Financial planning isn’t just a for-profit necessity

Building a reserve requires periods of positive net income. If the budget projects unrestricted revenue exceeding expenses, that’s a good start. Successful fundraising events or annual campaigns can generate unrestricted cash, but appeals should be worded carefully. Don’t promise donors their gift will be used for a specific purpose unless it is truly restricted for that purpose.”

October is Financial Planning Month, a perfect time for nonprofit boards and leaders to treat their organization’s finances with the same care they give their personal and business planning.

A seasoned board member of a well-known nonprofit once discovered the organization was nearly out of cash despite having received a large, unrestricted grant just months earlier. It’s a scenario that’s more common than many realize: nonprofit boards and leaders sometimes overlook the same financial planning principles they’d apply to their personal or business lives.

Strong financial oversight isn’t just a for-profit practice. It’s essential to every nonprofit’s ability to sustain its mission and serve its community. Leaders should help guide the organization’s financial planning efforts to ensure it has sufficient financial resources to operate. This includes maintaining healthy cash flow, securing appropriate credit lines and planning for the future. Here’s how:

Create an annual budget

Budgeting is a key component of nonprofit financial planning. Short-term financial planning starts with preparing an annual budget in advance of the organization’s fiscal year.

There is a common misconception that a nonprofit’s budget should balance to zero. That’s not true. A nonprofit organization may have periods of no growth or even net loss, but to be sustainable for the future, the organization must operate in the black and build its operating capital.

Establish an operating reserve

Every nonprofit’s goal should be to always have three to six months of unrestricted operating capital. Don’t be misled by the headline cash balance in the bank. If part of that cash came from donor-restricted funds, those monies can’t be used for general expenses. Restricted funds must be used for the purpose the donor intended. Executive leadership or the accounting team should share how much is available for general use.

Rather than keeping all of the organization’s money in a checking account that earns little or no interest, consider using CDs or high-yield savings accounts to generate some investment earnings without taking on significant risk. These accounts are cash or can be converted quickly (CDs may have early-withdrawal penalties), so funds remain accessible when needed.

Building a reserve requires periods of positive net income. If the budget projects unrestricted revenue exceeding expenses, that’s a good start. Successful fundraising events or annual campaigns can generate unrestricted cash, but appeals should be worded carefully. Don’t promise donors their gift will be used for a specific purpose unless it is truly restricted for that purpose.

Use lines of credit wisely

If a nonprofit identifies periods where cash flow will be an issue, a line of credit may help bridge temporary timing gaps. For example, when a reimbursable grant pays after the organization incurs expenses.

A line of credit should fill a short-term need. If annual expenses routinely exceed revenue and the shortfall is structural rather than timing-related, focus on cost-cutting and revenue strategies. Don’t dig a hole the nonprofit cannot get out of.

Consider an endowment

For long-term planning, nonprofits may want to consider establishing an endowment. But first, understand what an endowment is: A true endowment fund is one in which the donor permanently restricts the spending of the contribution (also known as the principal or corpus).

Because endowment funds are permanently restricted, they generally need to be large enough to generate meaningful investment earnings. Low-dollar endowments — for example, less than $1 million — often won’t produce significant long-term support.

Organizational capacity and infrastructure should be in place before building endowments. The prime time to seek endowments is during a nonprofit’s mature lifecycle stage — not in the start-up or early growth stage — when the organization has a solid platform for its programs.

Endowment funds are typically invested in a mix of stocks, bonds and other assets. While investments can generate larger long-term returns, they carry risk — including the possibility of loss. Work with a broker or financial planner to discuss investment strategy and be comfortable with the associated risk.

Be an active participant

Just as they participate in personal financial planning, nonprofit board members are tasked with actively participating in the organization’s financial oversight. Ensuring adequate resources, which includes financial planning, is one of the key responsibilities of board members. Use Financial Planning Month as an annual prompt to review the budget, cash-flow projections, reserve policy, use of credit and long-term funding strategies.

Ask the critical questions: Do we have a realistic budget for the coming year? Do our cash-flow forecasts identify timing gaps and solutions? Have we defined and funded an operating reserve? Are our fundraising messages clear about restrictions?

With timely attention and simple, practical controls, nonprofits can protect their missions and ensure long-term impact.

Editor’s note: Lisa Stevenson, MBA, CPA is managing partner of Phoenix-based NPO Accountants. Please submit comments at yourvalley.net/letters or email them to AzOpinions@iniusa.org. We are committed to publishing a wide variety of reader opinions, as long as they meet our Civility Guidelines.