Financial Management For Nonprofit Organizations: Policies And Practices

Nonprofits need to manage liquidity (largely overlooked in nonprofit management periodicals and textbooks)since we are risk-adverse, to be able to cope with cash flow problems; management usually lament the ongoing cash crisis. Agency theory motivates us to better understand organizational liquidity. The book states that it is because managers (agents) build excess liquidity, or slack, because they are overly concerned about risk. Wherein in businesses, managerial risk aversion exceeds stockholder risk aversion, because stock-holders are well diversified. To the extent that there are multiple organizations engaging in similar services (and with the same or very similar values and philosophies), the probability of organization failure is of less concern to donors than to organization’s managers.

Donors simply reallocate to surviving organizations when one of the existing organizations fails. One could use simulation modeling or scenario analysis to show how the maximum liquidity limits the financial management options for small donative nonprofits that:

1. Do not use debt financing
2. Do not typically generate positive operating cash flows
3. Are unable to launch capital campaigns
4. Have no endowments.

Fortune 1000 treasurers consider short-term cash flow projections to be one of the most valuable tools for liquidity management. Beginning to project cash inflows, cash outflows, and the resulting cash position, is the first place to start in improving short-term financial management for over one-half of our surveyed organizations.

This book revealed to me the important concept that ‘if a nonprofit relies primarily on donations, it will experience more volatility. If an organization raises funds in advance of program and service delivery, it is engaging in a liquidity management strategy that explicitly recognizes the need for and value of a greater degree of liquidity.

For most organizations, this proactive liquidity management approach of prefunding future needs is the advisable approach. Though this approach is often ignored as many nonprofits measure their financial success solely by the increase in revenue and support and not by managing their asset positions. Organizations may partly offset the revenue limitations by turning to supplemental earned income ventures, but this implies four great barriers than are commonly recognized:

1. these ventures deploy already-scarce resources (which would actually exacerbate a cash flow crisis,
2. they may and often do defuse the organization’s mission focus,
3. quite often, the managerial team and/or board does not possess competencies requisite for profitably managing the ventures,
4. even when successful, there is long time lag between launching the venture and achieving positive net revenue.

Donative nonprofit organizations face an additional funding constraint in that they cannot issue stock. An important permanent source of funding is therefore unavailable to them. The only means of accumulating equity capital is to earn a surplus (profit equivalent) on operations. Yet, some organizations consider financial breakeven to be their chief financial objective, which implies that they are unwilling to earn significant surpluses.