November 16, 2018
 
Your Nonprofit May Be too Fat

By Tom McLaughlin

Tom McLaughlin
It's entirely possible your nonprofit organization is too fat – not in the sense of overweight executives, but with regard to the far richer and more common “imbalances” in your balance sheet.

It’s not about overweight CFOs or chocoholic executives. The focus is on the far richer and more common “imbalances” in your balance sheet. Hopefully these imbalances are in your favor. If they’re not, you’ll understand why not.

Carrying out various calculations based on the IRS 990 should give you some perspective. Okay, words like “pleasure” and “financial reports” don’t fit well together either.

Pull out your most recent Form 990, which is the functional IRS equivalent of a corporate tax return. On Page 1, look at line #5. This is where you (or your predecessor) filled in the box revealing that your organization employed “X” number of people during that recently completed year. Remember that in all likelihood the number of employees is larger—possibly much larger—than the actual week-to-week employment numbers. This is due to illnesses, unexpected resignations, etc.

Now slide down the page to line #12 directly under Current Year to find your Total Revenue. Move down in the same column to line #18, or Total Expenses. You can either do the math or just look below the total expenses block to line #19 which will allow you to conclude that you enjoyed a profit -- or sustained a loss.

In the upper left hand corner is the term “Balance Sheet,” which is accountants’ terminology for the one piece of paper that shows many fiscal developments during the past year. The page 11 sheet can tell you the amount of assets your organization has accumulated, which are balanced by the total number of liabilities plus net assets.

A smart CFO will keep a running (and ever-changing) version of the balance sheet, and most of the rest of the organization will never know the importance of that information. For instance, line #19 gives the reader revenue and expenses for the current year and the preceding one. This line should produce a positive number. If the numbers in line #19 are both negative, it means that your organization lost money in both of the past two years. A single yearly loss or two is not usually cause for deep concern but several losing years in a row might be.

The balance sheet, which can be found on page 11, is perhaps the single most powerful communication tool that financial folks use on a regular, even daily, basis.

The Balance Sheet

A balance sheet makes it easy to sum up various categories. The Total Assets category is just what it sounds like – 15 lines of various kinds of assets. The Liabilities category is smaller (nine categories) plus the Sum of Liabilities. The third category is called Net Assets (or Fund Balances). Since most of this group relates to certain types of net assets plus things such as retained earnings, this is the scorecard. Hint: Well-run organizations will always have more assets and fund balances than liabilities.

A balance sheet can also communicate many things to readers. Start with the kinds of assets that nonprofits can expect to own. Cash is always the first such asset, followed by Temporary Cash, Accounts Receivable, and others (such as loans to outsiders, which is also generally considered to be short term assets. It shouldn’t take very long to pull some money out of those 9 lines and/or to put it back in.

The first consists of lines 1 through line 9. These items are all, in one way or another, liquid assets meaning that they can be quickly pulled out and used to benefit the organization in some way. Why would we stop after line 9? Because line 10 is the first asset that is explicitly a long term asset. This is why line 10a talks about the investment the organization has made in land, buildings and equipment.

The Liabilities section (row 17 through row 25) is the reverse of lines 1 through 9. These items—such as Accounts Payable (row 17) and Secured Mortgages (line 23)—were all created when the organization borrowed money, almost certainly to help them thrive over the coming years.

Too Fat or too Skinny?

Here are some ways you and your team can gauge the effect of your financial practices. To make this a bit easier we will continue to refer to the items on an actual blank IRS Form 990. One of the most helpful calculations you can make derives from page 10, columns C and D. Go to line #25 on page 10 and do a simple calculation. Add the expenses listed in columns C and D (on the far right). Next, divide the sum of columns C and D by line #25 under the “A” column showing total expenses. The percentage that results can be mystifying without more background material, but the percentage itself can be telling. To the extent that there is any universal interpretation of the percentage, management costs in Column C row #25 should be 10% or less. Note that fundraising expenses typically are often well under 10% for many similar nonprofits.

When nonprofit financial managers find themselves heading into unfamiliar fiscal territory, it would be wise to stop and ponder the implications. It might be a good idea to thoroughly analyze the past few years of Form 990s submitted to the government. Fortunately, the government makes these reports relatively easy to learn and use. That same phenomenon would make it a bit easier to project the impact of the new terrain.

It would be wise to consider evaluating potential partners in a similar fashion. The economics of the next two decades or so will almost certainly bring many currently self-standing organizations to consider mergers or restructuring with other entities. This will happen because the Boomer generation is already in the natural process of winding down. The next two generations have much smaller numbers than the Boomers. The average birth rate of each of the GenXers and the Millennials is almost exactly half of the birth rate of the Boomers.

Already we are seeing combinations of nonprofits that wouldn’t have occurred 20 years ago. And the recognizable scenario of an internal executive taking over the Boomer CEOs role is becoming a pre-dictable story as the Boomers inch closer to retirement. But, there will still not be enough internal candidates to replace the Boomers, even if the pace of international migrations continues to grow at its current rate or even higher.

If your organization is too fat, it is likely because one or more of these guidelines has not been observed. Faced with a balance sheet, or worse, an IRS reporting form, many managers try to tip-toe out of the room. But the reality is that a well-managed financial back room operation is one of the most valuable elements of nonprofit management.

If your organization is too “fat,” it should be a good thing in this context. But the real payoff for careful planning and management is when you can conclude that your organization is neither too fat nor too skinny.

Thomas A. McLaughlin is the founder of the consulting firm McLaughlin & Associates and the author of Streetsmart Financial Basics for Nonprofit Managers (4th edition), published by Wiley. Email him at tamclaughlin@comcast.net. An earlier version of this article was published in The NonProfit Times.

February 2018

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