Social Currency

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

As we work with clients, provide workshops, and present on nonprofit finance issues across the country, one question pops up again and again: how much cash cushion should a nonprofit have? One of my NFF colleagues recently explained why the answer is different for every organization and depends on a number of factors. One rough benchmark often cited recommends nonprofits have enough cash to sustain operations for at least three months. Having less than one month of cash at your disposal is generally considered a cash crisis. 

NFF finds that organizations holding three to six months of cash have an easier time thinking long term and building up reserves: a rainy day fund, facility reserves, etc. Organizations with reserves are better prepared for an emergency (major building repairs, loss of a primary funding source, severe economic upheaval) and in a crisis it’s more likely that they can continue providing their services uninterrupted.

Earlier this year, nearly 2,000 nonprofit leaders completed our annual State of the Sector Survey. One question asked was, “How much cash (including reserves) does your organization have readily available?” Nationwide, 9% of the social service providers who responded reported having “0 months” of cash. Another 20% had enough to cover 1 month of expenses, while 34% reported that they had “2 - 3 months” of cash on hand. So the results seem to say that just about a third of social service agencies are experiencing a cash crisis, another third are managing, and the remainder has a comfortable cash cushion.

In practice, however, our consultants see a very different picture.

Twenty-five percent of annual operating expenses. That’s what the National Center for Charitable Statistics recommended in it's Operating Reserve Policy Toolkit for Nonprofit Organizations, published in September 2010 in partnership with the Center on Nonprofits and Philanthropy at the Urban Institute and United Way Worldwide.  Grantmakers in the Arts, in January 2010, launched their National Capitalization Project and at their October meeting in Chicago released a summary document which stressed the importance of well capitalized organizations and added, “…we repeatedly came back to the fact that the most common source of capital is accumulated surpluses. We agreed that getting organizations to achieve a surplus would require encouraging a significant shift in nonprofit practice and culture, a challenge we thought well worth undertaking.”

Nonprofit Finance Fund has long been a proponent of healthy balance sheets, but as the reports and recommendations mount, it’s clear that NFF is not alone in suggesting a course of action that considers the creation of reserves.  While reserves alone do not comprise total capital structure, they are an indicator of the degree to which an organization is prepared for the day to day and long term challenges they may face.   Capital structure is the nature, composition and magnitude of the assets, liabilities and net assets comprising the balance sheet – or in other words the financial and physical platform from which the organization’s mission is accomplished.

The provocative question is, how will nonprofits develop healthier balance sheets?  And perhaps more pointedly, how patient are we willing to be?  While generating operating surpluses may be ideal, it will take time and patience to realize a well capitalized sector utilizing this approach.  Our third annual national survey of over 1900 nonprofit leaders (funded by Bank of America) is telling on this point: 

So, is capitalization via accumulation of operating surpluses the answer?  In simple terms, if we are waiting for the sector to build (or re-build) balance sheets independent of new philanthropic dollars, it will take a minimum of five years for those functioning at the 5% surplus level to generate even the equivalent of three months of additional cash reserves.

At NFF our recently released paper, The Case for Change Capital in the Arts, sets out a series of definitions, strategies, and sample cases from our work with Leading for the Future (funded by the Doris Duke Charitable Foundation) that can inform the conversation about capitalization.  In today’s economic environment, in the midst of the conversations and changing dynamics in the field about capitalization for nonprofits, the time for an equity ethic, an embrace of philanthropic equity if you will has arrived.   While we have many tools to teach nonprofits how to create new strategies for operating that generate surpluses, the sector has been struggling for a long time with inadequate capitalization.   Asking nonprofit leaders to generate operating surpluses to build healthy balance sheets will also require asking ourselves if we are providing the proper support for that expectation to be realized.