The term “financial health” can take on many different meanings, depending upon who is trying to measure or accomplish it. For individuals, it is often defined as “the dynamic relationship of one’s financial and economic resources as they are applied to or impact the state of physical, mental and social well-being.”1 For businesses, financial health is seen as a measure of the company’s long-term sustainability based on an analysis of its liquidity, solvency, profitability, and operating efficiency.2
In the nonprofit sector, financial health is a hybrid of these two definitions. The financial health of a nonprofit organization is measured by its ability to impact the wellbeing of the people and communities it serves with high-quality, mission-driven programs while utilizing available financial and economic resources to maintain a visionary and sustainable organization.
For nonprofit managers and executives, this boils down to being able to perpetuate the organization’s ability to fulfill its mission in the long-term. This is easier said than done. As obvious as the connection between financial health and sustainability is, a great many nonprofits are struggling to find ways to achieve it.
How Financially Healthy Is the Nonprofit Sector?
According to the Nonprofit Finance Fund’s 2018 State of the NFP Sector Survey, 62% of executives surveyed expressed that financial sustainability is a top challenge, and 86% predicted that the need for their services will rise, with more than half of those respondents uncertain that they can meet the growing demand. Meanwhile, only 45% are developing succession plans—an essential element of long-term sustainability.3
Holding nonprofits up to the business definition of financial health (i.e., solvency, liquidity and similar metrics), things look even more bleak. According to SeaChange’s 2018 Financial Health of the United States Nonprofit Sector survey, which evaluated more than 220,000 nonprofits, 7-8% of nonprofits are technically insolvent (liabilities exceed assets), 50% have less than one month of operating reserves, 30% face potential liquidity issues (minimal cash reserves and negative working capital), and 30% have lost money over a three-year period.4
Many factors explain the financial state of the nonprofit sector as a whole, including rising demand for services, lack of adequate funding, closure of unsustainable nonprofits, and growing public scrutiny. If the strategies and tactics that nonprofits are currently employing to combat these challenges are overwhelmingly insufficient, changes clearly need to be made—CPAs are among those professionals best equipped to lead the charge.
CPAs’ Role in Turning the Tide
As the advisors closest to nonprofits’ operations and finances, CPAs can play a critical role in helping those nonprofits onto a path to greater financial health and sustainability.
One of the best ways to do this is to look at nonprofit clients through the same lens as business clients. While many nonprofits would never compare themselves to for-profit enterprises, there is ample evidence to convince them otherwise:
- Impact on the economy. The nonprofit sector contributes approximately 5.5% to the United States’ gross domestic product (GDP), employs approximately 10% of the nation’s workforce, and pays approximately 10% of the nation’s wages. The impact on New York State is even more significant. New York has the third-highest concentration (approximately 18%) of nonprofit employees among all states. The state’s nonprofit organizations account for approximately $26 billion in annual revenues and $511 billion in assets held.
- Business challenges. In addition to the industry-specific challenges noted above, nonprofits are not immune to many of the struggles that all businesses face, such as competition, cash flow issues, rising insurance and labor costs, talent recruitment and retention, employment law and minimum wage changes, diversification of investors and donors, technology challenges, lack of succession planning, and the impact of tax law changes.If the challenges are the same, why are the solutions not as readily available and promoted to nonprofit entities? CPAs can use the following solutions to help their employers and clients attain greater financial health and sustainability.
Achieve Organizational Alignment
All nonprofits should periodically revisit their missions, values, and goals to make sure they are still focused on the right things. Are the organization’s objectives and strategies moving it closer to its goals? Are the leaders determining which programs to enter and exit through the lens of how effectively they will fulfill the mission?
Second, management should set the tone from the top. Establishing and following leadership values will set the standard for all employees to follow and allow for easier decision making, consensus, priority-setting, and motivation.
The most important part for leaders in this area is to follow the values themselves, which will then trickle down to the rest of the organization. If the values do not become the foundation of the organization’s beliefs, establishing them will mean nothing. Furthermore, if these attributes are not upheld by the highest members of the organization, an erosion of values is inevitable, leading to employee discontent and misdirection.
Understand the Marketplace
Like businesses, nonprofits need to understand the changing needs of their service base. Regardless of the population a nonprofit serves, that community’s needs will shift and change as time goes on. Reassessing these needs regularly will aid in decision making around program needs, potential employees and donors, physical structures, competitive research, and identification of collaborators.
It is equally important to help a nonprofit understand their donor bases and how to retain and increase them. This includes a careful analysis of how, when, and why donations are made to ensure that fundraising efforts are aligned accordingly.
Prepare for the Worst
CPAs should keep an eye on nonprofits’ operating reserves (or “rainy day funds”) to monitor their ability to survive an emergency or unexpected drop in funds. Nonprofits should maintain operating reserves at targeted levels to:
- maintain stability and continuity in operations during difficult financial times (from economic downturns to natural disasters),
- have margins of error,
- self-fund large opportunities, and
- enable an organization to pursue opportunities of strategic importance.
If a nonprofit does not have a business continuity plan, CPAs can help it develop a framework, which should include an operating reserves policy and procedures. When discussing the necessity of this with nonprofit clients, it is important to make them understand that the organization is allowed to generate a surplus; in fact, the sustainability of the organization depends on it.
Organizations shouldn’t just prepare for the worst; they should do everything possible to prevent the worst from happening, where possible. This is where risk management comes in.
It is a well-known fact in the industry that most nonprofits do not have an adequate risk assessment process or formal risk management function, most commonly because they believe it would be too complex, time-consuming, or costly. Part of a CPAs’ role is to help nonprofit clients realize the potential costs of neglecting risk management, including damage to the organization’s reputation, financial wellbeing, and ability to withstand an unexpected event or setback.
Risk management is an “all-hands-on-deck” process that should include a cross-section of employees throughout the organization, including board members and even volunteers. It must be incorporated into day-to-day operations, with assigned responsibilities for identifying, assessing, and addressing risk aggressively and regularly.
Make the Tough Decisions
Maintaining financial health at either a nonprofit or for-profit does not happen without making some difficult decisions along the way. One of the hardest decisions for a nonprofit organization to make is to exit a program that holds some special meaning. CPAs can provide an objective and data-driven case for re-evaluating programs that are operating at a financial loss.
When determining the need to exit programs, the following steps can guide the process:
- Identify which programs are operating at a loss.
- Identify reasons for not exiting programs that are operating at a loss (i.e. reputational damage, void in community services, moral obligation, other nonfinancial benefits).
- If the organization decides to keep the program, it should explore ways to reduce costs and identify ways to operate the program more efficiently.
- If the decision is made to exit the program, an exit strategy should be carefully developed and deployed, including a communication plan, redeployment of staff, and identification of other organizations willing to conduct the program.
Another important decision that may arise when a nonprofit is struggling to maintain good financial health is the consideration of a consolidation, collaboration, or business combination with another organization. These options include acquisitions, mergers, and shared services. Bringing two or more nonprofits together can be a very effective way for all parties to achieve improved program and financial success, as well as continued sustainability. Regardless of the type of transaction or arrangement, it is essential that all parties have commonalities among leadership, mission, and programs. To be successful, the union must be mission-focused, provide mutual benefits, and offer complementary opportunities for all parties to exercise their own uniqueness. CPAs will play a key role in the due diligence and financial analysis upon which this critical decision will be based.
Finally, nonprofit executives have a challenging responsibility to assess their board members and make difficult decisions about how it is composed. CPAs can help their nonprofit clients critique the board and measure the engagement, talent, and effectiveness of its members. CPAs can be the neutral party a client needs to identify missing skill sets and assess whether board members have sufficient business acumen and connections to get the nonprofit where it needs to be.
Think Outside the Box
Considering the economic climate facing nonprofits, it often takes innovative and proactive ideas on top of operational improvements to make a lasting change for the better. Here are some additional effective—but often overlooked—ways for nonprofits to achieve financial health:
- Investment strategies. From better diversification of the funding portfolio to more strategic investment in necessary resources, a nonprofit can and should revisit its investment strategies regularly.
- Asset monetization. Nonprofits are conditioned to provide services and resources for free, but there is nothing keeping them from generating revenues in areas where it would be appropriate.
- Vendor management. Often overlooked in the busyness of accounts payable and receivable activities, establishing preferred vendor protocols is a best practice of every successful nonprofit.
- Human resources. Sometimes financial issues stem from a mismanagement of human capital. Effective overtime and employee benefit policies and procedures can yield significant cost savings for nonprofits.
- Credit. – When a nonprofit is struggling financially, the last thing it may think to do is incur more debt. However, the use of a line of credit—when used sensibly and strategically—can open the door to better day-to-day cash flow management and improved financial performance.
How to Best Serve the Client
As the accounting profession continues its evolution toward an advisor-first role, there has been much discussion of business consulting, best practices, and bottom lines. Not applying similar principles to nonprofit clients is a huge disservice to those organizations, the communities they serve, and the nonprofit community as a whole.
This article was originally published in the April 2020 issue of The CPA Journal.
1. “Financial Health Defined,” Financial Health Institute, http://bit.ly/2x7GLP6
2. J.B. Maverick, “What is the Best Measure of a Company’s Financial Health?” Investopedia, June 19, 2016, http://bit.ly/3a9ZY1D
4. Oliver Wyman and Guidestar, https://owy.mn/33oteix