Nonprofit finance a tool for change

Todd Cohen

While Clara Miller’s grandmother attended the symphony in Hanover, N.H., every month, Miller’s daughter waits until the last minute to decide whether to go to a concert in New York City.

For performing-arts nonprofits, that generational shift in attendance patterns means that “revenue is much less reliable,” says Miller, a leading expert on nonprofit finance. “So you don’t necessarily build your cost structure based on a membership model.”

That shift also reflects much more sweeping changes in the economy and in the way nonprofits need to be doing business, she says.

“There is much more of a long-term way of thinking about your business,” says Miller, who on March 1 joined the F.B. Heron Foundation in New York City as president and CEO after 30 years as founder and CEO of the Nonprofit Finance Fund.

Outmoded thinking

Nonprofits are no different than organizations in other sectors in the tough hit they have taken from the battered economy, Miller says.

Yet because they lack the resources to pursue goals set through entrenched and outmoded thinking in the nonprofit sector, she says, small nonprofits actually may be “better positioned to ride out the storm” than mid-sized nonprofits.

“We are prisoners of our own fantasies,” she says. “Everybody imagines that having a building and an endowment are the answers to everything, that growing and having fixed assets are going to make the business easier to run, and you will have financial stability.”

Organizations that persist in that kind of thinking are “going to have a harder time adapting to the new reality,” Miller says. “This is not about riding out the storm. This is about making a change to a new kind of economy.”

Surviving and thriving in the new marketplace requires that nonprofits find new ways of thinking about and handling their finances, assets and accounting, Miller says.

Yet while they face the same challenges as for-profits in adapting to the new economy, nonprofits must address some challenges of their own.

In many states, for example, state governments are not paying their bills on time.

And nonprofits “with no clout, and services that are preventive,” not only are stuck with bills that government is not paying but also face possible cuts in services, Miller says.

“So in a difficult economy, those services get cut first or paid late and are much more likely to go belly-up in a crisis,” she says.

Cash is king

Nonprofits can take some simple steps to adapt their thinking and finances to the new marketplace, Miller says.

First, nonprofits should recognize that “cash is king,” she says.

“To the extent possible, don’t make long-term investments with short-term revenue,” she says.

Nonprofits instead should “build your cost structure so that your reliable revenue will be equal to or greater than that.”

If combined revenue from sources such as fees, state reimbursements and annual fundraising events trail total costs, “then you’re constantly carrying a structural deficit,” Miller says.

In scrambling to try to make up that deficit, “people work overtime and get burned out, and the executive director and board are constantly in a cash crisis,” she says. “You get to a certain point and have to decide to downsize or simply refocus the business. That’s the most heartbreaking and difficult moment of all.”

The way to avoid that situation is by “projecting your cash-flow over the year you’re entering,” Miller says.

That includes separating capital from revenue, separating extraordinary revenue from recurring or reliable revenue, and building fixed costs so they are close to or less than or equal to, but not greater than, reliable revenue.

Growth costs

Nonprofits also must “understand that growth is expensive and has capital costs that are above and beyond the regular cost of operations,” Miller says. “Most managers, no matter the tax status, don’t really get this,” she says.

Nonprofits seeking grant support for new programs, for example, traditionally do not build into their grant requests the funding they will need to add staff and provide training to help existing and new staff learn new skills and procedures for the new program, Miller says.

“Most people try to do that without raising capital specifically for that purpose,” she says.

Nonprofits can avoid that potential trap by being careful “not to take on projects that in fact involve capital expenditures that are not paid for,” she says.

And the philanthropic community “has to understand the difference between giving a grant to buy existing services, and a grant that’s pushing an organization to build something new,” Miller says. “When it’s the latter, it invariably involves capital costs, and also multi-year and capital funding that’s more by far than the marginal cost of buying the product.”

To address nonprofits’ need for investment in their capacity, the Nonprofit Finance Fund in 2006 launched NFF Capital Partners as a consultant to nonprofits.

Among 16 organizations that worked with NFF Capital Partners to secure and invest a total of $312 million in “philanthropic equity,” or “growth capital” to help the nonprofit grow or change in a sustainable way, nine increased their annual revenue by a total of $20 million.

The Nonprofit Finance Fund — which has worked to help thousands of nonprofits gain access to capital, has invested over $1.3 billion in nonprofits, and provides financial consulting to nonprofits — has developed an accounting treatment that separates capital from regular, repeatable revenue, Miller says.

“So both the funder and the nonprofit can track progress toward a sustainable business model at a higher level of operations,” she says. “Whether you’re getting bigger or higher quality or more efficient, all those things require capital.”

In the accounting methods nonprofits typically use, capital is “hidden both from the public and managers and the board because capital and revenue go through the income statement and are not treated differently in nonprofit financial statements,” Miller says. “So you get confused. It’s completely obfuscated by the accounting.”

New marketplace

To succeed in the “new economic reality,” Miller says, nonprofits need to move beyond their traditional way of thinking.

Nonprofits in many fields believe their organizations progress through various “stages of life” leading to the need, for example, to own and occupy a building.

“We’ve got a sector that’s somewhat overbuilt on the real-estate side and undeveloped in other ways,” Miller says.

Arts organizations like the symphony Miller’s grandmother attended need to deal with changing demographics and consumer habits, and with new technologies that dramatically change the way organizations deliver programs and services, and market themselves.

Nonprofits also tend to have an outmoded idea of what their assets are and about the timeline for showing results, Miller says.

People, technology and knowledge are fundamental and powerful assets that nonprofits need to factor into their business strategies.

“A lot of what we do depends on being online and having a strong presence with our audience and maybe hiring more people rather than adding more square feet — human capital as opposed to bricks and mortar,” Miller says.

So capital campaigns, for example, can raise money to create a “different type of organization that has to invest in technology and new skill sets, and develop programs that attract revenue for what we want to do.”
Adaptable, flexible

In the 30 years since she founded the Nonprofit Finance Fund from a spinoff of the New York Community Trust, Miller says, she has seen at least the beginning of a shift in the way nonprofits treat finance.

The financial rules of thumb nonprofits traditionally learned focused mainly on “compliance and comportment” and so were of limited usefulness in making decisions because they “did not reflect the financial dynamics,” she says.

“It represents real progress to start understanding that nonprofits are much more similar to for-profits than not,” she says. “They have different commercial characteristics, tax status and social imperatives, but the financial dynamics are the same.”

So nonprofit accounting should not be about “checking boxes,” she says.

Rather, it should be “much more adaptable and flexible to the realities of marketing, and giving them the judgment tools to manage a dynamic organization,” she says. “So you understand what the drivers of revenue are in the business model.”

The old business model “focused on formulas like the overhead rate that didn’t have much to do with operating the business,” Miller says.

As a result of the start of that shift in thinking, she says, the “for-profit sector has learned how hard it is [in the nonprofit sector], and the nonprofit sector has adopted some of the business dynamic and rules of the for-profit sector.”

Still, she says, the nonprofit sector has adopted the “continuing push toward short-term results” in the for-profit sector and, along with that push, the use of “measurable results.”

Those results are “almost invariably short-term, and this is pushing the entire sector to do something that is not always in the best interest of the bigger world or economy, in much the same way it’s happened in the for-profit sector,” she says.

In the for-profit sector, many of today’s biggest problems are the result of “solutions people thought were good, and you end up driving low-value outcomes into the economy,” Miller says. “The business model that drives the shortest-term profits ends up having lower economic value.”

In the nonprofit world, she says, the “notion that only things that can be measured should be funded is limited.”

Many of the most significant improvements in areas such as health and education, for example, are the result of private funders investing in ideas and innovations that did not have a short-term payoff but produced true progress for the long-term, she says.

“Funders can fund for the long-term,” she says. “It’s common sense.”

Citing funders like the Ford Foundation and Rockefeller Foundation, she says, the “really revolutionary social benefits which everybody loves, you can only just glance back in history and see they’ve taken years and years and lots of investments.”

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