Balancing the Mission Checkbook

Reading the headlines reflecting concerns and jitters about the direction of the economy is causing leaders of nonprofits to ask how it will affect their organizations. For some people, a state of worry has set in. I can see why. Today, the StarTribune posted this article on their website, “Chairman Bernanke says Fed ready to cut interest rates again as needed.” The article predicts further cuts to key interest rates “to rescue a weakening economy.” Factors cited included the unemployment rate, weak real estate, tightening credit, and high energy prices. What’s a nonprofit leader to do? Anyone who has worked for a nonprofit for more than three years has experience with a tough economy, so many directors and managers will be well prepared to respond to lean times. But how worried should you be right now and what are your concerns? I think it’s worth a review of the causes and effects that may have a direct impact on your nonprofit organization.

The key is to understand your income mix. There are essentially five distinct sources of nonprofit income and each income source expands or contracts depending on different factors in the economy. If you understand the sources of income that are most important to your organization, then you can focus on following movements and trends that will matter. One overall trend to keep in mind is that the “nonprofit economy” tends to lag the general economy by about a year. Here are some ideas for trend watching the economy.

Program service revenue, or payment for directly providing services, is the largest total source of income for nonprofits. Income from contracts for service, especially from government agencies, is determined based on tax receipts and state and local budgets. We know how many reductions occurred a few years ago and most of these sources haven’t rebounded. If this is your primary income source, the keys are the reports from the state and the budget process. You can track these through the Minnesota Budget Project. To survive with contracts, it’s important to understand the true costs of delivering the services (which is probably not the amount you are paid for delivering the services) and having your eyes open about the need for additional subsidy - and where to get it.

Program service revenue that is paid directly by the user of the service - like tuition, memberships, tickets, and fees – is a lot like business income and reacts to market downturns depending on the buying power of your customer. If your service is considered discretionary, like entertainment, then consumer spending is worth tracking by reading the business section of the paper.

If foundation grants are an important component of your income, watch the stock market. Because endowment payouts are calculated in a way that evens out big increases and decreases, there is no reason to expect a big decrease in 2008. However, pay attention to the excellent surveys and analysis from Minnesota Council on Foundation including Grantmaking Outlook and Giving in Minnesota. If the market performs poorly over time, some reductions in grants could develop. Keep in mind, though, that even with the poor market performance several years ago, grants from Minnesota foundations have increased total dollars almost every year (more details in the MCF reports). If your endowment is an important source of income, the same market trends described above apply.

For nonprofits that rely on individual donors it’s a mixed bag of economic news. This recent online discussion about the Outlook for 2008 hosted by the Chronicle of Philanthropy highlights some opportunities for planned giving and large gifts that transcend the economy, and emphasize the importance of relationships and communications in maintaining a building a donor base.

So don’t assume the worst or start a chorus of woe about the poor economy. Yes, there will be challenges, but you can understand how economic trends will affect your nonprofit. Knowledge is power and will help you anticipate and plan for any changes.

How important are financial ratios? I’ve had several very lively discussions recently about the value of using financial measurements, specifically ratios, to assess the financial health of nonprofit organizations. The appeal of ratios is that they are so tangible and certain, which makes them seem very reliable - especially compared to attempts to evaluate management strength or program effectiveness.

I will confess that I’m a finance person and I love financial analysis the way other people love mystery novels – I can follow the clues and tell a story from the numbers. So I’m surprised that I find myself in these discussions taking the devil’s advocate role that ratios are valuable only at certain times and with a lot of conditions. Used as a generic measure, ratios can potentially even mislead. To prove my case, consider the value of the “program service ratio” in evaluating nonprofits. This is the percentage of total expenses that are spent on program services rather than general and administrative and fundraising. Whenever someone attempts to impose a standard ratio that all nonprofits should use, we all bray about how different organizations are depending on their size, years of operation, field of service, client base, etc, etc. I agree with all of those arguments against a single standard and use the same reasoning to argue that ratios are valuable only when used in the right context and with the right information.

The first law of quality financial analysis – always use the right comparative information. Financial information by itself is just a list of numbers on paper. The understanding comes when it is compared – to the budget, the previous year’s reports, a set of goals, a peer organization or industry averages. Ratio analysis follows the same law. Yes, you should calculate ratios to analyze financial information, but then the ratios must be used with the right comparative information. There is no single “current ratio” for all nonprofits, but there is probably a good one for your nonprofit. A small nonprofit with few bills can have a strong current ratio compared to a larger organization with a larger budget, but that doesn’t tell us that one organization is in better financial shape.

After making an argument about the shortcomings of ratios, let me switch sides and offer a resource for ratio calculations.  Analyzing Financial Information Using Ratios has just been posted on our website as part of our Financial Management Resources. It includes an overview of ratios, definitions and descriptions and an excel worksheet for the calculations.

When I argue that ratio analysis is not a complete and reliable method to assess financial health, I have to offer some alternatives. How can we assess nonprofit financial health? What IS financial health? In a word, financial health is stability - the confidence that the organization will be able to serve its community and clients in the future. I can think of only three universal signs of stability that can apply to all nonprofits: reliable revenue, managed expenses and adequate cash. Pretty simple, and even these have to be understood in the context of the organization. Measuring and assessing these three components can take the form of ratios, trend analysis, comparisons with peers, budgets, plans or history. They are the fundamental financial levers that build stable operations. If you are interested in going through an in-depth analysis of your organization’s financial picture, with an emphasis on the types and reliability of income, consider attending Minnesota Council of Nonprofits’ workshop: Planning for Financial Sustainability on May 8th.

How should I answer the question, “How do I start a nonprofit?” I need an answer because it’s a question I hear pretty frequently. The common scenario is a phone call to our office looking for assistance to start a new nonprofit organization. (We are the Nonprofits Assistance Fund, after all.) The person on the line feels a personal call to action to address some need in their community – tutoring for kids, beds for the homeless, treatment for victims of abuse, and many other important and urgent issues. The question, though, shouldn’t be “how do I start a nonprofit”. The question should be, “How can I help to address this important community need?.” I try to help them step back a little and consider the real problem, not the conclusion they’ve already reached. If they can think about the bigger picture of how they can add their energy and talent to a community need, the options are vast. The answer is not always (in fact frequently is not) to incorporate another nonprofit organization. Time Magazine has a terrific article in the March 5, 2007 issue on this topic, “Rethinking Nonprofits”. Dan Kadlec boils the question of whether or not to start a new nonprofit organization down to three essential questions: Am I cut out for this?, Is my idea different?, and “Is a start-up necessary?”. The reality is that starting a new nonprofit corporation requires focusing the initial time, effort, and money on the start up rather than on the important community need. If someone is absolutely set on starting a new organization, we always send them to the Minnesota Council of Nonprofits web site for all the basic steps required. Note that the very first section of the “How to Start a Nonprofit” section at MCN is titled “Alternatives to Starting a New Nonprofit”. For a longer, more comprehensive resource about starting a new nonprofit, download the publication “Get Ready, Get Set” from the Center for Nonprofit Management in Los Angeles . The guide discusses how to conduct market research on the community need and available funding, and the legal and organizational steps. The Exempt Organization Division of the IRS also has several helpful publications and a new on-line training program.

The phone callers asking about starting a nonprofit tend to fall into categories. One group are of people who are deeply committed to helping their community and they just don’t know about the alternative ways to get involved. A second group are people who are ultimately trying to create a job for themselves and they believe the myth that there are “millions of dollars in grants available for you today!.” I don’t have much patience for them. The last group are those who have already started an informal program or project and want to find a way to get some money or help to continue or survive. These calls are the most complicated and the toughest to help. I can only hope that they have put some effort into the basic research and needs review as described in Dan Kadlec’s article. Otherwise they will confront the harsh reality of funding, boards, and the steep learning curve of a start up.

The Minnesota Office of the Legislative Auditor issued the Office of the Legislative Auditor’s report on January 5, 2007 that evaluated state agencies’ methods for awarding and administering grants to nonprofits. The report was critical of state agencies for their lack of consistent and transparent systems. However, the report was not critical – in any way, shape or form – of any of the nonprofit organizations who receive state grants, of any of the grant programs, or even of the value of the community work that is funded by these grants. Unfortunately, there were those in the public and nonprofit sector who were quick to jump to conclusions about the report and conclude that the report implied that there were problems with grants and the nonprofit recipients. Some nonprofit directors have expressed concern that their work will get more cumbersome with additional reports and reviews. Please, everyone, slow down, read the report, and consider the recommendations.

According to the report, in 2005 the State of Minnesota made $4.7 billion in payments to nonprofit organizations for a wide range of services in health care, education, environment, and human services. The Office of the Legislative Auditor reduced the pool of payments for review by removing payments of $3.7 billion made to hospital, health plans and similar “institutions”. Of the remaining $1 billion, about $700 million flowed through counties and was therefore not granted to nonprofits directly by state agencies. That left $300 million (approximately 1% of the state budget) for the purposes of this review and resulting report. The report states that the use of nonprofits to deliver services to citizens of the state is appropriate and valuable. The purpose of the report is to evaluate the systems and practices used by state agencies, not the programs and services delivered by nonprofit grantees.

The report includes three primary conclusions:

1. The state’s approach to managing grants to nonprofit organizations is fragmented and inconsistent, and does not provide adequate accountability.
2. Many state agencies have grant-making policies and procedures, but they vary considerably in the degree to which they provide for oversight and accountability.
3. Agency oversight of grant recipients is especially weak when the Legislature selects and names a recipient in law, rather than allowing the agency to select the recipient.

These conclusions don’t seem revolutionary to me. Anyone who has dealt with more than one state agency for grants, or even more than one program within an agency, could tell you that the process for applying for, reporting, and receiving payment for grants is not always consistent or easy for a new grantee to access. The recommendations from the Office of the Legislative Auditor follow their findings – to establish a Grants Management Office in the executive branch to strengthen accountability and improve management of state grants; to formalize and require agencies to follow the best practices discussed in the report; and that the Legislature should not name grant recipients in law but allow agencies to select recipients through a competitive process.

In general, I think that all nonprofits in Minnesota could embrace the concept of a clear, consistent, easy-to-access process for applying for and administering grants from state agencies. Imagine if all of the grants a nonprofit received from the State of Minnesota used the same budget format, report requirements, and payment system. Rather than worry about more cumbersome requirements we could work with the state to simplify, streamline and make both the state government and our nonprofits become more efficient in serving our citizens and clients. The Minnesota Council of Nonprofits has also responded with support for the overall goal of creating a more efficient, transparent, and consistent process for state grants.

I’ve had several conversations lately with directors and board members of nonprofits about offering benefits to employees. The question often starts as a budget question - can they afford it? After a while, though, we end up in a discussion about organizational culture and values. Nonprofits often have stated values - a set of guiding principles that have been crafted during strategic planning with the board, staff and other constituents. Our goal and intention is live out our values in every aspect of the organization. Here are some values that are frequently embraced by nonprofits: Respect, Integrity, Cooperation, Teamwork, Dignity. These values statements and employee benefit questions can collide when nonprofits make financial decisions and feel that they have to choose between budgets for employee benefits and wages or budgets for added programs. But what about those values? If respect, teamwork, and mutual support are core values, what about living wages jobs and employee benefits?

How can nonprofits justify spending 70% of the budget on payroll?

I’ve talked to three nonprofits in the last month that are working their way through this question – with difficulty. One of the difficulties is caused by the ambivalence that some staff and board members may have about compensation in general, particularly in young or small organizations. I was recently asked by a new employee of a nonprofit “how can nonprofits justify spending 70% of the budget on payroll?” I asked him how he thought they should spend their budget and he answered, of course, “the clients”. He needed a quick lesson in the financial basics of how nonprofit social service agencies provide their services. This same naiveté leads boards to convince themselves that employee pay and benefits are a less worthy budget choice than other priorities. Every nonprofit with paid staff has to face this question at some time.

Of the three nonprofits I’ve talked to about benefits recently, two of them have been operating for less than three years and are navigating a familiar organizational transition in staff and structure. The third nonprofit is a long-established organization, with social justice as a core value, that’s had employee benefits on the priority list for years. They’re having the hardest time with the benefits question because it has become a critical values clash that’s been avoided for years – and it’s getting worse as time goes by without facing their responsibility to “walk the talk”. So look at your values statements again and make sure that you haven’t been ducking your responsibilities.

To learn more about employee compensation structure and employee benefits in Minnesota, see the Minnesota Council of Nonprofits Salary Guide. The Guide reports overall benefit trends by filed of service, budget size and location, and specific information detailed by benefit categories and positions.

October was conference month for me. I attended four annual conferences of statewide or national organizations. I started with the joint conference of the Minnesota Council of Nonprofits and MN Council on Foundations followed by the MN Association of Community Health Centers, Independent Sector and ended with Opportunity Finance Network. One conference each week in a single month – why does everyone have to meet in October? I attended five plenary sessions, three keynotes, two awards dinners, and (I think) eleven topic sessions. I also presented three of the sessions at two different conferences.

I heard many smart and experienced people talk about important, urgent issues. I learned about technical and financial topics and policy and economics. After all of my conference experiences this month, I have one burning question: what’s the point of PowerPoint? Many of the conference sessions included a PowerPoint presentation, but in very few cases, did the visuals add anything of value. I hate to admit it, but the PowerPoint that I created for one of my sessions was a case study in dullsville. We all complain about it, but when are we going to stop mistreating our audiences and improve the practice?

The typical use of PowerPoint at the conferences was a number of slides with 4 to 8 bullet points containing 40 to 70 words. Most used no visuals except the logo of the presenter’s organization or a Microsoft design template. In many sessions the presenter also distributed printed copies of the slides as a handout. The best of the presentations used the slides as a focus point for the audience with key phrases and issues. Less effective presentations used slides with every word of the information, lots of data and detailed descriptions, and lists of the names of the panel members and topics for the session. The worst users included slides with complex charts that were unreadable both on the screen and on the printed page. Unfortunately, the audience can end up frustrated, confused, bored, or insulted.

Despite my complaints, I don’t hate PowerPoint. Research about learning styles shows that many people learn through visuals, and PowerPoint can be a great communications tool. Here are a few suggestions to improve your use of PowerPoint:

• Learn how to use PowerPoint. It’s not a difficult program but there are features that need practice and testing.
• Good presentations don’t just happen, they require planning and preparation. The problem with templates is they make it easy to take shortcuts and create a bad presentation.
• PowerPoint is a visual tool – make it visually interesting and engaging with pictures and graphics that build on your message. This includes both the pictures and the slide design.
• Get a copy of the book “Why Bad Presentations Happen to Good Causes” published by Cause Communications. This terrific book, less than 100 pages long, is full of practical information to improve presentation content, delivery, and use of PowerPoint. Most nonprofits can get a copy for free.
• Visit David Canfield’s 8 Mistakes of Microsoft PowerPoint Presentations for a list of common mistakes we have all made at one time or another.
  

I’m back from conference-land. Next week I’ll be back with thoughts about financial issues for nonprofits.