Balancing the Mission Checkbook

Ah, summer. A time for hammocks, reading on the porch, and leaving early every day. If only this were true. There was a time in my professional life when summers really were slower-paced, with fewer deadlines and urgent projects. I haven’t done any research on this, but it seems that the combination of technology, financial pressures, and recession-driven anxiety and uncertainty results in more demands at a faster pace year-round. Earlier this week in the StarTribune, the column Ideas come to the idle, and we are not by Christian McEwen helped me realize that the pace is not just stressful, it’s counter-productive. We all need some slack in our lives and not having it has consequences.

The same is true for organizations. One of the values of scheduling retreats and off-site meetings is to change the pace and build in some down time, but the need for slack is ongoing. In the article Organizational Slack (or Goldilocks and the Three Budgets), published in the Spring 2007 issue of Nonprofit Quarterly, Woods Bowman offers this definition of slack from management literature:

A cushion of potential resources which allow an organization to adapt to internal pressures for adjustment or to external pressures for change in policy, as well as to initiate changes in strategy with respect to the external environment.

It’s easy to think of all the times when our organizations have needed this. While we may initially think of financial resources, organizations also need a cushion of management, time and staff capacity. Recently many nonprofits in Minnesota needed this kind of slack really badly. In the six weeks or so leading up to the state shutdown, nonprofit staff and board members spent many hours (and many brain cells) developing scenarios, contingencies, communication and HR plans. Every nonprofit I talked with during that time was doing all of this on top of their already overloaded schedules. None of them had built much, if any, slack time in to their schedules or annual plans. In Woods Bowman’s definition, these organizations needed “a cushion of potential resources to adapt to external pressures”. The shutdown’s impact taxed everyone’s capacity. We at Nonprofits Assistance Fund also invested an enormous amount of time in shutdown preparation and response (read the summary of what we did here). Lots of other projects and plans were put on hold, and now the must-do list is really long. Without sufficient slack in our organizational capacity, our choices leave two options: require everyone to work unreasonable hours or take some projects off the list.

Another type of cushion, of course, is financial. Nonprofits that have operating reserves and reliable cash flow were able to prepare for and weather the shutdown with less disruption than those without. Bowman’s article delves into financial capacity as an indicator of organizational slack. Operating reserve balances seem like the obvious measure, but he emphasizes the importance of planned surpluses, capacity to borrow when appropriate and including contingency funds in the budget. Financial slack allows nonprofits to manage cash flow and budget hiccups AND to jump on new ideas, experiment with new strategies, and invest in program redesign. Financial slack also pays for  staff capacity and critical time, especially when needed surrounding the state shutdown.

The lesson I’m hoping I’ve learned is that both organizations and people need some slack all the time, not just for crises. If you’re headed into a planning cycle of any kind, think about how to build organizational slack. You know that you’ll need it.

Some choices that nonprofit leaders have to make are really tough. Others are tougher. Right now, there are many nonprofits in Minnesota that need to make some of these choices in the next few weeks because of the strong possibility of a state shutdown. In the recent post When the Worst Case Scenario is Really Soon we advised all nonprofits that rely on payments from the state to start working on cash flow contingency plans. As reports are trickling in about notices and conversations with grant and contract managers at state agencies, it’s clear that these plans will need to go beyond cash flow. That’s when questions go from tough (can we pay the staff and bills?) to tougher (can we continue to provide services in our community?).

State agencies are developing their own plans to suspend operations if necessary, and they are dealing with uncertainty just like the rest of us. Many state grant and contract managers are contacting their nonprofits contractors to alert them to possible disruptions in payments or the risk that any services provided during a shutdown may not be eligible for retroactive payment. How much impact would a state shutdown have on your organization, and what kind of plans to you need? The answer (as always) is “it depends”. This very fluid situation demands multiple versions of “what if … “

• What if … a state agency pays funds to the nonprofits from a source other than the state general fund budget, including federal funds or a designated source? A worst case state shutdown could either stop or slow down payment processing of contracts and grants – you need to create a conservative cash flow plan.
• What if … the nonprofit has a long standing state contract or grant? Even with an active contract or grant, a shutdown would stop payments for the near term, and could cause a longer payment lag due to backlogs and other disruptions. Review the contract terms, or check with the grant manager, to confirm whether or not payments are certain for services provided during a shutdown. You need a plan for cash flow delays including both immediate term and some lag time.
• What if … the nonprofit has an established contract with the state that is signed annually with a start date of July 1st or later? This situation poses more risk to the nonprofit because of uncertainty whether a new budget will include a provision allowing retroactive contracts. The budget passed in July 2005, the time of the last shutdown, included such a provision (thanks to Minnesota Council of Nonprofits). You need to take this risk into consideration as you plan – is this a cash flow delay, or a possible loss of some revenue? Could your organization absorb the reductions if you provide services without retroactive payments?
• What if … the nonprofit has a new state grant or contract that begins July 1st or later, or is waiting for a final approval or announcement for state funds? These funds are at the highest risk as long as there is not a budget in place. Be very cautious about assuming that the terms will be untouched and retroactive once a budget is in place.
• What if … your nonprofit doesn’t rely on state funds, or receives small amounts from the state? Rather than feel relieved, think about the impact a shutdown may have on your clients, other organizations with whom you partner, and other community services. You may see a ripple effect in new requests for service, higher demand, or service disruptions elsewhere. Spend a little time brainstorming how your organization might be affected and how you could respond.

The what ifs could go on and on. The only way to answer any of them, and many nonprofits have more than one state contract or grant, is to systematically review the terms, check with grant managers (while they’re still available) and consider the options. In some cases, the options may fall into three categories: tough, tougher, and toughest. The Minnesota Council of Nonprofits is communicating policy information, news, and resources through email and a page on their web site. Nonprofits Assistance Fund is working with MCN to sponsor six free Government Shutdown Emergency Briefings around the state that will include background of how we got to this point, crisis communications techniques, financial planning, and open discussion with your peers. Register through the MCN web site.

For the last six weeks or so there have been quiet conversations and meetings at nonprofits to prepare contingency plans in case of a state shutdown. As with all contingency plans, no one wanted to have to use them. Now that the May 23^rd legislative adjournment date has passed, and the governor vetoed the budget bills as expected, the likelihood is much, much higher. The conversations have moved from private conference rooms to big meetings and headlines, including Shutdown Looms in the Star Tribune, and MPR’s post Get to Know a State Shutdown. The State of Minnesota must have a budget in place by July 1^st or the money to operate the state’s activities runs out.

How concerned should you be? I think that we’re probably all concerned about the broad policy question and impact on the state. How worried should you be in your role as a nonprofit staff or board member? If you receive funds that flow from the State of Minnesota, you should be very worried. There are a lot of variables to consider and information to sort out, and it’s hard to accurately predict exactly how the state government would manage the shutdown if it happens. At the time of the shutdown in 2005 some services were declared “essential” as described in the MPR article, but don’t rely on those decisions made by a different administration. Budget Commissioner Jim Showalter has said that a shutdown this year could be “much, much more extensive.”

We are urging all nonprofits that rely on payments from the state to develop a worst case contingency plan as soon as possible, with an emphasis on one thing: CASH.

Here are our recommended steps:

1. Do you have revenue that comes to you directly from the State of Minnesota? Do you have revenue that is indirectly from the state, even if it is paid to you through another entity, such as a county, a collaborative, or partner?
2. If you do receive state funds, how much do you expect to receive in July and August? What would be the impact if you do not receive any of these payments in July and August?
3. Now is the time to update your cash flow projection or create your first one. We have two good resources, the guide to Managing Cash Flow and the cash flow template (Excel) that you’ll find in the Nonprofits Assistance Fund resource library. If you need some help developing your projection, Contact Us to talk with one of our staff.
4. Do you have internal cash accounts or reserves that could handle the cash flow gap?
5. Do you have a line of credit available that could cover the cash flow gap? Would the loss of state payments affect your ability to access your credit line? If you don’t know, find out.
6. If nonpayment would impact your agency’s ability to maintain services, meet payroll obligations, or sustain basic operations, you need a cash plan fast. To be prepared, consider managing cash flow starting now to accumulate a temporary cash cushion even if you don’t have reserves.

If the cash flow projection gives you bad news, be prepared. There may be very tough choices to make about temporary service reductions, staff furloughs, or expense reductions or delays. There may be ways to lessen the impact with advance planning. That’s what contingency planning is for. Don’t wait.

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.

I’m pretty sure that every nonprofit would love to have enough money that some of the funds can be invested for the future. In the past month, though, nonprofits may have seen their investment portfolios buffeted by the markets. If that wasn’t enough of a concern, this week we read about losses for some local nonprofits from investments related to the Petters Company fraud case. News reports this week in both MinnPost and the Star Tribune describe the negative impact on organizations that may lose millions from investments that were made to provide short-term loans to companies for inventory purchases. As Scott Russell said in the MinnPost article, these cases are “a wake-up call for other nonprofits to review their investment policies and portfolios.”  As an outside observer, it’s easy to say that these investments seem like an unlikely fit for a nonprofit organization, but we don’t know what standards or criteria those boards were using to evaluate and select investments. This is a good time, though, to review some fundamental guidelines for investments by nonprofits.

• Time Horizon – Funds that may be needed within a few months must be invested in highly liquid, safe investments. This is the most common type of investment fund for most nonprofits, composed of operating funds and reserves. In order to be assured that the funds will be available as needed, the investment choice must be readily available. The recent financial news has even raised red flags about some short-term investments – see my earlier post It’s 10 AM, do you know where your cash is?.

• Risk Tolerance – One of the fundamentals of investing is the balance of risk versus return. Investments with a higher return almost always also come with higher risk. The key question for nonprofit leaders and boards is to understand how much risk is involved and to decide if they can accept the risk. As an example, if the funds to be invested represent the balance of a large program grant that will be spent over the next year, then the organization can’t afford to risk the loss of any of the funds. A permanent endowment fund, on the other hand, is usually invested in a diverse portfolio that includes more risk in return for a higher long-term return.

• Responsibility – The nonprofit’s board of directors is responsible for overseeing this balance of risk and return for the health of the organization and any legal requirements. In order to fulfill this responsibility the board must act as prudent and loyal stewards of the organization’s assets. The board may decide to employ professional staff or outside advisers to manage the investments if the amount if large enough.  At minimum, the board needs to adopt and follow an investment policy. I highly recommend a booklet from BoardSource, Minding the Money: An Investment Guide for Nonprofit Board Members.

In this economic environment, every nonprofit needs to take a look at their investments and understand any risks that may have been taken for granted. It’s better to spend some time now and avoid surprises later.