Accounting and Advising in the Nonprofit Sector

The nonprofit sector is comprised of passionate, caring individuals striving to make our world a better place. Every day they create strategies to house and care for the homeless, educate children, feed the hungry, heal the sick and bring music, art and dance to enrich our lives.  Indeed, the sector plays a vital role in building the vibrant communities in which we all want to live.  They are also substantial businesses.

Few individuals, both staff and volunteers, get involved with a nonprofit organization because of their passion for nonprofit accounting.  However, representing approximately 7% of our country’s GDP and 12% of our workforce, the nonprofit sector represents more than just a community engine: it represents a business engine.

Nonprofit businesses are complex. Without a strategy to accomplish an organization’s mission—without the necessary complementary financial strategy to provision those efforts—it will remain a vision, and never be realized.

Likewise, we volunteer and work with nonprofit organizations because of our passion for the mission, not our unending desire to build a financially strong organization.  For an organization to thrive it needs to manage to have impact, and be financially viable, at the same time.

Managing this dual—bottom line of impact and finances is complicated by organizational structures which often silo these two components—marginalizing the interconnectedness and setting up a dynamic for making decisions without considering either the finances or the mission. This leads to unintended consequences and less impactful, sustainable, organizations.  Committee structures are partly to blame with separate finance, fundraising, and program committees. This disconnect also happens, in part, because leadership does not fully understand nonprofit finance.

Fortunately, accountants are uniquely positioned to break down these silos in order to engage staff and board in conversations geared towards deeper understanding of these complexities, and help them guide the organization toward greater sustainability.

Implementation of the new financial accounting standards provides an opportunity to discuss the world of nonprofit accounting and to build financial literacy among board and staff.  Focused beyond the tactical steps for implementation, the discussions can lead to stronger decision making and strengthen sustainability for the organization.

Donor Restrictions

Donor restrictions are one of the most misunderstood areas in nonprofit accounting. Clara Miller, who at the time was the CEO of the Nonprofit Finance Fund, compared it to Alice in Wonderland where all is not what it seems in her seminal article, “Through the Looking Glass of Nonprofit Money” published in Nonprofit Quarterly.  While the new accounting standards rid us of the jargon of permanently, temporarily, and unrestricted net assets, the concept of donor restrictions remain.

Board members with for—profit experience rarely grasp the significance of donor restricted funds and that all dollars are not necessarily equal.  Unlike the for—profit sector, the donor’s wish trumps management’s desires by controlling which aspect of the organization they will support with their restricted donation. To release the restriction, the organization must fulfill their obligations to the penny, or obtain a written release from the donor.  Creating efficiencies and shifting surpluses to other strategic imperatives is not in the purview of the board or management with these restricted funds.

These restrictions place a premium on two aspects of the organization – generating unrestricted support and understanding the true costs of programs.

Generating Unrestricted Support

Like manna in the wilderness, unrestricted support is the lifeblood for many nonprofit organizations—allowing leadership to allocate funding to areas that will allow the organization to maximize its impact.  Sometimes, this may be for programmatic growth or innovation—exploring a new strategy to accomplish its mission.  Other times, it may be to strengthen the infrastructure of the organization.  In other instances, it may be, more importantly, to not spend the money at all, but to build a reserve or savings account for the proverbial rainy day.  Operating a program at a surplus and utilizing that surplus to build an operating reserve is not permissible with restricted money unless explicitly stated in the donor agreement.

Building an operative reserve is a strategic decision every nonprofit should explore, and a discussion the accountant is uniquely qualified to lead.  Often boards may wish to wait for a windfall or a slightly higher budget, but there will never be a time when the organization feels “flush with cash” where it can put off investing in a program.  Operating reserves provide flexibility during funding shifts or economic downturns, and the accountant must communicate that building a reserve is an investment in the mission of the organization.

While the often-repeated mantra is that nonprofits should have between three to six months of operating reserve, we prefer to consider the volatility of revenue streams when arriving at a target. A reserve equal to the organization’s most significant and vulnerable revenue stream will allow leadership the flexibility to evolve and respond should the need arise.  The reality, however, is that many nonprofit organizations operate on a slimmer reserve of between one to three months, with several more still operating on less than one month.

Accountants should lead the discussion in establishing the appropriate level of reserve for an organization, but need to be careful not to fall in the trap of discussing it from solely a financial perspective.  Rather, tying the purpose of the reserve to furthering the mission of the organization can help bring all members of the organization’s leadership—staff and board—along in the discussion.  Reserves are what enable organizations to provide critical services during economic downturns and what help make sure the mission and important work of an organization last long into the future.

The need for reserves will be highlighted in the new liquidity disclosures in the accounting standards.  For non-accountants, the concept of accrual versus cash basis accounting remains vexing, but despite a somewhat complex calculation, the liquidity disclosure can help drive a more accessible discussion of the resources available for the organization to accomplish its mission.

Reserves are not created overnight and accountants should emphasize that building a reserve is a long, tension–filled task that balances the needs for operations today with the security for the future.  Building a reserve requires unrestricted support which tends to come from two sources: fee for service, and philanthropic support. Accountants have an important role to play in both.

Like any professional services firm, and similar to the for-profit world, the fee for service revenue stream is a typical exchange transaction requiring a deep understanding of the cost of services provided and the market needs the product seeks to fill.  Accountants can lead both of these discussions, calculating the cost of services and inquiring among board members and other stakeholders about competitive pressures the organization might face.  Nonprofit leadership tends to be skilled in calculating direct costs, but accounting assistance in calculating fully allocated true costs of programs—including direct and administrative expenses—is essential.  Accountants have the skills and perspective to lead this important discussion and price services correctly.

Philanthropic fundraising has the equal distinction of nonprofit accounting as being a necessary evil.  On its own, it is often one of the least favorite aspects of board membership.  Holding the big picture of the organization and how everything works together to drive impact and financial viability, the accountant is well positioned to reframe the discussion around fundraising.  Rather than viewing the organization as engaged in separate activities, the accountant can draw the connection between programs whose primary purpose it is to accomplish the organization’s mission and the need to resource those efforts.  While many board members understand this subconsciously, making the link between being great at program delivery and being great at generating resources.  Beyond making this connection, knowing the cost of delivering impact can be motivating for solicitors and donors alike and help drive a conversation around value.

For an organization to be great at delivering its mission, it needs to be great at resourcing it.  This requires a level of financial literacy; understanding the expenses associated with mission delivery, and an assessment of the organization’s overall financial health to build a strong foundation for the future. The implementation of new accounting standards provides an opportunity for these discussions.

Accountants have an opportunity and the skill to facilitate these vital conversations whether they serve on the board, work with nonprofits as community volunteers or have the privilege of counting them among their clients.  Nonprofit organizations build the heart of our communities.  They’re also complex businesses.  Recognizing and facilitating conversations that encompass both sides of the dual bottom line will allow accountants to be a pivotal strategic partner in building stronger leadership, stronger nonprofits and stronger communities.