Accounting lessons from the recession

Ret Boney

With unemployment at a two-year low and consumer spending the rise, it’s possible the economy finally is looking up.

And while the charitable sector’s recovery typically lags that of the overall economy, there is evidence that funding cuts are slowing and nonprofit revenues are picking up, according to a new study from The Bridgespan Group.

But the pain is far from over, sector experts say, and it’s time for nonprofits to heed the painful accounting advice dealt out by the recession if they are to rebuild strong and stable financial bases.

“There were some organizations that were not well prepared and had not managed the business in a disciplined way,” says Cathryn Mattson, a partner and chief administrative officer for The Bridgespan Group. “These kinds of difficult times exacerbate everything. If there are any weaknesses, they’ll be accentuated.”

Jeanne Bell, executive director of CompassPoint Nonprofit Services, agrees.

“What the recession did was bring into relief a set of endemic sustainability problems that plagued a significant minority of the sector,” she says.

The task now is for nonprofits to address those issues and move forward responsibly and successfully.

Keep eye on cash

Even during strong economic times, having predictable and reliable cash-flow is a necessity for any organization, including a nonprofit.

Because nonprofits differ from for-profits, and from one another, and therefore have widely varying cash needs, an organization’s cash-management policy must suit its business model.

“If your balance sheet needs to fund programs in the next year, it shouldn’t be tied up in illiquid investments,” says Alan Tuck, a partner with Bridgespan. “That’s not new, but it’s more important when your cash isn’t going up every year.”

During the recession, not only did many nonprofits bleed cash, the credit crunch that hobbled organizations large and small made finding emergency funds almost impossible.

That should be a lesson, says Tuck.

“Think through whether you should have a line of credit in place,” he says. “The worst time to consider that is when you really need it.”

And given that nonprofits often receive restricted funding, which can only be spent on specific programs and activities, it is critical to understand where the cash is coming from and when it will arrive for the next six to 12 months.

“You may have a lot of cash in the bank, but if you can’t touch that until a specific time, that’s a problem,” says Mattson.

Maintaining a cash reserve, which is a perennial challenge for many nonprofits also is imperative.

The general rule is that nonprofits should have a three-month unrestricted cash reserve in place at all times, says Bell of CompassPoint.

But nonprofits have never really maintained that and certainly don’t have that in the wake of the last few years, she says.

“You have to make immediate, reactive cuts if you don’t have any of your own working capital,” says Bell. “If a foundation calls – and most of us got at least one of those calls – and says we’re not renewing this grant, you have to make decisions.”

And having to make those decisions in crisis mode can be dangerous, forcing chief executives and boards to start trimming and cutting to make payroll, without taking the time to examine the underlying business model.

If they are not already in place, Bell says, now is the time to develop reserve policies, which outline an organization’s minimum reserve, reason for creating it and circumstances under which it can be tapped.

The worst of the recession may be over, but for many nonprofits, the difficult work of creating, or recreating, a stable financial foundation is just beginning, says Bell.

“Many of us now have to go into a long period of rebuilding reserves,” she says.  “If you spent down to weather the storm, you have to become even more effective financially to get back to where you were. If you only had a two-month reserve to start with, and now only have two weeks, you’ve got some real questions to ask yourself.”

Surplus imperative

Perhaps the best way for nonprofits to recover from the last recession, and to guard against future squalls, is to create an organization that generates more money than it spends.

“The real question is how do you put together a set of activities that generate modest surpluses,” says Bell. “The actual financial requirements of recovery and finding a new way to sustainability means being profitable.”

Many people believe the only way to do that is through earned income rather than contributed income, but that’s not necessarily the case, says Bell.

“It’s about putting together a mix of resources that in sum give you a surplus each year,” she says. “Any mix of things could work; the bottom line is it has to be surplus-generating. You can find that in both donative and earning activities, and usually it’s a mix of both.”

But getting to a suite of services that together generate a profit doesn’t happen by accident: It requires serious study of the organization’s business model and its individual lines of business.

Before the recession, too many organizations were looking at their overall results and not asking the deeper questions about the trajectory of their various business lines, says Bell.

The result was they were engaging in activities that in the past may have been cash-generating, but over time had become cash-draining.

“I actually think that we are a little slow to cut expenses,” Bell says of the nonprofit sector. “And there are good reasons. Sometimes, we can’t cut costs and still deliver on contracts. It’s a real catch-22. But if the model is so broken that you can’t perform on a government contract, maybe you shouldn’t be in that contract.”

Boards and staff must delve deeply into the core activities of the organization, including the revenues and expenses in each programmatic and fundraising business line, and develop a three-year prognosis for each.

“You really have to get into an anticipatory stance, not a reactive stance,” says Bell. “Once you do that, you can make honest assessments about whether you should be in that business line anymore.”

Plan for the worst

But even the most careful, financially-savvy boards and staffs can find their organizations rattled by an economic earthquake.

The key is to know in advance in which direction to run when the tremors start, says Bridgespan’s Mattson.

“We do contingency planning annually as part of our budget process,” she says of her organization. “If we have to moderate our costs, we know where we would go first, second and third, and what cuts are off limits because of our mission.”

Done well, contingency planning makes an honest assessment of the risks the organization faces and lays out steps to take should a major disruption in funding occur.

One set of actions might come into play if revenues dip 10 percent, while different and more drastic measures could come into play if funding falls 20 percent, 30 percent or more.

“That’s not something you can do effectively in the middle of a crisis,” says Mattson. “It has to be done well in advance so you can act immediately when you need to.”

For Bridgespan, which itself is a nonprofit, that means spending significant board and staff time agreeing on what to do when certain triggers fire, a practice Tuck says served Bridgespan well during the most recent downturn.

“We had clear internal rules about triggers that allowed us to act quickly in the future and not waste three months doing additional planning,” he says.

To cope, Bridgespan was able to implement new hiring procedures that better aligned the addition of human capital with contracted work.

“Hopefully you won’t have to use those contingency plans,” says Mattson. “But it’s a comfort to know you have them.”

Prove it

An indirect result of the recession has been a renewed emphasis placed on results by foundations, government funders and donors.

With their own assets pummeled by the recession, and therefore fewer funds to give out, there increased pressure to ensure that every dollar awarded or contributed is well-spent.

As a result, linking financial information with outcomes of nonprofit activities has gained importance, says Tuck.

“You still want to tell your heartwarming story,” he says. “But they now want to know how much it costs to do that and how much it will cost to replicate that. It’s no longer purely an overhead concept to be minimized.”

When submitting funding proposals, Bridgespan includes clear plans for tracking goals and outcomes, activities that require internal capacity.

“More donors are looking for a sustainable model and are coming at this with a business lens,” says Mattson. “And that’s a good thing.”

CompassPoint’s Bell agrees, and along with evaluation, stresses the growing importance of social media and communications.

“These are now assumptions around best-practice nonprofits,” she says. “These need to be built into the very fabric of your programming.”

And the costs to support evaluation, social media and communication can no longer be shoved into the overhead percentage, but belong “above the line” in grant proposals.

“They are not overhead activities,” says Bell. “They are part of the excellence. Nonprofits have to very intentionally start to move those things into the way they develop grants and contracts.”

That means incorporating evaluation costs into the cost structure of the organization, regardless of whether funders are willing to pay for it.

“First and foremost, nonprofits have to build it into their business model, and then they need to go out and price that into their projects and contracts,” says Bell.

It is no longer acceptable not to be a learning organization, she says, one that collects and analyzes data, and refines its programs based on the findings.

While costly in the short-term, failing to incorporate learning into the business model will have costly, longer-term effects.

“You won’t attract resources in the long term,” says Bell. “It will be much easier to cut you than someone else who is doing this work.”

Silver lining:

This latest recession was brutal. Many nonprofits froze salaries, cut benefits, laid off staff and axed programs, and some even closed their doors.

But perhaps there was a silver lining of sorts of sorts, says Mattson.

Nonprofits were forced to look more closely at their management practices, evaluate their core businesses, and determine which programs are critical to their missions.

“It’s easy not to take a cold eye and assess programs as thoroughly as you should,” she says. “Many of the practices that were required in times of difficulty are continuing. Some organizations didn’t make it through, but the strong ones that kept their eye on the ball have emerged stronger.”

Bell agrees.

“As someone who focuses on supporting leaders facing challenges,” she says, “there’s no doubt the urgency of the last few years has intensified my commitment to analysis, to discipline, to making faster decisions.”

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