Balancing the Mission Checkbook

Personnel costs are the number one expense for most nonprofit organizations. Many of our clients have made some very difficult choices in the last few years to reduce expenses, including reducing staff, cutting wages or eliminating some benefits. These emotionally-difficult changes can have serious impacts on services, but may be necessary for the long-term health of the nonprofit.

The second-largest expense in most organizations is spent on rent or mortgages and related costs.  Facility expenses can sometimes evoke nearly as much emotion as staff costs, but often generate less examination and conversation at the board or community levels. In tight times, there are some critical issues to keep in mind when thinking about space.

• Your space can impact your mission and vice-versa. Some organizations are very tied to a neighborhood or even to a specific building. Planning for the costs to stay in an area is a priority for some organizations where others may be less tied to a community and could move for less-expensive rent. If you are restricted to a space (through a long-term lease or ownership), changes in your community over time may force your mission and programs to shift.
• Ownership isn’t right for everyone. Many nonprofits consider the idea of buying space as a great way of locking in costs and gaining equity over time, but owning real-estate requires a different set of commitments and management, and can distract from mission-related questions. Buildings may even lose equity if the organization doesn’t reinvest in the property (ask us about funding depreciation in your reserves policy!).
• The costs of a move can outweigh the costs of staying put. A five-percent increase in a lease may seem unbearable in a market with lots of vacancies, but if your nonprofit can make the decision to move, it’s best to understand all costs involved. Compare your current costs against the prices of moving. Think about all the additional expenses that add up such as running new phone lines and data cabling which can consume potential savings. To help you plan ahead, IFF offers nonprofits templates to consider costs for your current space, future space, or a move.

Many other factors can impact what is the right space at the right time for your organization and your mission. Join us at the Minnesota Council of Nonprofits Annual Conference for a break-out session on facilities costs. We’ll be joined by brokers from Northmarq to talk about professional representation in space decisions. Sneak peek: your landlord will often cover the costs of your broker to get professional advice without breaking the bank. Stay tuned — learn more ways to cut down on facility costs at the conference!

At Nonprofits Assistance Fund, we value scenario planning and we often find ourselves communicating this information with nonprofit leaders by asking, “What would you do if…?” Due to the high demand for a resource to help anticipate these situations, we even created a concise template for budget scenario planning. As times have changed, it is getting more and more difficult to have confidence in funding assumptions. For many nonprofits, decisions are made in rooms and conferences far outside of their influence that have major, and sometimes sudden, impact on their future. In the meantime, you hold your breath and wait.

The drawn out debate and standoff over the state budget was an amped up case study. In comparisons between the Governor’s and Legislature’s versions of the proposed budget many nonprofits could see different futures – reductions, increases, hold steady and eliminations. For weeks, if not months, these directors and program managers continued to provide services and manage their organizations while not knowing what was to come. Because the final budget bills were completed and passed so quickly, holding your breath was the norm.

For example, this Minnesota Budget Bites blog post summarizes some big changes contained in the Jobs and Economic Development budget bill. For some of the nonprofits that provide jobs, training, and economic development services in the community, many of these changes are major and long term. And they’re in effect right away. I know one organization whose budget will shrink by 25%, and another that expected a similar reduction but got an unexpected one year reprieve. Neither organization knew what was in the bill until early morning on July 20^th. In both of these cases the organizations knew that their programs were “in play” in budget talks. They’ve both developed some scenario plans and had board discussions about changes to come.

Scenario planning is only one component of managing uncertainty. Nonprofits must have a solid understanding of their financial structure and what levers they have (or don’t have) to make changes. The “ideal” financial management practice for right now is the capacity to adapt, which requires you to have a system in place for forecasting and managing cash flow.

Last week, we got some great news. We were awarded a $1.5 grant by the CDFI Fund of the US Treasury Department. You can read the press release here. This is award will help us grow our loan fund and serve more nonprofits for many years. I knew when the awards were going to be announced, and I was pretty distracted and jumpy while I waited in anticipation. This award means a lot to our future, but I really had no idea what to expect. About 10 minutes before the scheduled announcement of the awards I realized that I was holding my breath. I wonder if lots of others were holding theirs’, too. We were one of 155 organizations that received good news from the CDFI Fund, but I know many great organizations that got bad news that day. I know the feeling – anticipation, disappointment and let down, and then take some time to re-group.  When decisions that have a big impact on the fate of your organization and its work in the community are really out of your hands, what do you do? Do you have a grounding in structure and options, or do you close your eyes and hold your breath?

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.

If you haven’t, you should call them soon and ask about SAS 112, a recent change in auditing standards that will affect audits of nonprofits. Because the new standard was effective in December 2006 we are just beginning to see audit reports using the new standards. SAS 112 establishes new definitions and standards for Communicating Internal Control Related Matters Identified in an Audit. Auditors have always considered the quality and sufficiency of internal controls as a component of the audit. If weaknesses in internal controls are observed, the auditors submit a management letter to the board describing the weaknesses and recommending further attention to these controls. We often joke that the “Segregation of Duties” comment is printed on the letterhead of the audit firms since so many nonprofits receive management letters with this finding. We all understand that it is very difficult to properly segregate all financial duties with a small staff. The new auditing standard could greatly increase the number of internal control weaknesses identified and reported – and cause concern and strong responses by nonprofit boards. The new standards do three things: provide new definitions and terminology for internal control weaknesses; allow the auditors less discretion in identifying weaknesses as significant; and require that auditors apply more complex standards that consider combinations of weaknesses, quantitative and qualitative factors. This article from the AICPA includes links to the SAS 112 document for a thorough review. Enough of the technical – what does this mean for your nonprofits?

The likelihood that control deficiencies will be identified and reported is probably higher. The auditor simply has to consider a much wider range of factors and apply a new and higher standard.

According to accounting firm PricewaterhouseCoopers, “we believe that the new definitions will lower the bar such that more control deficiencies will be considered severe.”

Even for the management letters with the same findings as previous years, the new terminology may cause concern. The term “reportable condition” is replaced with “significant deficiency”. More nonprofits will receive reports of control deficiencies related to their capacity to apply generally accepted accounting principles to financial transactions and financial reports. Think about your internal year-end financial reports. Do you correctly report the following information according to GAAP accounting rules: receipt and release of temporarily restricted funds, in-kind contributions, accrued expenses, and depreciation? If you have relied on your auditors to provide audit adjustments for these items, you should be prepared for a possible finding of a control deficiency. What should you do?

• Talk to your auditor before they come to start fieldwork about SAS 112 and how they will communicate with you during the audit.
• Next, communicate these new standards to your treasurer, finance committee and board of directors. The last thing you want is a surprise when the audit report is presented.
• Last, and most important, do what you can to improve your internal controls and quality of financial accounting. This is the ultimate purpose of the audit standards, and the goal for your nonprofit as a steward of your donor and supporters’ funds.

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.

This month, Nonprofits Assistance Fund announced a new training service designed to help members of nonprofit boards understand and use their financial reports titled Financial Clarity for Nonprofit Boards. This idea has been brewing for a couple of years in response to the many nonprofit directors who come to one of our workshops and say, “I wish my board were here.” One of the most important factors that we considered as we were developing this new training was the diversity of nonprofit boards. Not all nonprofit boards are the same – and that’s a good thing. Unfortunately, I have read too many books and articles about board roles and responsibilities that describe a one-size fits all approach.

In a typical chapter about boards, the list of responsibilities includes: hiring and evaluating the executive director, fundraising, strategic planning, financial oversight, and identifying future board members. Beyond that list, board members are warned, they should not meddle. Well, this list may be appropriate for organizations with sufficient resources and staff to carry out all of the ongoing activities but there are many nonprofits that are not at that point – and may never be. Young organizations with a small staff need more involvement, and nonprofits that are reaching into communities with deep and specific needs may need a different kind of board – community involvement. How the board actually gets its work done needs to vary depending on the organization’s current needs (which will change). With this understanding, we created the financial training for boards to be flexible and allow us to meet the board where they are and build the capacity that fits them.

I recommend a report from a study that was completed in fall 2006, “Coloring Outside the Box: One Size Does Not Fit All in Nonprofit Governance” by Kim Sundet Vanderwall and Ellen Benevides for MAP for Nonprofits. The study reports on discussions about how boards work in 40 small grassroots nonprofits and organizations based in cultural or rural communities. What they found was a variety of different ways that organizations had created to get the work of the board done. In few cases were the boards following the “textbook” model.

Common strengths the researchers discovered were the level of shared commitment, values and connection between board members. Common struggles were attendance and engagement, clarity of roles, and some of the specific roles and structure. It’s interesting to read the differences in perceptions about the board given by board members compared to directors and staff members.

The report concludes not with a prescription for all boards to follow, but a list of five core recommendations:

1. Know what you must do as a board.
2. Find a way to make that happen in as streamlined a way as possible.
3. Be creative and think outside the box.
4. Keep the spirit of the organization alive in all you do.
5. Challenge those who provide technical assistance to boards to present standards and best practices in a way that takes size, resources, and culture into account.

Another consultant who frequently writes about a variety of approaches for boards is Mike Burns at Brody Weiser Burns. Mike’s article “Avoid Pigeonholing Your Board into Traditional Models” was written almost 10 years ago but it’s still very timely. Mike also has a blog on nonprofit board issues now, Nonprofit Board Crisis.