Social Currency

Great art is often created without lots of money and can be enjoyed for many years. Great arts organizations without the right kinds and amounts of money, however, struggle to see another day.

Mission success for nonprofit arts organizations is reflected in the creation, sharing and appreciation of meaningful work.  Each organization has a different artistic vision and goals, as well as its own strategy for reaching and engaging audiences.  Behind every successful organizational strategy there should be a sound approach to obtaining and stewarding the financial resources required to support mission execution over time. This is a capitalization plan. At its essence, a capitalization plan serves as a roadmap for ensuring an organization has the cash and other assets it needs to manage risk and pursue opportunity.

Strategic plans often lack a rigorous financial foundation. They fail to consider the long-term financial resources needed to support program goals. And when they do include a financial plan, they often conflate regular revenue (ongoing) with capital (periodic), or neglect capital needs altogether.  While financial projections that quantify the future revenue and expenses associated with a strategy are critical components of any strategic plan, they are not enough.  Consideration must also be given to the organization’s long-term balance sheet –or capitalization– needs. 

A capitalization plan is really just an approach to building the right balance sheet. It should consider the kinds and degrees of artistic and organizational risk an organization can and wishes to tolerate, as well as the creative ambitions to which its leaders aspire.  Specifically, a capitalization plan should address an organization’s financial health and goals in the following three areas: liquidity, adaptability and durability.

• Liquidity: having adequate cash to meet ongoing operating needs
• Adaptability: access to flexible funds to adjust to evolving circumstances
• Durability: assets to address a range of future needs

Capitalization planning is not one-size fits all

While the amount of adequate liquidity may differ by organization, cash is king for all nonprofits, regardless of size. Many organizations also need periodic access to flexible capital to pay for adaptation –whether related to growth, restructuring, program revitalization or even downsizing. 

Editor's Note: A version of this post originally appeared at the ASU Lodestar Center Blog as part of their Research Friday series.

At Nonprofit Finance Fund (NFF), we use financial data every day in our work with nonprofits and their funders. One source of data informing this work is our annual State of the Sector Survey. Throughout the year, I’ve been blogging about key trends from our 2011 survey, which was completed by nearly 2,000 nonprofit leaders nationwide. They told us about their organizations’ financial outcomes from 2010 and speculated on what 2011 would bring. As we look back on what was certainly a challenging year, I thought it would be interesting to revisit some of their expectations.

Nonprofit leaders told us about planned changes to their service offerings in 2011: 

Although contributed revenue was generally down from public and private sources alike, a majority of nonprofits indicated that they actually planned to add or expand their offerings in 2011. Many anticipated expanding the geography they serve or partnering with another organization in order to meet the increased demand for their services. In fact, 88% of respondents indicated some sort of shift in their service delivery. But it wasn’t just program change; management steps and tough decisions were also required.

Nonprofits told us about their planned financial management actions in 2011:

Nonprofit leaders have learned to expect the unexpected. As a result, many predicted that they would engage more closely with their board and develop a “worst case scenario” contingency budget. If they were fortunate enough to have reserves, some groups planned to tap them. Many organizations decreased expenses. But some collaborated to manage their expenses and a third of organizations actually increased their expenses. Twelve percent even expanded their space. A big picture takeaway from both these charts:

Attendance at the TCG Fall Forum on Governance is comprised of primarily executive directors and board members, with a sprinkling of representation from artists and staff members from the nonprofit theater world.  So, after a day of terrific conversations, it was with great pleasure that I gathered a handful of them together for a panel discussion: “So You Have a Deficit, Now What?”  What followed was a refreshingly frank discussion punctuated with practical lessons applicable to the work of any nonprofit administrator: 

Preliminaries
We began with a few general concepts:

• Talk of deficits demands a consideration of assets, but some valuable assets don’t appear on a balance sheet.   Assets can also include intangibles such as:  audiences, knowledge, staff members, a board of directors, openness to change, technological tools and savvy, diversity of background and age among your staff, board and stakeholders, civic and business partners, your “brand”, organizational self awareness, and, critically, when seeking to overcome deficits, knowing your impact. 
• When considering “health” metrics at NFF, we think in terms of “months of cash” on an Unrestricted Liquid Net Assets (ULNA) basis.  If you strip away all of the buildings, property, equipment, temporarily restricted, and permanently restricted items from your Net Assets, how much cash is left for operations?  It can vary, but a rough starting point for an ideal is a 3 month cash/ULNA reserve.  
• Deficits can be “financed” through a variety of means including: accounts payable, mortgage debt, drawing on reserves, foregone wages, employee furloughs, and over-extended lines of credit.  It can be difficult to ascertain whether an organization is operating at a deficit, and structural operating deficits can be masked by a period of operating at sub-par capacity levels in order to keep expenses in-line. This will not be sustainable.

Managing Costs and Revenue

Tracy E. Long, General Manager of Adirondack Theatre Festival started off the panel by describing an initiative to overcome a $29,000 shortfall on a prior year’s performance, an 8% deficit on the annual budget.  While the scale may seem relatively small, the deficit posed a significant challenge to their cash flow and was an ongoing concern.  Long took on the deficit by addressing both revenue and costs: 

Revenue side

• Increase ticket revenue on the margin by raising ticket prices by $3 each.
• Develop theater projects with partners to share costs but generate new and increased revenue.
• Respond to board member interest in hosting a “Brewfest” with board member spouses and another nonprofit to generate fundraising revenue. 

Cost Side

• Decrease rehearsal periods for plays that could still be produced effectively with shorter advance time,.
• Change the design on printed materials to result in lower printing costs.
• Cut the full-time production manager and move to a “variable” staffing method – hiring as needed for theater tech and sharing the management tasks among the remaining staff.

Accumulated vs. Structural Deficits
Michael Gennaro, Executive Director, Trinity Repertory Company, began by making two important points:

• Even well managed companies are beginning to fail.
• Accumulated deficits and structural deficits are different and managing them requires different strategies. 

Michael drew from his experience with the Pennsylvania Ballet as his first example.  When he went there he found an accumulated deficit of $2 million on a $6 million operating budget.  In that instance Michael suggests the first step is to analyze what makes up the debt you are inheriting and evaluate any creative strategies you can employ to get rid of it.  At the Pennsylvania Ballet, the debt was almost completely financed through accounts payable, so Michael negotiated a “work-out” with the vendors to pay a percentage on the dollar of outstanding bills and thus retire the deficit.

In his current tenure as the Executive Director at Trinity Rep, he inherited a more challenging scenario:  Three separate lines of credit were maxed out or frozen, and the building required an expensive update to meet fire code standards.  Together, they amounted to more than $3 million dollars of accumulated deficit with the cost of deferred upgrades to the building generating a structural deficit.  In this instance he took the following steps:

Organizations that can clearly and accurately articulate their financial story and resource needs are better positioned to make a strong case for support. In both good times and bad, your stakeholders will be more engaged if you can provide a data-driven assessment that links your nonprofit’s financial health to its impact and accomplishments. This can inform strategic planning and guide leadership in making mission driven, financially sound decisions.

We've created a worksheet divided into six core areas of nonprofit finance, described in detail in the document available as a pdf here or embedded below:

1. Revenue
2. Expenses
3. Probability and Savings
4. Health of the Balance Sheet
5. Liquidity
6. Financial Planning

Use the worksheet to capture a snapshot of your nonprofit’s strengths and weaknesses. Together, these areas help you balance the three critical components essential to your organization’s long-term viability: Mission, Capacity, and Capital.