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Call it what you want – surplus, positive change in net
assets, or profit – nonprofit organizations really need to plan for, and
embrace, the importance of building financial capacity by generating a cushion.
We don’t have a common language for this, and many nonprofit leaders would be
uncomfortable using a term like “profit” when describing their financial goals.
The word is much less important than the practice of budgeting and managing to
build surpluses. Read "Organizational
Slack (or Goldilocks and the Three Budgets" by Woods Bowman, published
in the Spring 2007 issue of The
Nonprofit Quarterly, for a very helpful overview of the topic.
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. | 