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!

So in the spirit of year end lists, here are five goodbyes for 2011 – and hopes for 2012:

Goodbye

1. State budget impasse and shutdown: Without a doubt the low point of the year for nonprofits was the long budget battles, anxious uncertainty, and the twenty day state government shutdown. While many services were maintained by court decision, nonprofit leaders had to divert their attention to preparing, information gathering, planning, and navigating appeals and systems to survive.
   Silver lining: Nonprofit leaders learned a lot about contingency planning and budgeting which has led many organizations to begin more substantive scenario planning for 2012.
2. School funding shift: For three years, the state budget has shifted part of the funds for public schools to the next year in an accounting maneuver to close budget gaps. As of July 2011 the shift is up to 40%. The impact of this shift on charter schools is particularly difficult because of limited cash reserves and financing alternatives.
   Silver lining: Nonprofits Assistance Fund made our first significant public policy effort to provide data and analysis on the impact of the shift on charter schools. We look forward to more policy involvement in 2012.
3. Information overload: So much data, information, analysis and opinion to read, hear and see. I’ve been pretty overwhelmed this year by it all, but I can’t seem to stop myself. Between printed media (yes, I still read daily papers), online journals, broadcast and cable media, Facebook, and Twitter, I should be as well informed as humanly possible. When I found myself standing by the steps of the capital at 11 pm on June 30th, though, listening to MPR on a tablet computer and reading tweets on my phone, I realized I had fallen into the well.  I had to learn to “curate” for myself (new buzzword alert).
   Silver lining: We have amazing journalists in Minnesota through nonprofit and for-profit media outlets that make their reporting available. My hope for 2012 is that the economic models for high-quality reporting and ideas gain stability and support from all of us who rely on them.
4. Financial crises and closures: A number of nonprofits in Minnesota ran into severe financial problems in 2011 which resulted in major program contraction or closing their doors. The prolonged recession was a big contributing factor, but not the only factor.
   Silver lining: Some board members have woken up to the need to to ask better questions about both short term financial information and long term structure and sustainability. We hope in 2012 to see better financial governance that goes far beyond micromanaging budget variances.
5. Unemployment: We all know too many people who have been laid off by nonprofits, government agencies and businesses in the last three years.  It’s been a loss to have talented, experienced, committed workers sidelined and spending long months or years searching for work.
   Silver lining: There are glimmers that nonprofits are finally being recognized as employers and “job creators”.  As reported in this Nonprofit Quarterly article the nonprofit sector is generating jobs at a faster rate than the private sector. A new advocacy organization, CForward, was formed to “champion the economic role of nonprofits”. We are hopeful that a variety of incentives and policies will be adapted to support the nonprofit sector as an economic force.

My final goodbye for 2011 is to thank all of the staff, volunteers, and board members of nonprofits everywhere for your commitment and effort to help people, build community, create magic, and bring us all together. My hope for 2012 – that all of your organizations are productive, effective, satisfying – and well-funded – in 2012.

This focus makes me wonder about something: How much impact does the departure of an executive director have on a nonprofit? Of course the executive leadership role is important (as an ED myself, I certainly hope so). But if nonprofits are thrown into chaos or disaster by the loss of their ED, they have systemic problems that need to be addressed. A succession plan will give the board a roadmap to react to a departure, but building leadership within the organization is more proactive and effective. Some nonprofits groom another person to step into the ED role. There are lots of reasons not to lock into a selection prematurely, though.

Shared leadership is one approach to strengthening organizations by distributing authority and responsibility broadly. The article “Doing More with More: Putting Shared Leadership into Practice” in a recent issue of Nonprofit Quarterly reports on a two year study of 27 organizations that put this into practice. The concept of shared leadership isn’t radical or new, but as the authors note:

Most organizations continue to accept a hierarchical structure, with the executive director shouldering an enormous burden of responsibility for organizational success. The LLC participants generally reported that this was true of their organizations. However, we found that this concentration of power was not because executive directors were power hungry. Nor was it even deliberate. It was due to a lack of familiarity with the alternatives.

Implementing this approach requires nonprofits to un-learn some common practices. Success depended on senior leadership’s commitment to change, time to educate and plan fundamentally sound management practices, and engagement and accountability. They found that the 27 organizations adapted the practice to their organizations. One result was that “These organizations’ leadership capacity has expanded. (…) This reduces the stress and potential burnout on the part of executive directors, while helping to advance, develop, and retain other staff.” It seems to me that this would also make the departure of ED more easily managed. Boards could rely on the distributed leadership to maintain stability and agility and help define the profile of the next ED.

I’m also intrigued with the possibilities of this finding, “In many cases, shared leadership has also led to programmatic changes, and many of the participating organizations are beginning to think about how to expand the concept of shared leadership to their boards and allies.” Sharing leadership outside the staff chart could change relationships and impact significantly.

Another proponent of this kind of shared leadership is Leslie Crutchfield, one of the authors of the book Forces for Good. The book examines high-impact nonprofits to discover the common traits and practices. One of the six practices that help these nonprofits to produce results is to share leadership across staff, board members, and external networks.  I’m hoping to learn more about shared leadership and how to implement these practices from Crutchfield when she’s in Minneapolis this fall for United Front 2011. Crutchfield is speaking at the luncheon that is also part of the schedule for the MCN’s Annual Conference.

Nonprofits that develop broad leadership by sharing authority and responsibility effectively will be well positioned for transitions and departures – whether they have a written succession plan or not.

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.

I’ve told the story many times about my first job at a nonprofit. I was a receptionist at an arts organization (a long time ago). The board of directors discovered that payroll taxes had not been paid for many months. The financial situation was dire and the board took extreme action. All but two staff members were laid off or furloughed, the board took over all financial matters, and a major budget reduction was implemented. They had to have someone answering the phones (this was long before voice mail and email), so I kept my job. After the immediate crisis was over I was asked to take on some financial tasks and eventually became business manager. That firsthand experience with the impact of unpaid tax liabilities is forever seared on my brain. It’s the worst way to solve a cash flow problem ever.

Here’s how it happens – slowly and silently. Cash flow is tight and when taxes are due, the director/business manager/accountant holds off on the payment “until the grant check comes next week.” The check comes, but other obligations are due. Pretty soon it’s time for payroll again and cash flow is still tight. By the third payroll, the unpaid taxes are starting to add up to more than can be paid all at once. Meanwhile, the landlord, vendors, and contractors are calling to remind our intrepid manager that payments are due. The IRS doesn’t call, though. This is one of the most insidious parts. People often choose to pay low priority bills before urgent obligations because of relationships, annoying phone calls, or emotions. The IRS doesn’t take action to demand payment of delinquent taxes for quite a while. When they do, the matter is immediately urgent and expensive and becomes the #1 priority for the organization.

As an example, this article from North Carolina, Nonprofit’s IRS bill tops $850K, describes a mental health agency that had their state funding cut by 23%. They reduced their budget but also had serious cash flow delays. As stated in the article, “they fell behind in making payroll tax payments.” It appears from the article that the agency financed their budget deficit by deferring tax payments. Ultimately, the IRS filed a lien and the situation became a crisis so severe that the agency ultimately closed in July 2010. When they faced the state budget cuts and delays, the statewide mental health agency had to make some tough decisions. It’s really unfortunate that they chose delayed payroll taxes to “manage” their finances.

If you need another reason to stay current with payroll taxes, share the article Not Paying Your Taxes? Your Board Could Be Personally Liable from Nonprofit Quarterly with your board members. The article lists seven lessons learned from payroll tax cases.

Lesson two: Virtually any alternative – including taking on additional debt, restructuring, downsizing, and filing for bankruptcy – is better than failing to remit withholding taxes to the government.

That’s a pretty harsh lesson, but it underlines the severity of consequences of this financial choice. The worst one.

The rapid changes in the availability of government and philanthropic funds to pay for and subsidize services have led many nonprofits to examine their financial structure and realize that they can’t afford to continue to offer their services for free or nearly free. That model may have worked when the grants and contributions were available, but it doesn’t any more.

Nonprofits Assistance Fund offers workshops and webinars for staff and board members of nonprofits on financial management topics. We charge a fee for these training programs. What’s the right price for us to charge? Change the specifics and that same question is being raised at nonprofits of every size and scope. The answer, as with everything, is “it depends.”  It depends on the purpose and goals, both programmatic and financial, of offering the service. Should prices be based only on costs, or does market demand factor in understanding what your clients or audience are willing to pay? Some of the fee-based services offered by nonprofits are more naturally based on market and competition. Others are much more sensitive to the ability of clients to pay. Theater tickets and tutoring for low-income students have different economic models.

When you start this analysis, it’s important to recognize that discussions about starting to charge a fee or making changes to prices often get caught up in emotions about money and organizational and personal values. When the suggestion of requiring a payment from clients first comes up, expect some of your colleagues to recoil in horror. Someone may even tell you that nonprofits are not legally allowed to charge for their services. (Please tell that to the two colleges that I’m currently supporting!) Talking about money is uncomfortable for many people, and offering services for no charge is very easy. Unless you have adequate subsidy dollars from contributions or other sources though, it’s not sustainable.

A recent post on the Stanford Social Innovation Review blog, Nine Tips to Better Nonprofit Pricing, provides a good start with the market approach. I highly recommend the article To Fee or Not to Fee?, published in the Summer 2004 issue of Nonprofit Quarterly for a thorough review of whether or not to charge a fee, how fees and program access can be aligned, and how to set prices. The article makes a strong case that charging fees improves the relationship with clients:

The most powerful argument in favor of charging fees is the discipline of the marketplace – that fees increase accountability to the people receiving services.

They include a summary of research that showed that fees may help clients buy-in to the services more and perceive greater benefits.

For most nonprofits, charging fees and setting prices will depend on a number of factors, but most of these can be addressed with operational capacity, program design, and differential pricing. This topic is worth a thorough review whether you currently charge fees or not as a part of long term financial planning and strategy.

On the heels of this article, Nonprofit Quarterly offered a preview of a new book, Just Another Emperor: the Myths and Realities of Philanthrocapitalism, by author Mike Edwards, opening with:

“A new movement is afoot that promises to save the world by revolutionizing philanthropy, making non-profit organizations operate like business, and creating new markets for goods and services that benefit society. Nick-named ‘philanthrocapitalism’ for short, its supporters believe that business principles can be successfully combined with the search for social transformation.”

Edwards makes a strong argument that this movement is the wrong direction for several reasons, chiefly that social transformation is an entirely different “product” than producing goods and services. The preview sparked a lively response in blogs and on NPQ’s Forum from leaders in the sector. There is an air of “think tank” to this for me, though. We can have a healthy, and undoubtedly lengthy, debate on theory, myth, and reality. Most of the nonprofit organizations that we work with every day are not immediately affected by this trend, if that’s what it is. Most charitable dollars are still received from individuals or from traditional grantmaking practices. For “service-providing” nonprofits, delivering the essential social services, health care, and education needed in the community, public dollars dominate and are unlikely to take a radical turn towards long-term “investment.”

The growing awareness of philanthrocapitalism in the business world will require an equal awareness and response from nonprofits. If you think this debate can be ignored and relegated to the think tankers, I’d suggest that the discussion is important for us all to pay close attention to. Remember that there was a time decades ago that the basic structure of grantmaking was created. You wouldn’t want to be caught napping if the world that you know really changes. This topic relates to my post last week, which generated a comment recommending the book Good to Great and the Social Sectors by Jim Collins. Edwards also notes this short (35 pages) and valuable book – add it to your must read list.

Find out how one organization weighed the decision about whether it should close, and contribute your own analysis of whether they made the right decision in the Nonprofit Quarterly Online Forum.

Beginning today you can join Mark A. Hager of the University of Texas, San Anton, and Kate Barr of the Nonprofits Assistance Fund in the Twin Cities, to discuss “The Ultimate Question,” authored by Mark and published in the Fall 2007 issue.This will be a great discussion for executives, consultants, board members, and funders interested in how such decisions are made — and may be considering such decisions themselves.Just register on NPQ’s Web site to access the Forum and join us for a thought-provoking exchange where you can offer your experience, pose questions, and comment on those of others.

Once you have registered, a link to the NPQ Forum appears under the User Menu. Inside you’ll find a reprint of the case, financial background material, and some starter discussion threads that you can add to, comment on, or create your own.

So register on the NPQ Web site today to participate.

Andrew Crosby, Editor

p.s. If you have any technical questions, contact webmaster James Morgan. For any questions regarding content, please contact Andrew.

The definition of slack used by Bowman is “a cushion of potential resources which allow an organization to adapt to internal pressures for changes in policy, as well as to initiate changes in strategy with respect to the external environment.” The benefit of a cushion is probably clear to any nonprofit director. Money doesn’t just fall into your lap to build a reserve. Bowman makes it simple and direct: “Where does financial capacity come from? There can be only one place: annual surpluses.”

Planning for an annual surplus, specifically an unrestricted surplus, is a positive, important, beneficial, and necessary practice for all nonprofits. I emphasize the importance of viewing unrestricted operating results, rather than the total of all unrestricted and restricted funds, because of the volatility in results caused by the timing of project and multi-year grants.

One step that could encourage the practice is to add a measure or ratio that defines the annual addition to the reserve or cushion. In the for-profit world, this is communicated in a fundamental ratio:

Net Operating Income = Profitability Ratio
Total Sales, or Revenue

The comparable measure for a nonprofit could be a CINA (change in net assets) ratio:

Unrestricted Change in Net Assets = CINA Ratio
Total Unrestricted Income

Try calculating this ratio for your nonprofit organization for the past few years and you will start to see how well the ratio can communicate the building, or depleting, of financial capacity. How high should the ratio be? On this point a for-profit and nonprofit organization will differ. A for-profit company seeks the highest ratio possible. For a nonprofit the ideal amount of surplus depends on what they need – and that balancing act is complicated. Bowman’s article has a whole section on measuring the right amount of slack needed.

Nonprofit Quarterly has been one of those guides recently with their spring issue titled “Revenue is Destiny”. I enjoyed reading a preview of the summer 2007 issue, especially this excerpt from an interview with Richard Brewster, executive director of the National Center on Nonprofit Enterprise. NCNE “helps nonprofits make wise economic decisions”.

NPQ: What should boards focus on if they are concerned about long-term sustainability?

RB: This may be counterintuitive, but the central question is the quality of the program. In other words, the worst threat to nonprofit sustainability is if your program is crap. A nonprofit’s only reason for keeping going is to change people’s lives, communities, the environment, and so on for the better. If a nonprofit is not making the biggest difference it can with the resources available, it is being wasteful. From an economist’s perspective, it is not putting its resources to best use and is inefficient. I’d find it odd to apply the word sustainable in any really meaningful way to such an organization.

I love the directness of this comment. Why should nonprofit directors and board members be concerned about their financial and economic condition? As a tool to deliver good programs to change communities and lives, both today and in the future.