One of the (many) benefits of working at Propel Nonprofits (formerly Nonprofits Assistance Fund and MAP for Nonprofits) is the frequent invitation to talk with groups of foundation program officers about the finances of nonprofits. While no two foundations, or program officers, have exactly the same mission, goals, or grantmaking approaches, there are some common questions and themes. How can I tell if a nonprofit is financially healthy? What are the red flags to watch for? What are the best practices and rules of thumb that we should follow? After realizing that my stock answer of “it depends” isn’t very helpful, I developed this set of financial fundamentals to share.
Nonprofit organizations impact communities and individuals by delivering services, providing advocacy, and building community. Behind the scenes, powerful missions, innovative programs, and passionate staff and volunteers are supported by financial activities and decisions. Supporting healthy nonprofit organizations includes an understanding of financial information and management practices that build stability and flexibility both today and in the future.
1. Complex Businesses – Nonprofits operate at least two businesses to make the organization work – a program delivery business and a revenue generating business. Unlike for-profit businesses, the revenue (buyer) is often not the same as the program recipient (customer.) Each business comes with its own set of opportunities and challenges.
2. Diverse Funding Sources – While it sounds good, diversifying funding sources isn’t easy, and isn’t necessarily a smart move. Different types of income require different capabilities, systems, structures, relationships, and communications.
3. Restricted Funds – Not all funding is the same for nonprofits. Many sources of income, especially grants from foundation and government sources, are restricted for a specific purpose or time period. Both nonprofits and their funders need to be aware of expectations around restrictions and prepared to manage restricted funds responsibly.
4. Budgeting – Budgets matter because they provide the financial information to support all planning. Effective budgets are realistic, using sound assumptions and clear accountability to achieve those assumptions.
5. Program Costs – Financial decisions rely on good information. It is essential that organizations understand the real costs of their programs in order to make decisions about fundraising needs, contract terms, and program expansion or modification. Some programs can match expenses with revenue while others require subsidy, and that choice rests on complete information.
6. Overhead Costs – Nonprofits are required to account for functional expenses – program services and general/administration & fundraising (or overhead). While lower overhead expenses may sound better to donors, this emphasis is destabilizing and unsustainable. There isn’t research that connects the percent of overhead to effectiveness. (There are some bad apples, though, that take advantage of donors.)
7. Balance Sheets Tell All – No single financial report communicates more about a nonprofit’s financial situation than the balance sheet. This statement reveals the organization’s long-term financial stability and strength by reporting information about cash, investments, and liquidity, debts and other obligations, restricted funds, and accumulated surpluses and deficits (Net Assets.) Financial literacy includes reading balance sheets.
8. Cash and Reserves – Day to day, cash in the bank to pay the bills often matters more than any financial statement or long-term plan. Cash flow can be monitored and managed with a few basic management tools. Every nonprofit needs to have some cash in reserve to respond to an unexpected downturn or opportunity, but there is no perfect target number that every organization should maintain. Since the best way to build reserves is by generating an annual surplus, everyone needs to embrace the value of positive annual results.
9. Business Models are Interdependent – Financial management connects to every aspect of a nonprofit – governance, planning, programs, evaluation, on and on. Nonprofit business models reflect this with four essential components: revenue mix; cost of effective programs; infrastructure; and capitalization. Keeping everything connected is what financial leadership is all about.
10. No One Size Fits All – Nonprofits come in all shapes, sizes, and styles when it comes to community, clients, programs, budget size, and financial structure. Comparing one nonprofit to another is often unhelpful.
Dig into these ten fundamentals and join the ranks of smart program officers. Applies to smart nonprofit leaders, program managers, and board members, too!