Many, upon joining a nonprofit board, assume the organization is sound financial plan and even financially resilient for the next few years of board tenure (unless we have joined an organization knowing it was distressed). As a board member, you may not know how to assess whether an organization is financially resilient, yet you can see from the outside that the organization is well supported. You might even do more homework before joining the board by reviewing the Form 990 or researching their status on Guidestar or CharityNavigator. All looks well.
You attend a board meeting before officially joining the board and the Finance Committee has smart, well-qualified people who seem confident in the ways the reports are produced and shared. You join the board, are seated on a committee and you begin fundraising. All is well.
But is it?
Previous economic downturns showed us that fragile nonprofits can cease to exist or close their doors. According to the Center for Charitable Research Statistics, roughly one-third of nonprofits cease to exist after 10 years.(1) By contract, successful nonprofits were able to weather the economic volatility and continue to deliver on their mission.
We can debate on what “successful” means since it can be viewed through multiple lenses of program delivery, impact, sustainability, financial, etc. However, nonprofit leaders may say otherwise. In a 2018 survey by the Nonprofit Finance Fund, 62% of nonprofit respondents indicated that “financial sustainability is a top challenge”.(2)
As a nonprofit board member, you may wonder what more you can do to check your organization’s financial resilience and sustainability. You can take our free financial x-ray assessment offered here on our website. For robust answers to the assessment, it may be worth engaging the Board Treasurer or Executive Director.
The outcome of the assessment may show your organization in one of our 4 categories: Fragile, Surviving, Emerging and Thriving. Since our Financial Resilience X-Ray is designed as a check-in point, let’s dive deeper into why the areas we focus on in the assessment are important.
Concentration of Revenue
As cited by Dr. MacKenzie Arbogust in her dissertation “Why do Nonprofits Fail? A Quantitative Study of Form 990 Information in the Years Preceding Closure”(3), increasing revenue concentration appears to be a strong indicator of failure for nonprofit organizations. What does this mean from a nonprofit board member’s viewpoint and how can you influence change?
As an independent board member, you can begin by doing the following:
#1 Revenue Source Reporting: What sources does your organization’s revenue come from? How many and how diverse or concentrated are they?
Compile all sources of revenue for your nonprofit organization including government grants (if any, including municipal, state and federal), foundation or community grants, corporate donations, individual donations, events, galas, membership dues/fees and merchandise. Be sure to include any sources of earned income such as investment income and unrelated business income (e.g., this could be the café that your museum operates).
I was on a nonprofit board trying to increase revenues / donations and diversify income streams. We hosted regular online, sponsored training sessions above the cost they took to produce. It had never occurred to our board this was a separate revenue source and it was initially lost among the general income for the organization. However, once the COVID-19 pandemic happened, we could no longer host in-person events and suddenly that revenue source came to light.
#2 Revenue Concentration: How many different categories of income do you have? Within a category such as foundation grants or individual donors, is there a single donor who funds a large percentage of your organization?
As Dr. Arbogust cited in her dissertation mentioned earlier (3), the nonprofits in her 3-year study had higher revenue concentration in the years preceding closure. The nonprofits that were in the successful group in her study had broader revenue diversification.
My friend is on the board of a direct service nonprofit organization doing amazing work on behalf of children and families in their community. They have donor concentration with one community-based grantmaking foundation which represents 85% of their annual revenue. Fortunately, my friend and the Executive Director recognize this issue and have been working to diversify their funding sources through individual and corporate partnerships.
Many years ago, a nonprofit I was involved with started programmatic expansion based on a forthcoming funds from a private donor. That promised donation represented over 35% of the organization’s revenue. Unfortunately, the donor unexpectedly died and the family decided to pursue a different charitable organization. This loss of revenue had a knock-on effect to the organization in terms of financial resiliency and health. Their premature expansion caused financial strain on the rest of the organization as it wasn’t properly funded. The nonprofit ultimately closed its doors.
#3 Audited Financials / External CPA Firm – Check the Guidestar Profile: Does your organization have audited financials or an external CPA Firm who prepares the Form 990?
Nonprofits receiving over $750,000 in federal grants are required to have Single Audit and in California, organizations with a gross annual revenue of more than $2 million are required to have an independent audit. The National Council of Nonprofits has a listing of state audit requirements if you need more specific details. While having audited, independent financials isn’t a determining factor in whether an organization closes its doors, research has determined that it ultimately leads to increased transparency of an organization, which can in turn lead to increased revenue and donations among supporters.
While Dr. Arbogust’s study of “Why Nonprofits Fail” did not find audited financials as a significant factor in failure or success of nonprofits in her cohort, research by scholars (4) found that audited financials increase transparency, thereby leading to increased donor support. Organizations such as Guidstar (now Candid) have seen tremendous growth in their financial and governance reporting for nonprofits since it launched it’s more robust reporting capabilities beyond the Form 990 in 2013
It is worth exploring whether your nonprofit should have a professional, independent CPA firm prepare the Form 990. While I have seen some nonprofit organizations have a board member donate their time to prepare the 990, research by Gross and Neely from 2014 (5) found “organizations that hire an outside accounting firm to prepare the Form 990 report higher quality financial information than organizations that choose to prepare the Form 990 in house.”
#4 Unrelated Business Income: Does your nonprofit have unrelated business income? If your organization earns income that is unrelated to its exempt purposes and it is an activity that is regularly carried on, the revenue from this activity may be taxable income under IRS rules for “unrelated business income taxation”, also known as UBIT.
Sometimes unrelated business income can be quite helpful to the overall financial health of the organization in the case of one of our museum clients. They run a café on the premises which generates a nice added boost to the overall revenue of the organization. However, as Arbogust cited in her paper (3), “an organization that reports unrelated business income is more likely to fail than one that does not report such income”. Further back, research from a 2005 study (6) found a major gap between the desire of the nonprofit to appear more “disciplined and business-like to their stakeholders” and the reality that very few of these ventures make money.
One client of ours used to run youth programs that were meant to develop job skills and earn revenue for the nonprofit. In reality, their programs had high overhead and the youth staffing these ventures were inconsistent and resulted in net losses. In the end, our client closed these businesses and instead decided to partner with other nonprofits and for-profit businesses for job-training opportunities for their youth. They realized their focus was diminished by running these “unrelated businesses” and instead concentrated their focus on what they did best – engaging and training youth on job placement.
#5 Major Programmatic Changes: Has your organization undergone major programmatic changes in the past couple of years? Has it widened its geographic footprint or its target client? Has it deepened the number of service offerings?
If the programmatic changes are supported with both strong budget and risk management support, then major programmatic changes might be a sign of an emerging or robust nonprofit that is going through positive expansion.
Or, this can be a sign that an organization is in a “fragile” or “surviving” state as we mention in our Financial Resilience X-Ray. Dr. Arbogust found in her research that almost 25% of respondents in failed organizations from her Form 990 cohort group reported significant programmatic changes. As she cites, this may relate to downsizing of programs prior to organizational closure whereas respondents of successful organizations are less likely to cite these differences on Form 990.
Several years ago, the board that I am still on now, went through significant programmatic changes and the organization was in a fragile financial state. The organization had grown too quickly and lost focus on its core mission. Similar to the youth development organization cited in #4 above, the organization decided to expand into an unrelated business income program that would provide revenue to the organization and a job-training facility for youth. However, the expansion was not supported by a robust and well-reviewed budget with solid income streams and a risk management process was not in place. The program sucked away budget and reserves from the rest of the organization, encountered delays in revenue generation and ultimately closed 6 months after it launched.
It was devastating for the organization and the board at the time. Employees were laid off, external clients were left without resources and other programs became impacted. The organization went from a $5.5 million dollar budget to a $2 million dollar budget in 1 year, ultimately closing 5 programs and 4 sites in the process. Board Members, donors, employees, vendors and community stakeholders were worried about the survival of the organization.
The organization ultimately survived and within 3 years is not only cash flow positive, but has a robust reserve. While that story had a good ending, it’s an important signal when looking at programmatic changes. As a board member, you can help you organization prepare for expansion and contraction through proper financial resilience planning and risk management.
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- Nonprofits Fail – Here’s Seven Reasons Why – Tracy Ebarb, “the real data from National Center on Charitable Statistics reveals that approximately 30% of nonprofits fail to exist after 10 years.”
- Nonprofit Finance Fund’s, “2018 National State of the Nonprofit Sector”
- Arbogust, MacKenzie. “Why Do Nonprofits Fail? A Quantitative Study of Form 990 Information in the Years Preceding Closure” (2020). Doctor of Philosophy (PhD), Dissertation, School of Public Service, Old Dominion University, DOI: 10.25777/n8yg-9475 https://digitalcommons.odu.edu/publicservice_etds/45/
- Harris EE, Neely D. Determinants and Consequences of Nonprofit Transparency. Journal of Accounting, Auditing & Finance. 2021;36(1):195-220. doi:10.1177/0148558X18814134
- Andrew Gross, Daniel Gordon Neely, The role of the paid preparer in nonprofit reporting quality, Advances in Accounting, Volume 30, Issue 1, 2014, Pages 55-66, ISSN 0882-6110, https://doi.org/10.1016/j.adiac.2013.12.006. (https://www.sciencedirect.com/science/article/pii/S0882611013000643) Andrew Gross, Daniel
Foster W, Bradach J. Should nonprofits seek profits? Harv Bus Rev. 2005 Feb;83(2):92-100, 148. PMID: 15724577.
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