Changing the Dialogue: Nonprofit Finance Myths and Realities
Nonprofit organizations (501 (c) 3s) experience a unique set of financial problems that stem from both how the sector operates outside the traditional rules of supply and demand and the way our culture views philanthropy. Often, nonprofits enter the market when for-profit and governmental sectors can't, won't or shouldn't, generally due to a gap or failure in the market economy. Their customers are often unable to pay for the services that they provide, and demand for services often goes UP as ability to pay goes down.
This systemic flaw is why nonprofits use two tools to subsidize their operations: tax exemption and access to tax-advantaged charitable contributions. Unfortunately, this system has its drawbacks, and many of them stem from an antiquated ideology our society has about what it means to be ‘nonprofit.' For example, ‘surpluses' (AKA ‘profits') are often looked at critically and seen as antithetical to the authentic mission-driven organization. Expenditures on ‘overhead' are also called into question, perceived as a sign that an organization is not spending their money on their mission. This ideology has serious consequences for nonprofit health—and their ability to fulfill their mission. Without surpluses, nonprofits struggle to achieve long-term stability and are frequently operating from month-to-month, without the breathing room to plan for the future of their organizations and the long-term impact of the work they do. Programmatic growth also often increases the need for fundraising and decreases “self-sufficiency.”
Nonprofit leaders live with these management realities every day. To cope with the organizational implications, however, takes a unique set of financial disciplines that often get overlooked when mission is the primary focus. Below, we share a few foundational finance tips as a refresher to help new or emerging leaders remember to keep business and finance as an integral part of decision-making.
- Remember that you actually run at least two businesses. There's the core business, related to delivering on mission (e.g., teaching, providing shelter, providing health care), and then there's the ‘subsidy business' (usually fundraising) that makes up for the market flaw.
- Keep mission, capacity, and finance in balance. These three interdependent elements, which we call the NFF triangle, change together. If one changes, the others change, too. Capacity and finance are the base on which mission rests. Money doesn't actually flow directly to programs; it is turned into program execution through this base. If the base is weak, program execution will be undermined.
- Insist on having clear, reliable, routine, and management-friendly financial information. Oftentimes, nonprofit leaders and staff lead with their hearts, sacrificing their time and health to keep their organization's mission alive and impactful. But the most effective leaders are also business-people, producing, analyzing, and communicating their financial situation with their staff, board, funders, and internal and external stakeholders. They use finance as a tool to effectively communicate their organization's story, blending the three components of the NFF triangle, and tailoring their language to the needs of their different audiences.
- Regularly forecast how your organization will end the year financially, starting at the beginning of your fiscal year. What will make your prediction more or less likely? At the end of the year, what patterns developed that you can learn from to improve the visibility into the following year? The best way to improve visibility is to update your predictions with “actuals” regularly and continue to build in new projections as the year proceeds. It's also important to share these routine numbers with the board, and make course corrections accordingly.
- Plan for the full cost of doing business. It's easy to forget that organizations must absorb the ‘full cost' of delivering programs. This includes not only direct program expenses, but also capital investments, regular maintenance of facilities, replacement of equipment and systems, principal debt payments, and savings for the future. While it's often difficult to cover basic annual expenses, nonprofit leaders must track these other items so they can articulate the support they need to remain sustainable in the long-term.
- Approach growth with caution, and treat regular, routine operating revenue as distinct from capital. Growth is capital intensive, takes a long time, and is risky. Increased revenue frequently means decreased net revenue. We recommend making a clear financial distinction, in reports and use, between money allocated for growth and money for fixed costs and regular operations. Using NFF's financial approach can help an organization improve the chances that it will come out the other side of its growth period being more, rather than less, sustainable.
We recognize that financial disciplines are easier said than done when the consequences may mean turning away a person in need. As a nonprofit itself, NFF also struggles with this conflicting dynamic every day. That's why a long-lasting solution requires a more systemic change in how our culture perceives and funds nonprofits. This means that it's our burden as nonprofit practitioners to be communications experts and do our best to educate funders about the true costs of running our businesses or programs, avoiding the urge to apologize for those numbers or reduce them with the hope that we can make it work no matter what. Over time (and with patience), NFF believes that if we work together under a common business mindset, we can move the sector towards an ideological shift in which funding is seen less as ‘charity' and more as philanthropic investment in the shared improvement of our society.