Streetsmart Financial Basics for Nonprofit Managers

by Thomas A. McLaughlin

Overview

The complete guide to the basics of nonprofit financial management

Let's be honest. Most books about financial management are densely written, heavy on jargon, and light on practicality. Expert financial consultant and author Tom McLaughlin takes a different approach with his fourth edition of Streetsmart Financial Basics for Nonprofit Managers. This comprehensive guide provides effective, easy-to-use tips, tools, resources, and analyses.

The light, humorous tone in Streetsmart Financial Basics for Nonprofit Managers makes it an accessible resource for nonprofit executives, board members, students, and those new to the field. This book forgoes useless, pretentious verbiage in order to outline real-world strategies that work. This edition includes:

• New insights, updates, vignettes, case studies, and examples to deal with the implications of nonprofit financial management
• An examination of nonprofit business models in relation to growing demands from the government and other funders
• How to construct business plans for virtually any nonprofit entity
• Customizable resources—including financial worksheets, forms, and Excel templates to help nonprofit managers complete their day to day assignments
• A guided tour through common aspects of nonprofit management, such as financial analysis, accounting, and operations

Practical and informative, Streetsmart Financial Basics for Nonprofit Managers is the go-to financial management reference for nonprofit managers, boards of directors, and funders.

Product Details

ISBN-13:	9781119061328
Publisher:	Wiley
Publication date:	02/23/2016
Series:	Wiley Nonprofit Law, Finance and Management Series
Sold by:	JOHN WILEY & SONS
Format:	eBook
Pages:	368
File size:	6 MB

About the Author

THOMAS A. MCLAUGHLIN is the founder of McLaughlin & Associates, a nonprofit consulting firm. He is a contributing editor for the NonProfit Times, and he taught financial management and strategic management to mission-based MBA and international students at Boston University and Brandeis University for 28 years.

Read an Excerpt

Streetsmart Financial Basics for Nonprofit Managers

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By Thomas A. McLaughlin

John Wiley & Sons

ISBN: 0-471-20570-2

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Chapter One

Organizational Structure: Programs and Corporations

The nonprofit industry is enormous. Tens of thousands of such organizations are created every year. Exhibit 1.1 shows the growth curve for the last several years. Nonprofit organizations in the United States spend over $340 billion each year. They employ nearly 7 percent of the total workforce and are responsible for 6 percent of the Gross Domestic Product. Universities, research centers, religious institutions, and museums produce priceless accomplishments. Nonprofit hospitals are major elements of our health care system and in many communities are the largest employer. Social service agencies provide a wide variety of services to those less fortunate citizens. Other nonprofits educate people of all ages and at all levels. Still others develop communities and support our social lives.

There are many ways to categorize this industry. The IRS's way is discussed later in this chapter. The traditional way is by the service provided and, to a lesser extent, the size of the nonprofit organization. This approach may not be particularly useful from a financial management perspective since services and even size alone do not necessarily say much about the nature of the financial management challenge.

TYPES OF NONPROFIT ORGANIZATIONS

For financial purposes, a better way of looking atthis industry is to sort it into categories according to the primary economic function the organizations perform. Six distinct types of nonprofit corporations can be defined:

1. Direct service providers

2. Information managers

3. Resource distributors

4. Support and development providers

5. Grant makers or funders

6. Social organizations

Note that these groupings are chiefly for analytical purposes, and that the activities of many organizations can span several categories.

Direct Service Providers

These organizations are the classic nonprofits. Usually public charities, they are the hospitals, clinics, social service providers, and the like that provide some sort of direct and recognizable service to some or all of the public at large. Often major employers of professionals, these corporations provide a "hands-on" service.

Financial issues in direct service providers vary according to size and funding source. One characteristic that many share is the need to assemble a workable mix of funders, and to be careful about managing the relationships between funders' requirements. Complexities abound in their financial management profile because governmental and quasi-governmental entities are often major funding sources. One study from Johns Hopkins University found that 29 percent of all U.S. nonprofits' funding comes from government sources. Due to the limitations of government funding, philanthropy must also often play a role in direct service providers' management, and the stakes are high if money is accounted for inaccurately.

Payment in this field is moving from the traditional reimbursement for costs incurred to a defined price for a defined service such as one finds in health maintenance organizations. Level funding for many years has been the norm.

Information Managers

Another large category of nonprofits are the information managers-universities, museums, advocacy groups, trade associations, and a variety of similar organizations. Their role is to accumulate information of a predefined sort and share it with selected users, often in the role of broker. A university, for example, can be viewed as a broker between professors and students, or between researchers and consumers of research. Information management agencies range widely in size from the very smallest advocacy group to multibillion-dollar universities with international branches.

Consumers of information management services are multiple and naturally quite independent of each other; their financial systems must be capable of handling unusually massive quantities of information. These types of organizations tend to have memberships; therefore, the financial systems must store information about the same people for retrieval and usage over a period of years. In effect, membership records are the financial data.

In practice this scenario dictates a financial system, especially the revenue tracking component, that is capable of handling large numbers of small or large transactions. Frequently, the financial task is paralleled by the program manager's need to communicate with hundreds or even thousands of people, members and nonmembers. Fast and effective data management often becomes the only thing distinguishing one information manager from another, laying a heavy burden on the administrative infrastructure of each organization.

Resource Distributors

Resource distribution agencies reached their zenith during the Great Society days of the 1960s. For a variety of political, psychological, and logistical reasons, the federal government did a lot of business directly with local nonprofit agencies, positioning them as the last stop before direct contact with eligible clients.

No doubt it was politically useful for these local players to wield ultimate distribution responsibility, thereby shielding the federal government from criticism. It was also smart to graft onto the organizations' existing formal or informal support systems rather than re-creating them from scratch. Community action programs from the 1960s such as antipoverty programs are a good example of resource distribution nonprofits.

The premiere financial demand of resource distribution nonprofits is strict accountability. In many ways, they serve as the social equivalent of general contractors, assembling a team of benefit or service providers in order to accomplish a coordinated job. In other cases, they act mainly as a final distribution point for transfer payments, usually as part of an entitlement program. Their work typically involves outreach, evaluation, and servicing of eligible clients. From the funders' perspective, however, their real value comes after the client transaction has occurred and they make their reports to the payments' source.

Owing to the demand for accountability, resource distribution nonprofits' financial systems will tend to be shaped by individual transactions and the funding source's rules. Most programs of this sort are expected to track the flow of money, not the effectiveness of the programs. Accountability in this context means careful accounting, not managerial success. Perhaps not surprisingly given their role as intelligent conduits, many resource distribution nonprofits end up looking a lot like the governmental unit that funds them.

Support and Development Providers

The fourth category of nonprofit corporations refers to support and development groups. These organizations are limited in number but play a major role in areas of the health and social welfare sector. In size and focus they are not unlike resource distribution nonprofits, except that they concentrate on leveraging resources rather than simply marshaling them.

Financial management for support and development groups will be unremarkable except when ownership or financing of capital projects is involved. The task in these cases often relates to properly valuing assets, estimating the percentage of a project completed, and properly accounting for and reporting on funds received. The difficult aspect of financial management in the property acquisition or rehabilitation environment is dealing with irregular flows of cash in and out of the corporation, and keeping track of what are expenses of the current period versus what expenses should be considered part of the capital project.

Grant Makers or Funders

One of the most common of all types of nonprofits, grant makers or funders can range from the very smallest fund-raising agencies to massive private foundations. Their task is to raise money and decide who should get it, and, in the case of private foundations, raising the money may consist chiefly of effectively managing a portfolio of equities.

One of the things that makes the funder's financial management job at least theoretically easier than many in the nonprofit field-foundation CFOs, block your ears-is that things like revenue management may have to be done by outsiders such as investment managers. No financial officer can be expected to have the skills to manage a major chunk of investments, nor would the responsible board expect it. Moreover, there are arguments for accountability that favor separating investment management from operational tasks.

On a broader level, to do the grant-making job correctly, the funder needs to operate in a planned, disciplined fashion. Happily, good financial management can thrive under the same conditions. In effect, a funder is engaged in the business of shaping and directing streams of money over a period of years. This is a profoundly different dynamic than most other nonprofit categories, and it should not be underestimated in the context of designing a financial management system.

For all practical purposes, funders are accountable to no one. While the technical aspects of fund-raising and grant-making must be handled properly, it is relatively easy to hire skilled staff to see to that. Beyond the minimal level of legal compliance in both the public charity and the private foundation worlds, no significant person or authority is in a position to routinely challenge the workings of a funder. Ironically, this can be as much a hindrance to good financial management as anything else, since there is the possibility that complacency will crowd out effectiveness.

Social Organizations

The final entry in the list of major nonprofit types is social clubs and organizations. Whether fraternities, lodges, sporting clubs, quilting associations, or any of a vast array of other entities, they share the common theme that they exist in order to further the social interests of their members. Funding comes almost entirely from members' dues and from business transacted with members (such as restaurant and bar sales at clubs), and occasionally from rents or investments.

Typically, the financial stakes are low in a social club. Members usually have little interest in the details of financial management beyond seeing that the dues are collected and the bills paid on time. As a result, two of the greatest threats to a club's financial health are sloppy record keeping and fraud. The need for fiscal accountability is just as strong as in other categories, but much of the focus is likely to be on cash. One thing that tends to be true for social clubs is that their financial prowess is never any greater than what the membership demands.

STRUCTURE OF NONPROFIT ORGANIZATIONS

Programs

Programs are the most visible and best understood aspect of the nonprofit form of business organization, and its chief means of carrying out its mission. Also called services, projects, clinics, divisions, departments, floors, or any one of a thousand other names, programs are the activities of the nonprofit organization.

Coming up with a fair and workable definition of a program is difficult. Here's an attempt: A program is a coherently packaged group of activities, usually associated with a specific physical location, designed to accomplish a stated result.

Nonprofit organizations run all kinds of programs, and often more than one. Day care centers offer infant care programs, environmental groups operate recycling systems, museums run art appreciation courses, and so forth. The two keys to understanding programs are that they generally have some coherent internal structure, and that they appear as distinct choices to potential users.

In most nonprofit organizations, programs are like little businesses, with a structure reinforced by nonprofit accounting rules and one that has immense if largely unnoticed consequences for everything from compensation to organizational effectiveness. They represent a delegation of responsibility from the chief executive officer, and so they are the engines of mission. It is at the program level where the organization's goals are accomplished or not, and therefore those in charge of programs carry heavy moral pressure to get the job done.

Notice the use of the word "moral" in the preceding sentence. Typically, the motivations of those who run nonprofit organizations are different from those who do the same thing in the for-profit world, and the motivations of program managers everywhere are often different still from their bosses. We'll explore some of those differing interests later. For the moment, we'll use the program as the smallest management unit of the nonprofit corporation.

Corporations

The next major level of nonprofit management is the corporation that "owns" or runs the programs. The corporation is a statutory entity established by the legally sanctioned actions of one or more individuals. As a legally approved entity separate from its constituent individuals, the corporation has its own continuing existence. In legal theory, corporations are treated as distinct entities just like individual people, and corporations have their own collection of responsibilities, liabilities, and powers.

Why a corporation? The answer is disarmingly simple: because it's easier for the rest of us. Corporations can be mentioned in the same legal breath as the individuals who use their services, work in them, or simply exist in the same state with them. All are on the same legal footing, in that respect. The complicated and narrower answer to the question has to do with such practical considerations as revenue source regulations and liability strategies.

Revenue source regulations and political realities often nudge nonprofits in the direction of a specific type of organizational structure. Programs such as battered women's shelters almost of necessity start out as single-service corporations, while older and more established social service and health care groups may have developed a multiple corporate structure.

There are also liability laws to consider when operating different types of businesses. Nonprofit public charities traditionally have been granted generous protection from state liability laws, although that tendency is beginning to change. It's a tradition growing out of English Common Law that has been codified in many places around the country. Often there will be either an explicit limitation on suits or a prohibition altogether on the grounds that agencies funded by the public at large ought not to be siphoning resources into private hands via lawsuits. Liability considerations alone are not normally strong enough to determine a corporate structure, but the more favorable liability climate for public charities is clear.

Continues...

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Table of Contents

Preface xiii

Acknowledgments xvii

Note to Reader xix

PART ONE Analysis 1

CHAPTER 1 Structure of Nonprofit Organizations 3

Corporations 3

Programs 6

Hybrid Corporations 8

Loss of Tax-Exempt Status: The Monster Within 14

CHAPTER 2 Mission: Managing Your Two Bottom Lines 17

The Role of a Value System 18

The Nonprofit’s Dilemma and How to Solve It 20

CHAPTER 3 Accounting as a Second Language: A Nine-Point Program 23

The Entity Principle 23

Money Measurement 24

Conservatism Principle 24

The Cost Concept 26

The Materiality Principle 27

Going Concern 29

Dual Aspect 30

Realization Principle 32

Matching Principle 33

CHAPTER 4 Assets Are for Boards, Activities Are for Managers 35

Concepts Versus Details 36

Boards Invest, Managers Spend 37

If It Has to Be Decided Today, It’s Probably the Wrong Question 38

Boards Own the Controls, Managers Implement Them 38

CHAPTER 5 Balance Sheets: How They Get That Way 39

Current Assets (from IRS Form 990, page 11) 40

Noncurrent Assets 43

Current Liabilities 45

Noncurrent Liabilities 45

Making the Balance Sheet Dance 49

Transparency, Thy Name Is IRS Form 990 52

What to Do 53

CHAPTER 6 Financial Analysis: A Few Analytical Tools 67

Financial Statement Analysis for Math Phobics 68

Current Ratio 75

Days’ Cash 77

Days’ Receivables 79

Cash Flow to Total Debt 81

Debt to Net Assets 82

Operating Margin 85

Accounting Age of Plant/Equipment (or Land, Buildings, and Equipment) 86

A Footnote 87

CHAPTER 7 Beyond the C3: Alternate Corporate Structures 89

Commonly Available Structures 92

PART TWO Accounting 95

CHAPTER 8 Nonprofit Accounting: Acknowledging the Strings Attached 97

Net Asset Categories 98

Other Provisions 99

What It All Means 99

CHAPTER 9 Cost Accounting: How Much Does It Cost? 103

A Form of Management Accounting 104

Indirect Costs 106

Certain Support Costs Get Assigned to Other Support Costs 106

Breakeven Analysis—Another Use for Cost Data 110

Cost Accounting versus Cost Reporting 113

CHAPTER 10 Auditing: Choosing and Using an Auditor 115

Audit, Review, and Compilation 117

The Auditor Market 119

Getting Value from the Audit 122

Conclusion 124

PART THREE Operations 125

CHAPTER 11 Cash Is King 127

Up the Balance Sheet 128

How Much Cash Is Enough? 141

Conclusion 145

CHAPTER 12 Capital: Not a Four-Letter Word 147

Sources of Capital 148

The Mechanics of Capital Financing 150

The Present Value of Money 156

The Great Divide among Nonprofits 157

Future Access to Capital Markets 159

The Role of Net Assets 161

Strategic Capital Management 161

CHAPTER 13 Budgeting: Taming the Budget Beast 163

Playing Revenues Like a Symphony 165

Expenses 166

Conclusion 176

CHAPTER 14 Indirect Costs and Other Despised Items 177

Rules Govern Audits, Economics Rules Budgets 179

Still, It’s Low That Counts 182

Secrets of the Indirect Cost Game 185

CHAPTER 15 Managing Money-Losing Programs 191

The Origin of the Problem 192

Solutions 192

Other Sources of Value 192

Ding Ding Ding Ding Ding! 194

CHAPTER 16 The Milestones of Spending on Overhead Costs 199

CHAPTER 17 Pricing: How Much Should It Cost? 205

Pricing Methodologies 208

Going the Other Way—Contractual Adjustments and Subsidies 212

Pricing Strategies 213

How to Price 214

CHAPTER 18 Profit: Why and How Much? 217

Profit Defined 217

Uses of Profit 218

Profit—How to Get It 226

What Can Be Done 228

CHAPTER 19 To Raise More Money, Think Cows 229

Donations 230

Bequests—Cow to Charity 230

Charitable Remainder Trusts—Milk to Beneficiaries, Cow to Charity 230

Pooled Income Funds—Donors Put Their Cows in a Herd, Keep Rights to Milk 233

CHAPTER 20 Owning a Building: What’s in It for You? 235

A Three-Part Calculation 236

CHAPTER 21 Insurance: The Maddeningly Complicated Art of Covering Your Assets 239

To Insure or Self-Insure? 241

Risk Management 242

Captive Insurance Companies 245

Quality Assurance in Disguise 246

CHAPTER 22 Internal Controls for External Goals 249

The Elements of Internal Control 251

How to Monitor the System 264

Maintaining the System 266

Conclusion 268

CHAPTER 23 Scrutiny Intensifies 269

Some Predictions 272

The Growing Industry of Charity Watching 274

CHAPTER 24 Management Controls: Toward Accountability for Performance 279

Management Controls circa 1980 280

Beyond Management Controls in the Twenty-First Century: How to Do It 281

Messages 281

How to Prepare—Changes in the CFO Role 283

It’s Called Accounting for a Reason 286

Appreciate the Abrupt Change 287

Frame the New Role 288

Meet Your New CFO 288

PART FOUR Planning, Control, and Miscellaneous 289

CHAPTER 25 Finance Is Oil, Development Is Water 291

It’s All about Time 291

The Fix 293

CHAPTER 26 When Do You CFO? 295

DIY 296

The Financial Tasks Multiply 296

CHAPTER 27 Business Models and Business Plans 301

First the Model, Then the Plan 302

How to Build Your Business Model 304

What, Exactly, Is a Business Plan? 305

What Is in a Business Plan (Usually…)? 306

Start-Up Nonprofits 306

The Restructuring Nonprofit 307

New Program or Division 308

Goals Drive the Plan 309

CHAPTER 28 How to Beat the Next Recession 311

Understand the Demand Pattern for Your Services 312

Prepare for Reductions—in New Services 312

Anticipate Foundation Behavior 313

Proactively Communicate with Your Staff 314

Consider Repurposing Your Reserves 315

Stay Calm 315

Appendix A A Financial Management Cultural Primer 317

Appendix B Budget Bloopers 323

Appendix C Using the Website: Table of Contents with Commentary 327

Index 333