Cash On Hand Down To 1 Month For Half Of Nonprofits

The nonprofit sector as a whole is fragile and profoundly undercapitalized, according to a new report, but the financial health of organizations is not evenly distributed.

“The Financial Health of the United States Nonprofit Sector: Facts and Observations” examined the tax filings of more than 219,000 nonprofits from 2010 through 2014. The report is a collaboration by GuideStar with management consulting firm Oliver Wyman and SeaChange Capital Partners, an investment bank focused on the nonprofit sector.

Analysis was derived from GuideStar’s archive of digitized Internal Revenue Service (IRS) Form 990 data so it does not include nonprofits that are not required to file 990s, such as places of worship and organizations with less than $200,000 in revenue or less than $500,000 in assets.

Half of nonprofits have cash reserves of less than a month and almost a third lost money over three years. About 7 to 8 percent of organizations have liabilities greater than assets – technically insolvent – and 30 percent face potential liquidity issues because short-term assets are less than short-term liabilities. Yet, nonprofits account for more than 5 percent of Gross Domestic Product (GDP) and 10 percent of the workforce.

“The scale of the problem is vast,” said John MacIntosh, a partner at SeaChange, and an author of the report. “Just restoring current insolvent nonprofits to solvency would require an injection of $40 to $50 billion,” he said.

    Four key dimensions were examined in a nonprofit’s financial health:

  • Solvency: Total assets relative to total liabilities;
  • Liquidity: Short-term assets relative to short-term liabilities;
  • Net income margin: The ability to generate surpluses measured by total revenue relative to total expenses over a three-year period; and,
  • Reserves: Financial capacity to withstand negative events and stress scenarios, and self-fund large expenditures. Indicators include months of cash, liquid investments, and operating reserves.
  • After setting the stage with its findings, the 30-page report goes on to suggest what trustees, funders, regulators and policy-makers can do to address financial health, namely through a risk management framework.

At the top of that pyramid is compiling a risk management statement. The statement, similar to an organization’s mission statement, would indicate the appetite to take on major risks facing the organization and to “trade short-term programmatic impact for long-term sustainability.” Since risk management is the explicit responsibility of the audit and/or finance committees, the study urges organizations that are serious about risk management to “redouble their efforts” to recruit trustees with a wide range of experiences.

Most nonprofits are small, with two-thirds reporting operating budgets of less than $1 million. While 2 percent of organizations have budgets of $50 million or more, these account for 80 percent of total spending by the sector. Hospitals, health and human services and educational institutions account for almost half of the organizations in the sector and 80 percent of the $2.4 trillion in expenses.

These charities face similar challenges that small businesses with budgets of less than $1 million do, said David King, president and CEO of Atlanta-based Alexander Haas Co., a national fundraising consulting firm. They both lack necessary reserves to withstand a crisis or downturn or take advantage of a unique opportunity and struggle with cash flow issues.

“It’s really helpful to have such comprehensive data that reaffirms data our clients live with every day,” said Antony Bugg-Levine, CEO of the Nonprofit Finance Fund (NFF). “The fact is that most nonprofits are expected to do incredibly difficult work while not being paid the full cost of what it takes to provide those services, and over time, build a healthy organization. Over the long term, it’s not a sustainable way to continue,” he said.

“We can’t expect nonprofits that have been forced to be so fragile to then turn around and innovate, track outcomes, prove results and offer better solutions over time,” he said. “The implications of that financial fragility on leadership mean constantly being forced to scramble to cover this month’s rent or next week’s payroll, rather than thinking about what want and how do better,” Bugg-Levine said.

How many days of cash reserves are appropriate for an organization depends on the charity but one that doesn’t have more three months’ of reserves doesn’t have ability to see beyond the short term, to go from mentality of survival to innovation, he said.

Bugg-Levine suggested that organizations connect that financial data to the human implications of what happens when nonprofits are forced to operate in a system where it doesn’t allow them to financially be secure, not for the sake of being financially healthy but to position themselves to tackle society’s hardest problems. “We’re not setting up organizations to do what we ultimately need them to do,” he said.

Among his suggestions, King said organizations shouldn’t try to raise an endowment, which can hold money captive and not provide meaningful annual funding help. Instead, raise an operating reserve or quasi-endowment that can still be drawn upon to support budget needs. And, establish that operating reserve in small, regular increments – instead of trying to do it in one lump sum – which can help create a meaningful reserve without hampering cash flow.

Religious institutions and environment and animal-related nonprofits are predominantly funded by philanthropy. These nonprofits have less debt and larger reserves. The study suggests that private philanthropy allows them to build prudent reserves in a way that government contracts do not.

Educational institutions are, hospitals and health and human services receive the vast majority of funding from government contracts and fee-based services. They use debt more often, operate in a tighter liquidity range and have smaller reserves, and the report suggests that their ability to generate consistent revenues throughout the year may “allow for greater access to credit from banks or debt capital markets.”