Financially Frozen Nonprofit Ice Sculptures
April 15, 2013 Thomas McLaughlin
Are you frozen, financially, that is? Does it feel as if your organization’s financial portrait is covered in ice? Does every building-related expense seem to go out in agonizingly slow motion? Does the message from your financial statements seem inevitably chilling?
If the answer to any of these questions is yes, your organization is probably suffering from one or more of a handful of conditions that really can make it feel like you’re frozen in time. Some of these situations are easy to spot, while others could take a little sleuthing in your financial records to confirm
Try to perform a completely non-intuitive process, linking feelings to numbers on your balance sheet. Once we do that, there’s a warm exit from each condition.
The surest way to spread a chill through a nonprofit is to slow down or prohibit purchases. This happens in often subtle ways, such as the gentle suggestions “let’s wait a few weeks to buy that” or “are you sure we really need this?” These cautions usually happen when cash is a bit tight, but when it gets even tighter the prohibitions become more terse and direct.
Other tools to slow down cash outflow include delayed reimbursements and more complicated approval systems.
The underlying problem in these situations is a shortage of ready cash. Here’s how you can infer whether the cash trickle reflects a broader problem or whether it’s just one of those mysterious policies hatched by the always-nervous bookkeepers. Look at your organization’s federal Form 990. Find Part IX line 25A and divide it by 365 days. This tells you how much your organization spends per day. Remember the number.
Next, go to Part X, the balance sheet. Add lines 1B and 2B together and divide that number by the spending per day figure. This gives you an idea of how many days of normal spending are contained in the total amount of cash on hand.
If that number is less than, say, the 25-day range, your financial folks will be urging you to postpone purchases. If it’s below 15 or so, they’ll be blocking almost all spending.
This kind of frozen will affect all staff members, particularly those with some kind of purchasing authority. Unless there is a pot of gold hidden somewhere (such as Part X Balance Sheet lines 12B and 13B), this slowdown means trouble lies ahead.
Another kind of frozen is related to the building or buildings your nonprofit owns. When you look at them, do you see fresh paint, new roofs, good heating and air conditioning, and newly paved parking lots? Or, do you see leaky windows, balky heating systems and closet doors that get stuck all the time? The more you see the latter, the more likely it is that the nonprofit is not keeping up its investment in these tangible assets.
Here’s how to tell which is the case. Look at Part X Balance Sheet line 10b for the term “accumulated depreciation.” Hop backward a page to Part IX Statement of Functional Expenses, and find line 22A. Divide the first number by the second number.
The result of this division is a useful index that has the advantage of being intuitive. If the number you got from the previous paragraph was “10,” this means that the buildings and equipment the entity owns are on average about 10 years old. This means that most tangible things are generally not very new but probably aren’t all that old — comfortable, but you won’t find a lot of freshly renovated areas.
If, on the other hand, the number is something like “22,” it would mean that everything probably looks seedy, threadbare, or worse. When the roof leaks it gets patched, and then patched again and again instead of being replaced. More important, very little property gets refreshed at all because the organization can’t afford it.
This is frozen in slow motion. One gets the sense that nothing will ever look or work quite as well as it did yesterday, and tomorrow it will be just a little bit worse. After a while, everyone accepts it as inevitable. And, in a financial sense, it is almost inevitable.
The total value or net worth of a nonprofit is represented in what are called net assets. Look back to Part X Balance Sheet, lines 27B through 29B. This section tells you about the net worth of an organization expressed as whether that value is restricted or whether it is not at all restricted.
This is one of the most obscure sources of frozen you’ll find. And the truth is that it won’t affect staff and even consumers of a nonprofit much at all on a day-to-day level until it’s at a serious negative level. Net worth in a nonprofit doesn’t mean much in practice, unless the organization shuts down. If that happens, those negative unrestricted net assets on line 27B can be highly problematic.
Depending on the situation, senior executives and even board members could potentially be held liable for unpaid debts in the event of a closing.
But if senior leadership and the board are paying attention, they will be forced to make decisions that affect day-to-day operations, and it will probably require a significant period of time to work out of the jam. In essence, this negative number means that the organization owes more than it can reasonably expect to have if the organization were to go out of business.
The recipe for curing for all of these problems has two crucial ingredients: profitability and time. Ultimately most of the problems described above can be traced back to a weak capital structure, and profitability is one of only three ways that a nonprofit can build capital. The other two are borrowing and capital donations. Obviously, one achieves profitability only through reducing expenses or increasing revenue or both.
These two pathways are not equal. The reason most organizations chose expense reduction to rebuild profitability is because it’s quicker. Cutting an expense, no matter how painful or complicated, rarely takes the kind of time that finding and cultivating new revenue streams does.
Immediate expense reductions, if everything else is in check, will fairly quickly produce profits. This will drive up cash. In turn, better cash flow will allow higher re-investment in buildings and equipment, which will make them younger. And higher profits will restore negative unrestricted net assets. But be aware that profitability might have to continue for several years to correct all facets of the problem.
This sequence of choices is easier described than done, of course. But if you want to get unfrozen, warm up to it.
Thomas A. McLaughlin is the founder of the firm McLaughlin & Associates and a faculty member at the Heller School for Social Policy and Management at Brandeis University. He is the author of ‘Streetsmart Financial Basics for Nonprofit Managers’ (3rd edition), published by Wiley & Sons. His email address is email@example.com