The financial sustainability and related going-concern challenges for a not-for-profit (NFP) organization have become increasingly important in today’s economic and financial climate. Although the demand for program services has increased, many NFPs face significant challenges on a daily basis that make it difficult for them to fulfill their missions. Many stakeholders have become increasingly concerned about the future of the NFP sector and the organizations that are vital to the health and well-being of the public.

These challenges relate primarily to a lack of adequate funding, especially for organizations funded by the government; many New York State agencies have decreased the amount of funds provided to NFPs. These reductions have decreased the reimbursement of administrative and program costs, forcing NFPs to look elsewhere for supplemental funding, primarily to the private sector. As a result, NFPs face significant decisions: which resources or reserves to draw from, if available; how to utilize any endowment funding in the near term; whether to reduce program operations, cut programs, consider a merger or affiliation opportunity, or even cease operations altogether.

Lack of governing body oversight can exacerbate this problem. The board must be involved in understanding the current and projected financial health of the organization, with a strong view of profitability, cash flows, and projections. The board may also have key connections that could benefit the organization, identify new revenue streams, or provide insight on spending.

Culture plays a vital part of financial stability as well, and a strong tone at the top that focuses on empowerment and accountability allows employees to focus on the longer-term strategic goals of the organization instead of more immediate needs.

Public scrutiny and oversight of NFPs have become ever-present. Regardless of the source of funding, the public and the government want to know that organizations have the financial stability to continue to meet their missions. With this scrutiny comes the additional cost of measuring and monitoring key metrics and performance standards. Oftentimes this cost is not budgeted or paid for.

Financial distress has forced many NFPs to address these questions. Now more than ever, NFPs must rely on CPAs to provide them with the resources and guidance to allow them to assess, plan, make changes, and continue to meet their missions. Whether providing attest services or some other advisory-related service, a CPA’s expertise, knowledge, and wisdom benefits the NFP greatly. CPAs who provide these services, however, must maintain their independence under the rules of the AICPA.

Risk Assessment and Risk Reduction for NFPs

Boards of directors will often focus on the NFP’s mission and not pay close attention to the financial picture, relying on management’s presentation without inquiring or asking probing questions. CPAs should discuss this particular area with clients, along with noting potential financial and other risks, and how to best address those risks. The following are indicators that an NFP is at risk of not maintaining financial sustainability:

  • Continued operating deficits and resulting accumulated net deficit positions;
  • Negative operating cash flow;
  • Poor ratio analysis—that is, low accounts receivable turnover, negative current ratio, high debt service coverage, low days of cash on hand;
  • Significant reliance on one revenue stream—that is, a major government contract or significant donor;
  • Lack of budgeting and monthly internal financial statement analysis;
  • Significant turnover in key positions;
  • No or insufficiently robust risk assessment process;
  • Mandated governmental oversight;
  • Inefficient board oversight and inconsistent financial planning; and
  • Inability to attract new programs or funding streams.

Although the financial statements may disclose some risks, a responsible CPA will look for these key indicators and discuss them with executive management and those charged with governance. A CPA’s ability to identify negative trends and other associated risk factors can help an NFP to assess its financial picture and improve the financial health of the organization.

Many NFPs do not have an adequate risk assessment process in place, as they believe it to be too complex and time consuming and feel the benefits do not justify the cost of implementation. In practice, however, organizations that continually perform analyses of internal and external risks are better equipped to operate successfully. Healthy risk assessment includes a varied group of employees, board members, and volunteers, requires the assessment of financial, operational, strategic, legal/regulatory, technology, people/culture, brand, and reputation risks, and should be incorporated into day-to-day operations throughout the organization. NFPs must aggressively identify, assess, and address risks associated with various aspects of the organization. The development of a risk assessment plan will strengthen the organization’s position for long-term sustainability.

Financial Management of NFPs

Effective financial management is also critical. NFPs should identify and implement policies and procedures to ensure that financial assets are properly utilized, financial obligations are met, and financial reserves are created. Key components include the budget process, cash flow management, collaboration, diversity in revenue streams, and establishment of an operating reserve.

An operating budget allows the NFP to understand how resources will be developed and how expenses will be incurred, creating a projected financial picture for the organization. This budget should consist of all revenue and expense streams on a program and functional basis. This type of breakdown will provide a picture of profitability within programs and allow the NFP to identify financial excesses or shortfalls. As a top priority, management should conduct periodic performance reviews of individual programs to identify the financial health of these programs and evaluate their contribution to the overall mission. In addition, the NFP should prepare a capital budget; planning for capital spending is essential to determine if adequate cash flow exists, if there is a need for capital financing, or if other sources of funding are necessary. Finally, the budget should be periodically compared to actual results; this allows for improved planning, monitoring, evaluating and controlling of finances. The organization can redirect resources, contain costs, and shift focus if necessary.

It is important for an NFP to carefully manage its cash flow by consistently looking at cash flow projections. This can be a daunting task for government-funded organizations, especially in light of late payments on government contracts and ever-changing regulations. Even for NFPs that rely extensively on contributions, however, projecting the inflow of resources is challenging, since it is difficult to know exactly when payments will be received. Projecting cash flow helps to identify financial pitfalls and allows the organization to plan corrective action, especially when it is already in financial distress. Properly monitoring spending and improving the timing of billings and collections on outstanding receivables also allows an NFP to better manage its cash flow.

NFPs can greatly benefit from collaboration with other NFPs with similar values. Understanding where additional resources are needed and collaborating for those resources can reduce overall spending and improve financial health. Many times NFPs have similar programs, but one may have a stronger or more robust oversight process that the other lacks. Another example is when one NFP needs a particular program position, but cannot afford to pay for a full-time person; both NFPs together may be able to cover the cost. This also applies to back office and administrative positions, especially since revenue for administrative costs has decreased in recent years.

NFPs should also understand the impact of overreliance on a limited number of revenue sources. A change in such sources’ priorities can have a sudden impact on funding, and therefore on the ongoing provision of services. Therefore, maintaining adequate operating reserves can help the organization continue to provide services and sustain financial operations when an unanticipated event occurs. Such a rainy day fund also provides the NFP with more flexibility when addressing uncertainties and dealing with financial risks. CPAs should reemphasize the importance of maintaining adequate reserves, even if it does not seem like a priority to NFPs.

Maintaining Financial Health

The financial success of an NFP is never a given. There are significant items that can impact financial health. Strong organizational structure that identifies risk and measures financial health, coupled with a CPA who can provide insight and expertise, better equips an NFP to conduct business efficiently while enhancing its overall success.

David M. Rottkamp, CPA is the audit partner, not-for-profit practice leader, and the partner-in-charge.
Nina Bahazhevska, CPA is an audit manager in the not-for-profit practice group of the New York City office of Grassi & Co.