By Dr. Alicia Schatteman
Nonprofit finance is not well understood because of its complexity. COVID19 has put a spotlight on the financial health of nonprofits since many nonprofits are currently provided necessary services related to the pandemic. How prepared were nonprofits before this current crisis and what can they do differently going forward? There are basically three components to nonprofit finance that will determine the resiliency of nonprofits: sources of revenue, size of cash reserves, and existing debt.
There are many sources of revenue for nonprofits, all with different pros and cons. Below are a few of the most common.
Contributions – About 80% of all revenue into the nonprofit sector comes directly from individuals through contributions, whether outright gifts or from fundraising events. This does vary by sub-sector. Contributions from individuals are vital to the financial health of most nonprofits. These dollars are also often the most flexible, meaning they can be used for any purpose in the organization. These contributions do need a fundraising infrastructure in place such as staff, technology, and support materials. Fundraising is the sales function of a nonprofit and needs to be resourced in order to see the benefits.
Earned Revenue – These are basically funds received as a result of providing a good or service, like a typical transaction such as a ticket sale, tuition, program fee, or rental income. The nonprofit can typically use these funds to pay for any type of expense. With COVID19, earned revenue certainly declined for arts and culture organizations, that mainly rely on earned revenue.
Grants – Typically, this funding comes from foundations and to a lesser extent, government. The funding typically covers direct and possibly indirect costs, requires regular reporting, focus on program level effectiveness by comparing the non-profit’s work to industry standards or other performance metrics detailed in the grant request.
Service contracts or fee-for-service – Unlike grant funding, service contracts are paid after the service is delivered so nonprofits must first must provide the service then bill or report on that activity before being paid back. So this time of revenue is a drain on cash.
Nonprofit Cash Reserves
COVID19 has affected all forms of revenue for nonprofits, but that is only part of the picture. How resilient nonprofits will depend on their ability to building their cash reserves. It is suggested that nonprofits, and businesses, have at least three months of expenses in cash at all times, and six months is more ideal. Most nonprofits have less than three months of cash on hand, and many significantly less, meaning they have to juggle payables or take out lines of credit.
Finally, the financial resilience of nonprofits is related to existing debt and the carrying costs of that debt. If the nonprofit is significantly leveraged (owing almost as much as their assets are worth), they will have high debt payments and will have difficulties in negotiating interest rates or getting access to new debt if needed.
Ultimately, we don’t know what the financial impact will be to nonprofits and to what extent they will be able to financially survive this crisis. Nonprofit staff and boards who focus on these three key financial measures, however, will have a realistic picture of where they are now and be able to plan for the future.
“Sustainability to Survivability: 5 Nonprofit Finance Must-Do’s in the Time of COVID”, Nonprofit Quarterly, March 19, 2020
“Voices from the Field: Tangible, Timely Tactics for Nonprofits during Crises”, Nonprofit Quarterly, April 6, 2020
“Crisis Funding and Debt: What Organizations Need to Know”– Sandi McKinley and Avichai Scher, Nonprofit Finance Fund, April 2, 2020