

Setting the appropriate scenario budget triggers requires a good understanding of an organization’s business model drivers. Nonprofit leaders often wonder, “How exactly do I make this budget work?” Or, in other words, “What is the optimal level of service for our organization?”

The rest of this post will explore how to apply a break-even analysis to a nonprofit business model. A break-even analysis tells us at what level of service we’re able to achieve a net financial result of zero, or break-even. We’re going to get technical and do some math. And, it’s going to be fun and helpful in understanding our organization’s financial health!

Let’s first start with some definitions of concepts and terms key to our example:

• Q – Quantity. This represents the number of clients served.  Depending on the business, it could also represent a unit of production.
• CI – Contributed Income. These are subsidy dollars, such as grants and individual contributions, that do not vary when service levels change.
• EI – Earned Income. These dollars vary in direct proportion to the number of clients served.
• P – Price. Synonymous with variable income, this is the amount of revenue we receive for each client served.
• FC – Fixed Costs. These expenses do not at all vary with the number of clients served. For example, if we pay $1,000 in office rent, that expense line-item won’t change if we serve 50 or 60 clients.
• VC – Variable Costs. These are expenses that vary as the number of clients served varies.

Nonprofit budgets often depend on achieving a certain Q. That is to say, at what level of service does our business model work?

A key premise is that a sustainable organization or a sustainable program operates at a financial surplus.

Sustainability = Surplus

Surpluses occur when:

Income > Expenses

Using the above definitions, we’ll think about nonprofit income as either contributed or earned:

Income = CI + EI

Also using the above definitions, we’ll think about expenses as either fixed or variable:

Expenses = Total Fixed Costs + Total Variable Costs

 So, to achieve a surplus, contributions plus earned income must be greater than fixed costs plus variable costs. We’ll call this our Sustainability Equation:

CI + EI > TFC + TVC

Earned income depends on our variable income and the number of clients served, and our variable expenses depend on the cost per client and the number of clients served:

CI + (P*Q) > TFC + (VC*Q)

Since the purpose of this exercise is to find out what service level makes our budget work, we can do some algebra to solve for the variable Q.

CI + (P*Q) – (VC*Q) > TFC

Q * (P-VC) > TFC – CI

Q > (TFC – CI) / (P-VC)

Now we have a useful equation!  To put the analysis to work, we first need a good understanding (or a good guess!) of the following variables: Total Fixed Expenses, Contributed Income, Price, Variable Costs.

Let’s apply the formula to a simple example to illustrate the analysis.

All Services Nonprofit gets reimbursed $500 for each client served. Current staff has the capacity to serve more clients, so the only variable expenses of adding a client are $100 in transportation expenses.  Most of the budget doesn’t change with the addition of a client; we have fixed expenses of $500,000. The organization expects $300,000 in contributed income next year. How many clients does All Services need to serve to achieve a surplus?

Q > (TFC – CI) / (P-VC)

Q > ($500,000 – $300,000) / ($500 – $100)

Q > $200,000 / $400

Q > 500

The budget breaks even when 500 clients are served. If more than 500 clients are served, and all of the other assumptions are accurate, a surplus will be achieved. This is true because there’s a positive margin per client, so that 500 is a minimum quantity.

For some nonprofits, there is a negative margin per client, meaning that costs per additional client exceed revenue per additional client. In those cases, the quantity that the above analysis yields is a maximum not to be exceeded. Serving too many clients would lead to a budget deficit.

In the short term, we work hard to achieve the service level that makes our business model work. But, what if we can’t achieve this level of service? Let’s think back to our sustainability equation:

CI + EI > TFC + TVC

As soon as we suspect that our earned income won’t make its budgeted goal, it’s time to consider alternatives such as increasing the price, increasing contributed income, or decreasing expenses. (This highlights the important point that fixed expenses aren’t necessary inflexible expenses. All expenses should be considered flexible to some degree.)

Nonprofits Assistance Fund’s scenario planning template can help you to imagine what different levels of income and expenses would mean for your bottom-line.

For almost all nonprofits, service level is a key business model driver. It’s important to understand in which direction it’s driving your organization!