In a world where the last two years have produced 90% of all
data ever created (so
says IBM), there is something to be said for avoiding information overload.
This is especially true for nonprofit organizations whose leaders must constantly
balance money and mission, while marshaling ongoing evidence of social and
financial performance. With limited finance staff and multiple sources of
financial information, it’s no wonder these leaders and their supporters often
struggle to tell a clear, compelling financial story that makes sense of all
the data.
How can nonprofit executives, funders, and advisors identify
what matters most when examining finances? What are some trends and indicators
that can guide us through an abundance of data and help assess true financial
health?
Not all financial indicators are created equal. Below, I
offer a short list based on NFF’s years of experience lending to and advising
nonprofits. You can find this data on historical-looking documents such as
audited financial statements and Forms 990, as well as on forward-looking
internal budgets and projections.
Strapped for time to do this number crunching yourself? Financial SCAN, a data
platform developed by NFF and GuideStar, can do this analysis for you,
illustrating trends in an organization’s financial performance through
user-friendly dashboards and graphs. You can also use the tool to see how one
organization’s financial metrics and ratios stack up against its peers.
INCOME STATEMENT
INDICATORS:
Revenue
reliability. Rather than overly focusing on the ratio of earned to contributed
revenue, we suggest evaluating revenue reliability – an organization’s track-record
of bringing in recurring dollars, on an unrestricted operating basis, year
after year. Reliable revenue doesn’t always come from the same sources providing
the same amounts of money. However, it does suggest an ability to predict a
level of income with a fair amount of certainty, based on historical
performance and an understanding of market dynamics.
Otis
Bullock tells me that it can be a challenge “to pair a great business model
with great programming”. As the executive director of Diversified
Community Services
(“Diversified”), an organization that serves children and families in the Point
Breeze neighborhood of Philadelphia, he knows firsthand the challenges of
balancing the abundant needs of his community and constituents against the
constraints of limited or uncertain public and private funding.
It’s
a balancing act that requires the relentless stewardship of financial assets
and continual monitoring of financial and program data. Otis knows well that
sound financial management is grounded in access to reliable and timely
information about his organization’s annual performance, revenue and expense
dynamics, balance sheet health and liquidity.
He has found Financial SCAN, a
comprehensive new standard for financial health analysis, to be a helpful tool
in his financial management toolbox.
Here,
Otis shares his experience using financial data and analysis to guide his
organization forward in challenging times.
PK: How does Diversified achieve its mission?
OB: Rooted in South Philadelphia and embracing the
philosophy of the settlement house movement, our mission is to enable children,
youth and families to realize their fullest potential and achieve
self-sufficiency in safe neighborhoods. We’re recognized as the “go-to” organization in South Philadelphia because we
bring people together regardless of religion, race, or ethnicity in a spirit of
friendship to make our neighborhood a better place to live.
We believe in and act for economic and social
justice so that people have the opportunities to advance economically,
socially, educationally, and personally. Our community-building efforts promote
physical, economic, and social development – improved housing and safety, as
well as increased financial resources for individuals and the community as a
whole.
PK: As the new
executive director of Diversified, what are the biggest obstacles your organization
faces in effectively connecting money and mission?
OB: Our biggest obstacle in effectively connecting
money and mission is a past inability to pair a great business model with great
programming. Diversified is very well known for its work in the Point Breeze
community, especially our work in early childhood education and youth
development. However, we have not yet figured out a way to make it profitable;
mostly because the word "profits" was never in our vocabulary. As a
result, great programs with tremendous impact on the community could become
significant drains on the budget.
PK: That’s certainly a reality that most nonprofit leaders face. What
financial planning and management strategies have you employed to overcome
these obstacles?
In my previous post, I provided an overview of the strategic steps organizations should take in preparing a budget. Now, let's get tactical with some tips for assembling a sound, strategic and manageable budget.
Budget for unrestricted surpluses. While
we encourage organizations to be conservative in their budgeting, aim for
finishing the coming year in the black. Budgeting for breakeven leaves little room for
chance, when we know that each year brings unforeseen circumstances. Planning
for a surplus allows for some margin for error. Be sure to include depreciation
in your expenses even though it is a non-cash expense. Aiming to cover
depreciation in your budget can contribute to a cash surplus that can be saved
for future use to pay for replacement or repair of depreciated assets. Lastly,
make sure to include only unrestricted
revenue (and/or revenue that will become unrestricted in the next year) to
cover operating expenses.
Don’t plug revenue with mystery funds. Build
your budget with revenue that is already committed or has a high likelihood of
materializing based on past performance or known new relationships. Developing
a separate pipeline of additional fundraising prospects and revenue
opportunities keeps less secure funds from de-stabilizing your budget, while
still recognizing the value of new leads.
Distinguish operating revenue from capital. Funds
that are earmarked for capital purposes like facilities, endowments, or growth,
should be pulled below the “surplus /deficit” line (or reflected separately in
a capital budget) to provide a clear view of operating performance. Conflating
capital dollars for episodic purposes with the regular revenue that reliably
covers ongoing expenses can mask the true financial performance of your
organization. See NFF’s Financial Reporting Done Right
publication for more information and suggested examples for presentation.
Consider the balance sheet. The balance
sheet provides a window into resources available to be used for a rainy day,
pursue a new strategy, or adapt to changes in the environment. Nonprofits have expenditures
and savings needs that go beyond the direct and indirect expenses that appear
on their income statements. Setting annual revenue targets high enough so that your
organization can repay debt principal on schedule, address the wear and tear on
fixed assets, and/or add to reserves ensures that the budget is investing in
the longer-term resource needs of the organization. Our Financial
SCANtool can illustrate your
organization’s estimated full costs and reveal balance sheet trends in its multi-year
dashboard and graphs.
Plan opportunities to compare actuals to
budget and then re-forecast. Fundamentally, a budget is just a plan. And
all too often, circumstances don’t go exactly according to plan, so expect your
budget to change. NFF suggests reforecasting your organization’s budget at
least once a quarter based on actual performance to date and newly available
information. Ensure that a process is in place for how re-forecasts will be
conducted and clearly communicated to staff and the board.
Remember,
management not budgets drive financial performance. Even the best budget and reforecast will only
get you so far. Financial plans are meaningless if the leadership and
discipline aren’t in place to take action when performance setbacks occur. Many organizations find it helpful to develop
and share with leadership a set of financial “triggers” – events (e.g., (the
loss of a major donor) that will provoke a set of pre-determined decisions
(e.g., a particular expense reduction) if circumstances go awry.
At the end of the day, strong programs depend on strong
finances that ensure your organization can pay for the people, infrastructure
and activities supporting mission execution. Developing a financial roadmap,
backed by decisive leadership, can help ensure that your organization can advance
its mission next year – and in the many years to come.
What budgeting tips
have you employed to improve your annual plan? We encourage you to share your
additional tips below.
As we enter the fourth quarter, many nonprofit organizations
are getting more specific about their financial plans for 2013. In the scramble
to produce a budget in time for year’s close, leaders sometimes lose sight of the
larger purpose behind the planning. A
budget is more than just an articulation of how an organization makes and
spends its money. Done well, a budget serves to:
Make the business case for
mission-related goals
Provide an organizational
road map to align staff
Intentionally allocate
resources among competing priorities
Monitor actual performance
against plan to inform action
Developing a thoughtful, fact-based budget that resources
your programs while contributing to a healthier organization doesn’t have to be
hard. In this post, we share a few budgeting principles and tips to guide you
through the planning process.
Strategy comes first.
In NFF’s experience, organizations too often use the annual budgeting
process to drive their strategy, when really, the reverse approach is needed: a
nonprofit’s mission and business objectives should always steer its budget. A good financial plan takes stock of where an
organization is today and reflects its operating and program priorities for the
years to come. It provides leadership
with the data to track progress toward strategic goals and ultimately, to make
course corrections when the situation demands.
Look to past performance to ground your plan in reality. It’s
helpful to base future budget decisions on more than one year of financial
history. When examined over time, trends in revenue and expenses can illuminate
areas of volatility, growth and poor performance. By scrutinizing a few years
of recent financial information, nonprofit leaders can answer questions such as:
What are our sources of reliable revenue and which income streams are less
predictable? Which expenses drive our
overall cost structure and how have they changed over time? Are we generating
surpluses to contribute to savings?
Through a partnership with GuideStar, NFF recently launched Financial
SCAN, an easy to use and affordable online tool that can help nonprofit
leaders conduct a multi-year analysis of financial performance using Form 990
financial data. Running a Financial SCAN report on your organization provides a
clear, comprehensive picture of your organization’s recent financial past,
offering real financial data points to guide choices that can be reflected in
your budgets.
Consider future goals to keep current plans aligned with
strategic direction. By consistently anchoring budget decisions in the past
without consideration of the future, you run the risk of creating stagnant
plans or reflecting over-zealous ambitions. The budget decisions your
organization makes today should reflect your broader program and organizational
goals and objectives. What business and
mission priorities will you set this year to help move closer toward your
longer-term goals? How will these priorities and the activities they require
translate into revenue and expenses? What investments will you need to make in
your balance sheet so that you have the cash you need to manage the risk or
unpredictability in your strategy? Every
year provides an opportunity to make progress on your organization’s strategic
goals by reflecting them in the budget.
Summer is a great time to step back from day-to-day activities and think about the big picture for your organization. We've assembled some fresh, practical resources to help: Obtaining a Loan or Line of Credit If you missed last month's web chat with NFF's Nima Krodel and Barbara Libove, you can replay the conversation here and--as we promised!--see answers to the questions we couldn't get to during the live event. Of course, if you're getting ready to apply for a loan, whether from NFF or another lender, you will likely find our webinar "Preparing your organization to apply for a loan" extremely helpful. And as always, for some of the more obscure language that arises during the process, you can always visit our glossary of nonprofit finance terms.
Is Your Nonprofit Three Months from Disaster? Alice Antonelli and Rodney Christopher provided expert advice in a web chat with our friends at the Foundation Center on how to build and maintain operating reserves. You can replay that conversation here. Just to whet your appetite: Within the first two minutes, Rodney says "I have something controversial to say..." Click here to find out what that is!
Know Your Strengths and Weaknesses How about a simple worksheet to help you review your nonprofit's financial fitness? If you’re a regular reader of Social Currency, you might already have used this handy tool for examining the six core areas of nonprofit finance. As with many fitness programs, it's all about the core! Click here to download the worksheet.
Financial SCAN Everything checks out on the Strengths and Weaknesses worksheet? Step up to the Financial SCAN! This new tool--produced in partnership with GuideStar--focuses like a laser on your organization's finances, gathering your core metrics into easy-to-use trend charts and comparing them with peer organizations. Learn more about it here, and watch an engaging walk-through of this innovative diagnostic here.
Thinking about how to grow? Change Capital in the New York Times We're big fans of the Fixes column in the New York Times' Opinionator blog, and a couple of weeks ago, they wrote up a really nice description of the work of NFF Capital Partners around the idea of Philanthropic Equity or Change Capital. Click here to read "For Ambitious Nonprofits, Capital To Grow." Fixes also mentioned us in a column on Social Impact Bonds-a fascinating idea we've been exploring at our Payforsuccess.org learning hub. We're obsessed with getting organizations the capital they need to grow and thrive, one way or another!
One final tool Keep in touch! You can sign up here to have new posts to Social Currency sent automatically to your e-mail address, and if you’re interested in hearing more from us on a variety of topics, visit our Contact Us page and sign up for our e-mail list.
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/.
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