nonprofit fiscal management
In this month’s Social Velocity interview, I’m talking with Hilda Polanco. Hilda is the founder and CEO of FMA – Fiscal Strength for Nonprofits, a consulting firm that helps nonprofits and foundations develop the fiscal capacity they need to fulfill their missions, including stronger operations and fiscal management, improved foundation grant-making capacity, and increased staff financial knowledge.
In addition to leading FMA, Hilda serves on the NYC Human Services Coalition’s special commission to study the closure of high-profile human services organizations. She was a founding member of the selection committee of the New York Nonprofit Excellence Awards and has served as an adjunct professor at Columbia University’s Department of Health Policy and Management, as well as on the faculty of the Donor’s Forum of Chicago.
Nell: Your career has been about strengthening the financial capacity of the nonprofit sector. Why do you think nonprofits struggle so much with financial sustainability?
Hilda: All businesses struggle with sustainability, as it turns out, but in the case of nonprofits, there are several additional challenges: I think of these challenges as follows:
- Missions that compete with the business model for attention, creating an unclear vision of what it costs to deliver services and what the revenue and expense drivers are to delivering these services.
- A lack of focus on the balance sheet, and instead a focus only on annual operating results
- An insufficient focus on longterm financial planning
- A lack of common understanding of the meaning of sustainability, among nonprofits and the funders that support them
Mission-driven leaders who are so important to the nonprofit sector are not often motivated by the “business” of delivering services. They care about the issues, the causes, the communities. As a result, they may not understand what a nonprofit’s business model is, or they may have absorbed a popular mistaken notion about nonprofits — that they should not strive to preserve surpluses. In order to be sustainable, an organization needs to understand its revenue and expense drivers and strive to strengthen its financial position over time.
An additional challenge is pricing. This is commonly subsumed under a discussion of “overhead,” but that term conceals some of the details of the problem. Organizations will face challenges to their sustainability if they are pursuing work or lines of business without fully understanding the cost when compared with what funds they are raising. Where there is a gap between what they raise and what it costs to perform the work, a “structural deficit” takes hold. A structural deficit is not one you can cure with a targeted fundraising appeal –as you could, say, to replace your roof or buy a new school bus. A structural deficit is one that persistently drains resources from the organization until the underlying problem is corrected. It’s a roof that, by design, will collapse every single year.
Having a focus on the balance sheet means having a focus on establishing healthy reserves. We drill our clients constantly on their Liquid Unrestricted Net Assets (or LUNA, for short). LUNA describes an organization’s available reserves for addressing strategic opportunities or unexpected expenses. They appear on the balance sheet. Too many organizations reckon their financial standing by simply comparing income and expenses for a given year. They need to look at a balance sheet. A strong balance sheet allows a leader to address the organization’s future needs. A weak balance sheet creates uncertainty. And this raises the issue of capital. There are several ‘kinds’ of capital—funding that is raised or preserved for different uses, for growth or innovation, for example.
It’s not just nonprofit leaders who need to understand this. Foundation program officers, major donors, and all buyers of nonprofit services need to share in this viewpoint, to arrive at a common understanding of what nonprofit sustainability looks like. The market for nonprofit services is sort of unusual in that we expect the funders, as much as the nonprofit leaders—to be self-reflective about their role in the transaction.
Funders should not expect their grantees to deliver quality services without understanding the full cost of the enterprise. And sometimes, they need to engage in a substantive discussion about business models so they can come to a shared understanding. Funders can have a different conversation with grantees, even if they are only funding a project. The conversation should not be just about what they are “buying”, but also about the organization’s overall capacity. Rather than focusing exclusively on this moment, the question should be “How can we be sure that you will have the capacity to achieve your target outcomes over time?”
What should they be doing to remedy the situation? This isn’t easy to solve. In many ways, it goes against how we think about our roles in a buying and selling relationship. Think about how strange this is: If you value the service your local coffee shop provides, it would be like prodding its owner to charge you more for your coffee so they could stay in business and serve the community who counts on that coffee each and every day!
Of course, the future is unknown. Sustainable nonprofits need to be planning for at least a two year horizon. Decisions made this year will have an impact on future years and preparing for those future years is much more effective with a longer horizon to strategize, rather than pretending that life happens in one year increments in isolation from the following year. For example, new hires, raises, multi-year grants that may come to an end in the coming year. These are all examples of business assumptions that should be taken in the context of their impact on future operations. More broadly, an organization must revisit its financial model over time, understanding what may have changed in the funding ecosystem or what competing organizations are doing.
Nell: There are two parts to financial sustainability: bringing money in the door and then using that money effectively. There have been some strides toward changing cultural norms around how nonprofits use money (with the Real Costs project and the Overhead Myth campaign), but what about on the bringing money in the door side? How do we get smarter about that?
Hilda: Efforts to raise funds for “services” have created a tendency to raise money for particular programmatic activities, rather than for the mission and outcomes of the organization as a whole. When an organization can articulate its target outcomes, and know what financial resources will be required to achieve these, the conversation can shift to an investment in the organization’s vision, rather than the purchase of specific activities. These are requests for investments of capital.
We see a growing trend in capital campaigns lead by a “funder prospectus” – a vision for the organization’s outcomes, with a request for investment in these outcomes; a way to focus the conversation differently. And with a funder prospectus, multiple funders can come to the table to support a common strategy – rather than create parallel strategies to suit the goals of the funder, rather than the goals of the organization. These campaigns can be for the sustainability of current operating levels, or the funding for growth.
Another issue to keep in mind is the concentration vs. diversification strategic conversation. There are a lot of consultants advising nonprofits to diversify their revenue sources, and not put “all their eggs in one basket.” This can be good advice under some circumstances, but it is not a one-size-fits-all solution. Diversification sometimes means building a much more complex—and potentially fragile—business model. For many organizations, concentrating on one revenue source can help focus, strengthen, and build the business model. For example, the skills and capacity to successfully raise funds from foundations and corporations is different from special events, major donors, or government grants. Without sufficient activity in each, the business model may not be able to support the required levels of diverse skill sets. It is somewhat of a balance – a diverse revenue strategy means a diverse skill set and capacity to succeed; often not found in a common staff position or limited organizational infrastructure.
And lastly, there is the need to balance between raising funds for current operations, vs. raising funds for new and “innovative” programming. Here’s where the “shiny object syndrome” can undermine an organization’s sustainability. The Development Director is excited about new programs, but the organization isn’t raising the necessary funds to cover core programming. Years ago, an Executive Director I know lamented to me: “If I hear ‘innovation’ one more time, I’m going to lose my mind. What happened to tried and true?” This notion of balance need not be confined to the leadership of an organization. Indeed, in healthy and sustainable organizations, this sense of balance is shared across the organization. The development team and program leaders should, effectively, understand the organization’s financial model just as much as the finance team. It is particularly important for development leaders to be able to articulate a coherent and compelling financial story of the organization as a whole, not just respond to the new ideas a funder may be focused on.
Nell: What role does research to understand what works and what doesn’t play? There seems to be a dearth of research in the sector about effective financing models. Do you agree with that assessment? And if so, how do we change that?
Hilda: I agree that there’s not much research, and there should be more.
And the first step toward research is sharing knowledge and lessons learned as these are happening rather than waiting for longer term research and evaluation. We need to build more of a shared understanding of the universe of possibilities. For example, what are Program Related Investments (PRI’s)? We hear about PRIs from time to time, but what are some early lessons learned? Who is making them effectively? More esoteric investments like Social Impact Bonds have made a splash, but there’s little understanding of the risks organizations take on by accepting this type of investment and the lessons learned in getting them off the ground.
Funders who are funding in a more holistic way can help the sector by educating other funders about it. Can a foundation make an investment in an organization’s operating reserves rather than operations? What does that look like?
Funders who are willing to experiment and share their experiences can play an important role here.
Photo Credit: FMA
I started a new blog series in March about overcoming the many fears that cripple the nonprofit sector, the first one being the fear of investment. Today I want to talk about the nonprofit fear of money. Because the nonprofit sector is focused on mission, as opposed to profit, money is often ignored at best, or feared at worst. Many nonprofit boards and staff find money distasteful, burdensome, and avoidable.
But money can be used as a powerful tool to create more social change. In order to overcome the fear of money and start using it effectively, nonprofit boards and staffs must:
Embrace Its Power
Without money, your compelling, inspiring, world-changing mission is only a sentence on paper. As much as we might like to deny it, nonprofits very much exist in a market economy. So instead of trumping all, mission is merely one of the things nonprofit leaders need to be thinking about as they are working toward social change. Because without a smart strategy for how you will secure and use money you are sunk.
Really, Really Understand It
Of course money is scary if you don’t understand it, and most nonprofit leaders don’t have a finance background. So learn all you can about money. Find an accountant who speaks English and can explain how money flows in and out of your organization. Make sure you are receiving and sharing with your board monthly financial statements that are understandable. Ensure board and key staff all have basic nonprofit financial management training so everyone speaks the same language and understands the key ratios they should be analyzing. This common understanding should serve to generate substantive conversations about the best use of money to further the work of the organization.
Involve Everyone in Raising It
I know I sound like a broken record, but EVERYONE at a nonprofit should be involved in bringing money in the door in a way that fits well with their skills and experience. Every board member should have a money responsibility. Be strategic about putting each individual to their highest and best money-raising use. And every staff member, even program staff, can be enlisted to explain the program to potential donors, gather client stories, or provide data about the program so that you can garner more support. No one at the organization should be allowed to say “I don’t do the money thing.” Money is everyone’s job, because with no money there is no mission, remember?
Budget for Having Too Much of It
It is unseemly for a nonprofit to operate a surplus. Funders don’t like to see an organization too far into the black, and board members become uncomfortable when “too much” money sits idle. But money sitting in a bank account means the organization no longer lives hand to mouth, continually putting out fires, and focusing only on keeping the doors open. Operating reserves allow an organization to think strategically, take some risks, streamline the business model, innovate the solution, and weather economic uncertainty all in the name of delivering bigger, better social impact. So overcome the taboo and budget for a surplus that creates operating reserves.
Talk About It. All. The. Time.
Because money is so central to mission you cannot make decisions about the organization, about programs, about staffing, really about anything without understanding the financial implications of those decisions. Therefore, you must be talking about money all the time. Not just when the finance committee of the board meets, or when you are reviewing the monthly financial statements, or when your latest fundraising event falls flat. Money must be a constant conversation. It must be fully integrated into everything you do.
The key to financial sustainability, and ultimately significant social change, is being smart about managing money. But you cannot be smart with money if you are afraid of it. Money can be a beautiful, powerful tool for creating social change. Embrace it.
Photo Credit: orudorumagi11
If this recession has any silver lining it could be that it’s forcing nonprofits to completely re-evaluate how they use money. There is a tendency in the sector to shy away from, ignore, fear or dismiss money. But when there is less of it, you are forced to learn how to use it more effectively.
And it is up to the board, who has a legally-defined fiduciary duty, to step up to the plate and provide a strategy for how money is used. But because boards are such a bizarre mingling of volunteer strangers it can be difficult for the group as a whole to take a leadership role, especially in the taboo area of money. The solution lies in encouraging a single individual board member to rise up.
Several recent articles have illustrated the need for nonprofit boards to become better financial managers. From Jan Masaoka’s (Blue Avocado) call for boards to use a budget more strategically, to Rick Moyer’s argument in the Chronicle of Philanthropy that boards need to find “crystal clarity about their financial situations,” to Bob Carlson’s warning that poor nonprofit financial management can end up with legal nightmares.
But what all of these articles fail to address is that boards are ineffective fiscal managers largely because of their group dynamics. Countless times have I seen a nonprofit board of directors suffer from group think, head off in tangents, or avoid difficult conversations.
The opportunity lies in getting a single board member to play a leadership role. A nonprofit’s executive director can be instrumental in encouraging this coup d’etat by finding an individual board member who:
- Is passionate about the cause and the organization
- Has the respect of the majority of the other board members
- Understands, or is willing to be educated about, the basics of financial management
- Is confident enough not to be easily dismissed or swayed
And what does it look like when an individual board member takes a stand to move the board towards better financial management?
- Interrupting the annual rubber-stamping budget approval meeting to ask how the budget fully finances the overall strategic plan of the organization
- Asking for, and ensuring creation of, monthly financial statements that are understandable
- Ensuring basic nonprofit financial management training for board and key staff so everyone speaks the same language and understands the key ratios they should be analyzing
- Standing up to board members and staff who dismiss or discourage deeper conversations about how the nonprofit budgets, uses financial vehicles, handles financial reporting
- Interjecting, cajoling, persuading, and inspiring fellow board members to USE money to strengthen the work of the organization
As David Bornstein said, social change is often driven by “one obsessive individual who sees a problem and envisions a new solution.” So, too, in the world of the sometimes intractable nonprofit board. It may require a single board member to stand up and demand that financial business as usual doesn’t work anymore. If it takes a recession to make money a true tool for social change, so be it.
Photo Credit: faungg
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