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How much is enough?

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Lynda St. Clair, Ph.D

Harvard University has an endowment of over $30 billion. The University of Virginia, with the largest state university endowment, has about $5 billion.   

Numbers like these have led a number of people to worry about nonprofits hoarding assets rather than using them to achieve their missions. What level of net assets should a nonprofit retain, if any? Answering that question requires an understanding of some basic accounting concepts, so here is a quick refresher:

The balance sheet equation, which applies to nonprofit as well as to for-profit organizations:   Total Assets – Total Liabilities = Total Net Assets

Net assets may be in three different types of accounts:   Total Net Assets = Unrestricted Net Assets + Temporarily Restricted Net Assets + Permanently Restricted Net Assets

Thad Calabrese looked at over six years of data from The National Center on Charitable Statistics (NCCS).  To explain why most nonprofits seek to increase their unrestricted net assets, Calabrese used the data to test four hypotheses:

1.      To avoid debt:  This hypothesis was generally supported except for the Health and Housing subsectors. Because debt can be very costly, it often makes sense to accumulate assets and then fund operations from internal sources rather than from external financing.

2.      To subsidize clients:  This hypothesis, based on the idea that as a nonprofit’s need to subsidize services increases, the nonprofit will increase its unrestricted net assets, was not supported, perhaps because “organizations that rely on subsidies for operations do not wish to appear too wealthy” (Calabrese, 2012; p. 314).

3.      To create slack:  This hypothesis received mixed support.  Nonprofits in some subsectors (for example, Health, Housing, and Education but not Higher Education) did appear to try to reduce their financial vulnerability by increasing unrestricted net assets.

4.      To take advantage of increases in investment returns:  This hypothesis was not supported.  As investment returns increase, nonprofits tend to use those returns to fund current operations, rather than retain them.  

There is no question that retaining unrestricted net assets to avoid costly debt and reduce financial vulnerability can benefit any type of organization.  But how much is
enough?  When it comes to accumulating unrestricted net assets, there is no magic number. 

If an organization has a large proportion of Permanently Restricted Assets and Temporarily Restricted Assets, then even though the Total Net Assets may appear to be high, the nonprofit may lack flexibility useful for maintaining or expanding its operations. 

What justifies the accumulation of unrestricted net assets? Possibilities include:

a.     Plans for a large-scale project that will need to be financed

b.     Need for the organization to have a sufficient buffer to sustain itself in an unstable financial environment or through a lengthy financial downturn

c.     A forecast of increasing demand for services, requiring funds for future expansion, and

d.     Predicted reduction in revenue from contracts and grants (for example, after an election or other change of administration).

If there is no clear reason for accumulating net assets, then it is much more likely that a high level of unrestricted net assets will be interpreted as inappropriately hoarding assets.

Nonprofits can mitigate criticism of their level of accumulated unrestricted net assets by using good governance practices.  They should be transparent about finances and include individuals with financial expertise on the finance and audit committees.

No matter what target level is chosen for unrestricted net assets, someone may well question the choice. Nonprofit leaders should be prepared to explain the reasoning behind the target that they have set.

References:

Calabrese, T. D. (2012). The Accumulation of Nonprofit: Profits: A Dynamic Analysis. Nonprofit and Voluntary Sector Quarterly, 41(2): 300-324.


Lynda St. Clair, Ph.D., is a retired management professor and co-author of Becoming a Master Manager, now in its fifth edition.

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