Nonprofits and their donors often see endowments as the route to financial stability, but they aren’t the right solution for every organization. Here we debunk some of the longstanding myths about endowments.
Myth #1: A strong, sustainable nonprofit needs an endowment.
The one thing that sustainable nonprofits need is enough income to run their programs and pay for salaries, facilities, etc. An endowment is one of many ways nonprofits can generate income. But for some groups, it is unnecessary or even a bad idea.
So before deciding to establish an endowment, nonprofits should decide if doing so addresses how income will be used to achieve the mission, when it will be needed, and how much will be needed. Organizations that are in financial crisis, that have limited capacity to attract more donors, or that have short-term missions should avoid establishing endowments.
Myth #2: An endowment must be continuously funded and can never be drawn down.
Nonprofits can choose when it’s most feasible to add to their endowments. For example, if it’s important to increase direct aid during a natural disaster, a relief organization might reduce or even forgo endowment funding for some period of time and redirect donors to an emergency appeal. Alternatively, the board might continue to fund the endowment regardless of its current needs if, for example, it has a far-reaching goal, such as to eradicate hunger.
While most endowments have permanent restrictions on the use of their principal, others have only temporarily restrictions or even completely unrestricted components that allow the money to be spent. Endowments can also have end dates rather than existing in perpetuity.
Myth #3: An endowment is the same as a board-designated reserve account.
A designated reserve account is a pool of funds established by the board to provide certain types of capital to the organization. There are several kinds of designated reserve accounts: A working-capital reserve can provide funds during normal parts of the business cycle when cash is low–for example, when awaiting payment on a contract. A “rainy day” reserve is available for unexpected challenges or opportunities. Funds can also be reserved to help an organization recover from financial distress or to expand or acquire facilities. These pools are managed internally, though the board may place restrictions on their use.
Endowments, on the other hand, are not intended to fund routine operating activities and are often managed externally or held outside of the reach of the nonprofits’ general business managers.
Myth #4: There are limits on the amount of interest income that a nonprofit can take from its endowment
There are no such legal limits. The amount and timing of distributions is determined by the governing body of the endowment. Interest income is often used to fund board-designated reserves for future projects and to expand current programs and services. Nonprofits should, however, have realistic expectations about the yield on endowment investments. Only a large endowment that is professionally invested to maximize returns is likely to generate enough earnings to make a dent in the operating budget. Community foundations are well suited to manage smaller endowments.
When nonprofits recognize how fluid money can be, they can better assess the types of capital and cash flow they need to support both short- and long-term objectives and avoid making unnecessary trade-offs. They will also be able to tell a more compelling financial story to donors, clearly articulating their rationale and timing needs for a range of funding options including endowments, reserve accounts, grants, loans, and investments.
Nonprofit Finance Fund (NFF) has long held that nonprofit organizations are more than just the sum of their programs, and more than their overhead ratios. Existing nonprofit ratings platforms are simply inadequate to the complex task of analyzing and deriving insights from nonprofit financial data. They do not help nonprofit organizations communicate their financial story and goals to staff, board members and funders. They fail to provide a holistic picture of an organization’s business model and balance sheet.
Currently available tools can lead to premature or misinformed fund-no fund decisions, rather than a more enlightened grantmaker-grantee dialogue about what organizations need to survive and thrive. They risk turning nonprofit financial analysis into an exercise in compliance rather than a tool to advance organizational effectiveness.
If we’re honest with ourselves and really care about long-term effectiveness, we need to conduct the kind of comprehensive financial analysis that looks at the entire nonprofit enterprise. We need a more nuanced understanding not only of costs but also of revenue reliability, profitability, balance sheet health and liquidity. We need to look beyond numbers and ask probing questions about what kinds and amounts of resources are required in the context of an organization’s strategy, marketplace and lifecycle. These questions might include:
Which key revenue streams are relatively reliable and which are at risk?
Is the organization covering its full costs and generating regular surpluses?
If not, are expenses adjusted in line with changes in revenue?
Does the organization have adequate access to cash to manage its cash flow cycles?
Are facilities and other fixed assets maintained as they depreciate?
Is the organization’s board prioritizing saving for the long term and setting aside surplus cash into reserve?
Answering these questions takes time and requires sophisticated analysis skills. Fortunately, help is at hand. NFF has been working with GuideStar for more than a year to create a new data platform for nonprofit financial analysis and education. Financial SCAN (Situation & Comparables ANalysis) provides instant financial information on 280,000 nonprofits across the country.
Derived from Form 990 data filed with the IRS, Financial SCAN shows up to five years of financials for a nonprofit. Dashboards and graphs reveal ratios that are much more relevant to organizational health and stability, such as: profitability margins, estimated full costs, depreciation of fixed assets and months of liquidity. The platform allows you to compare the financials of multiple peer organizations to better understand trends across a sector. We’ve also incorporated an educational guide to help users make sense of the data and understand its implications.
By bringing transparency and comparability to financial information in the sector, Financial SCAN can provoke more informed, less judgmental and increasingly honest dialogue among nonprofits, their funders and advisors about what organizations really need to be stable and effective. We encourage you to learn more about Financial SCAN and how it can be helpful to you.
Pam: So Rebecca, tell me more about the problem that you are trying to solve – what is unique about this tool and how can it help nonprofits and foundations and professionals?
Lee Glenn, SVP of GuideStar, and Rebecca Thomas, VP of Nonprofit Finance Fund, discuss Financial SCAN
Rebecca Thomas, Nonprofit Finance Fund: NFF and GuideStar came together to really create a new financial health analysis standard for the nonprofit sector. Right now, there really is no industry-wide standard. Nonprofits are asked to create lots of reports, myriad data points for funders, reporters, advisors, and that really detracts from what they do best which is delivering a great program. Meanwhile, nonprofit funders and advisors score through all this data but really lack a shared understanding of what to look for and why it matters. The upshot is that no productive dialogue takes place between the parties about what it takes to run and maintain a healthy nonprofit organization. It’s not all that different from the challenges that we all face when we sit around the dining room table and talk about our finances – we don’t agree on basic financial terms and why they matter, we can’t have a good conversation about how we’re spending our money, how we’re saving for a rainy day and what kind of liquidity we need to pursue our future goals.
Pam: That sounds like a very interesting challenge to tackle. So Lee, can you tell me a little bit more about how specifically Financial SCAN will help me? How’s it work?
Lee Glenn, GuideStar: Financial SCAN is an online tool, it’s really easy to use, just like using TurboTax, so virtually everybody will have access to it and be able to use it and understand it. There’s something in it for everyone, no matter which position you are approaching the tool from: you can be a funder, advisor, or nonprofit, and it has some sort of information in there that will be interesting to you. We use a series of dashboards and metrics for at-a-glance analysis. We use graphic representations and educational content for a deeper dive and we also use peer comparisons so you can understand how your organization fits into a group of organizations of your choosing. It’s our hope that Financial SCAN will be used by decision makers in the nonprofit space to be consulted before they make any key decisions or start any big projects. Financial SCAN is a very cost effective way to get this insight. We know that cost is issue for nonprofits, so we developed a program for nonprofits to have temporary access a couple times a year.
Pam: That’s great. Rebecca, as a funder, donor or advisor, will this tool tell me where I should give? If I’m a nonprofit, do I need to be concerned the SCAN might rank me against my peers?
Rebecca: Nonprofits definitely don’t need to be concerned. Financial SCAN is really not about passing judgments on the relative merits of individual organizations. NFF really believes that the existing ratings and rankings platforms are inadequate for some of the complex decision-making that goes into deciding whether to support an organization and how to support that organization. Another thing I want to point is that Financial SCAN is really about a comprehensive analysis of an organization. We don’t focus on just a few limited metrics of organizational health like the overhead ratio – that’s one example of a metric that is commonly held up. Yet, in NFF’s experience, it really has no bearing on an organization’s stability or effectiveness in delivering in its mission.
Pam: So, informed conversations, no arbitrary metrics like overhead ratios – that is a noble goal, no doubt. I hope you don’t work yourselves out of a job in the process.
Rebecca: I hope we don’t either! But, in all seriousness, more analysis will have to be done. There is always more learning that all of us can do. But Lee and I are so excited to bring together all the stakeholders, involved in making social impact, to have a real candid conversation about it takes to effectively resource an organization, and what the relationship is between financial health and nonprofit effectiveness.
Pam: Wonderful. Well, thanks for your time guys, and good luck. And if you’d like more information, please click to http://www.guidestar.org/.
"Over the past 3 years, the length of stays at our shelter has increased from 11 to 27 to 33 nights, because of a lack of affordable housing. We are scrambling to come up with creative solutions to shelter women for whom we have no room. Economic recovery is still not a reality here."
-Sarah Lange, Abby's House
This is a quote from one of the 4,607 respondents to NFF's just-released Annual State of the Sector Survey. If this sounds a lot like your organization's situation, you are not alone. This year's respondents tell a collective story of a sector still stretched thin, with organizations feeling distant from their funders and boards, and staff facing more work with less money and fewer benefits to take home. While the recession may be over, the nonprofit financial crisis isn't. Here are a few facts from the survey (to check out detailed results and analysis, visit the main survey page):
85% of nonprofits experienced an increase in the demand for services in 2011.
This is on top of years of increased demand: previous NFF surveys found that 77% of nonprofits experienced an increase in demand in 2010; 71% experienced an increase in 2009; and 73% experienced an increase in 2008.
88% expect an increase in demand for services in 2012. 57% have 3 months or less cash-on-hand. 87% said their financial outlook won't get any better in 2012.
NFF conducts the State of the Sector Survey to provide the sector with concrete data to act as a compass for decision-making. While there are some glimmers of financial improvement, the fact remains that people who need nonprofit services are slipping through the holes in the safety net. In the current system, nonprofits cannot keep up. And with government funding on the decline and private funding not making up the difference, there are no signs that things will get better any time soon.
We'll be taking a closer look at the results over the next few months and posting them here. In the meantime, take a look at our new Survey Analyzer. In our efforts to make the data more readily available to even more people in the sector, we created a tool that allows you to filter the results by geography, sector, and/or annual expense. Please share with us here what you find!
In an annual ritual marking the change of seasons, pitchers and catchers just reported to Florida for spring training. Professional baseball sends a powerful lesson to those of us who work to solve social problems: Despite nearly 150 years of entrenched traditions, the sport has shown itself to be open to change. And that change is transforming how the game is played.
How does baseball point a path forward for those of us struggling to support a just and vibrant society in our troubled times?
The answer lies in the story of Billy Beane, manager of the Oakland Athletics, who demonstrated how radical innovation can allow anyone to achieve positive transformation even against seemingly impossible constraints.
Mr. Beane, immortalized in print and film by Moneyball,watched his baseball team lose the 2001 playoffs to the much wealthier New York Yankees. He approached the Athletics owner for more money to spend on salaries and was turned down—the money just wasn’t available. Yet Mr. Beane refused to take that as defeat. He still wanted his team to achieve greatness.
Mr. Beane’s staff members offered to work harder and put in longer hours to help the team win. However, he sensed that even an improved version of business-as-usual would lead to failure. He did not have access to the funding others had used to solve similar problems. He needed to radically reinvent how he ran the team to have any chance of success.
The
pursuit of a just and equitable society can invite a measure of paralysis when
you’re faced with the simple challenge of where to start. Even if you narrow your focus to the
nonprofit sector in particular, there are countless ways to approach the
question of how to effectively promote positive change.
At NFF, our
approach has been to help nonprofit organizations develop the financial
capacity to keep providing the programming their missions demand. The end goal of this work is the facilitation
of social change, but the approach demands an initial focus on the welfare of
individual organizations. But what if
we approached the question from another angle?
What if we started by focusing on the needs of whole communities and
then asked what resources individuals and organizations - including nonprofits
- could provide to fulfill those needs?
We recently
spoke with Cheyenna Weber ofSolidarityNYC, a collective which seeks greater
visibility and networking opportunities for organizations such as cooperatives,
collectives, and credit unions - participants in New York City’s “Solidarity
Economy” - in order to foster grassroots economic development and social
justice. Drawing on that conversation,
we plan to present a series of three posts, where we look at how the solidarity economy reframes
the problem of the economics that undergird an institution-focused nonprofit
sector, then we’ll flesh out the solution a solidarity economy framework
proposes, and, finally, we’ll look at real-world examples that suggest
practical steps funders, nonprofits and their communities can take to bring about
more comprehensive strategies for change in particular communities.
We
know that nonprofit organizations exist, first and foremost, to achieve social
missions. However, the current economic
crisis has also made it quite clear that regardless of tax status, nonprofits
navigate the same economy as their private and public sector counterparts.
Because nonprofit programs are designed primarily around criteria of mission
achievement rather than stand-alone economic sustainability, and because these
programs are often intended to serve clients who are unable to pay market rate
for services, they rarely earn enough direct revenue to cover the
organization’s costs. Instead,
nonprofits must rely on economic subsidy from other sources - often government
or private sector wealth.
So,
it’s not just that nonprofits are in the same macro-economic boat as everybody
else – nonprofits rely on these other sectors to survive. For nonprofits, this often means navigating a
dual relationship, trying to meet the priorities of those paying for services
on one side and the needs of those receiving services on the other. In this relationship, each party comes to the
table with a set of priorities which can sometimes vie for attention.
For example,
if a nonprofit relies on grant funds in order to maintain operations,
leadership may feel forced to adjust the program structure in order to pursue a
particular piece of programmatic funding (and the overhead coverage it
provides) even if it does not quite fit with the mission or client . Furthermore, two nonprofits with similar
missions can find themselves in competition for funding from the same sources,
and may therefore be less likely to undertake collaborative efforts with one
another, even if those collaborations might best serve their constituents.
In
other words, the power of money - even the most well-intentioned money - can
decrease the power held by clients and the organizations that serve them to
shape the programs intended to bring about change in their communities.
In our professional and personal lives, we are all asked to
take a dozen or more surveys every year.
At work, I receive email surveys on everything from how we use social
media to how we like the services of our vendors. At home, I get opinion questionnaires from
organizations ranging from political parties to movie ticket vendors.
Being the recipient of so many surveys, I pick and choose
which I respond to. No doubt you do as
well. As NFF embarks on its fourth
annual nonprofit State of the Sector Survey, I hope you will choose to spend a
few minutes of your valuable and busy work time responding to ours. Here’s why.
Nonprofits are our social safety net, particularly now,
during the hard times our country continues to experience. They help and enrich people and communities,
some of whom face dire health, housing, or food access circumstances. Yet many of the nonprofits that we rely on
for a just and vibrant society are themselves in dire circumstances. Revenue is down, particularly from government
funders, while service demand is up (77% saw a rise in service demand last year, on top
of increases in service demand in previous years).
As we’ve seen with the rise in democratic political
movements across the globe
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.
“The bomb buried in
Obamacare explodes today,” Rick Ungar declares in a December 2ndForbes blog post describing a
regulatory provision in the Affordable Care Act:
"[T]he medical
loss ratio...requires health insurance companies to spend 80% of the consumers’
premium dollars they collect—85% for large group insurers—on actual medical
care rather than overhead, marketing expenses and profit. Failure on the part
of insurers to meet this requirement will result in the insurers having to send
their customers a rebate check representing the amount in which they underspend
on actual medical care."
If this regulation is
indeed a bomb, then nonprofit administrators must now be totally shell-shocked
from navigating the demands of donors, institutional funders, government
agencies charity rating agencies, consultants and even board members who want similar
oversight of the ratio between program and administrative or fundraising
expenditures and then use that data to make claims about operational efficiency.
The fact that this
kind of ratio system is now being applied prominently to a for-profit industry gives
us an opportunity to highlight the way similar measures have served as a
minefield in the nonprofit sector for years.
The differences
between nonprofits and insurance giants are more striking than the
similarities. As for-profit entities, insurance companies’ customers are
expected to pay a market rate for their services, these funds are always
unrestricted, annual surpluses are encouraged rather than stigmatized, and
financial gain is the primary motivator.
None of these apply broadly to nonprofits.
Presumably as a
matter of public policy, the medical loss ratio is being applied to insurance
companies because those companies might otherwise spend even more on lavish
executive salaries, luxurious offices, and so on. But, in an environment where nonprofits face
restricted grants and overall scarcity of funds, not to mention baseline commitment
to mission, what would be the equivalent goal for imposing such ratios on the
nonprofit sector? Are such measures
likely to be successful in inducing “operational efficiency?”
In posts following up
on Ungar’s initial article, Sarah Kliff (on the Washingon
Post’s site) and Ungar raise the issue of how
the government will define which expenses qualify as direct medical care, which
will be administrative expenses, and which expenses could be left out of the
equation altogether. Many of these
particulars seem to be addressed up front in the legislation, though one
assumes that the financial staff of insurance companies will ultimately find
room for interpretation.
For the nonprofit
sector, too, that room for interpretation is significant.
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:
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