Financial Analysis 201: Assessing Nonprofit Financial Health

Transcription

1 Nonprofit Finance Fund Financial Analysis 201: Assessing Nonprofit Financial Health Presented to Presented by David Greco, Vice President Nonprofit Finance Fund This presentation is generously sponsored by May 29, 2013

2 Nonprofit Finance Fund: Where Money Meets Mission Served thousands of nonprofits and funders since 1980 $300 million in loans; $150 million in New Market Tax Credit deals; over $1 billion in capital leveraged Worked with thousands of nonprofit organizations to support financial sustainability Strategic partnerships to develop and deploy capital We work with all sectors 75% low to moderate income, 35% in areas of extreme poverty Nationwide network of experts in nonprofit finance Capital Access: Debt, PRI management, New Market Tax Credits, Philanthropic Equity, Catalyst Funds Financial consulting services and workshops National advocates for improving funding practices Serving nonprofits nationwide from seven local offices Northeast: Boston, New York Mid-Atlantic: Philadelphia, Newark, NJ Midwest: Detroit West Coast: San Francisco, Los Angeles [NFF is] arguably the most influential voice in the ongoing effort to reshape thinking and practice about nonprofit capitalization. The Nonprofit Times 1

3 Why Focus on Finance? Adaptive Capacity Leadership Program Management Financial Systems & Operations Financial Management and Capital Structure Fundraising & Development Board Governance and Leadership 2

4 Today s Goals Discuss some existing limitations both structural and behavioral to nonprofit financial health Learn the basics of assessing the financial condition of nonprofit organizations Discuss how to engage potential/current grantees in conversations about their financial situation and needs 3

5 Introductions Your name Your role at the foundation How comfortable are you assessing grantees financial health? (1 to 5 scale) 4

6 Agenda Welcome & Introductions Challenges of Nonprofit Finance Best practices that inhibit nonprofit health Assessing Financial Health Understand Operating Performance & Full Cost Determine Strength of Balance Sheet Evaluate Liquidity Condition Discuss Implications for Risk and Opportunity Wrap Up This presentation is generously sponsored by 5

7 Rules of FOR-PROFIT Finance In the for-profit world, Customer buys the product. Price includes the full cost of doing business. Overhead and profits are seen as necessary and regular part of the business 12-ounce latte = $3.00 Overhead & Profit 74% Direct Cost 26% (77 ) Source: Matt Milletto, Vice President of the American Barista & Coffee School 6

8 Rules of NONPROFIT Finance Nonprofits exist for a reason: Rarely an obvious commercial return Quality considerations make economies of scale elusive Client often does not pay or pays partially for the product (e.g., homeless do not pay per night for shelter) Nonprofits rely on third parties (donors and funders) to subsidize the cost required dependency Donors and funders want most of their contribution to go directly to the people served Overhead and profits are often seen as unnecessary and unrelated to achieving the mission 7

9 NONPROFITS NEED PROFITS: UNDERSTANDING FULL COSTS Like any organization, nonprofits need to cover the full cost of delivering programs Tax Status vs. Business Model Full costs > Operating Expenses Full costs include: Total operating expenses Depreciation allocation New capital investments Debt Savings for the future 0 10 Operating Expenses Debt Principal 10 Fixed Asset Additions Depreciation 1 Working Capital Reserves

10 Mission Support (Subsidy) Business Since nonprofits can rarely charge prices sufficient to cover the full cost of their core mission programs, they require support businesses (a.k.a the subsidy business) Common subsidy businesses include: Sweat equity (underpay, overwork, low benefits, use of volunteers) Fundraising In-kind contributions Investment income Real estate (rental income) Earned income ventures When program growth or change occur, one of two things happens: more subsidy; OR financial chaos 9

11 Restricted Funding In the for-profit world, we place no restrictions on the money we give to corporations either as buyers or investors However, in the nonprofit sector, restrictions are the norm: Restricted contributions implicitly and often times explicitly forbid organizations from using funds to pay for indirect costs Nonprofit leaders have become desensitized and trained to accept what they can get rather than ask for what they need 10

12 Takeaway: The Right Revenue The right money is recurring, reliable, and flexible It covers full costs and meets full enterprise needs Nonprofit leaders have a responsibility to: Accept that not all revenue opportunities are worthy of pursuit Manage costs in the context of revenue reality Articulate case for capital and revenue, based on full range of business needs Funders have a responsibility to understand these needs and define what role their money will play 11

13 The NFF Triangle Mission and Program What you do, and how you do it. Capacity The people, space, and processes that allow you to do what you do. Capital What resources and assets you to have to work with. 12

14 Agenda Welcome & Introductions Challenges of Nonprofit Finance Best practices that inhibit nonprofit health Assessing Financial Health Understand Operating Performance & Full Cost Determine Strength of Balance Sheet Evaluate Liquidity Condition Discuss Implications for Risk and Opportunity Wrap Up This presentation is generously sponsored by 13

15 Financial Health: Uncovering the Financial Story Understand Operating Performance Determine Strength of Balance Sheet Assess Ability to Handle Risk and Pursue Opportunity Comprehensive Financial Analysis 14

16 Why Do We Need Financial Analysis? Comprehensive Financial Analysis More Informed Grantmaking Stronger Alignment: Grantee Business Needs & Funder Dollars More People & Communities Served 15

17 Sources of Nonprofit Financial Data What documents do you currently use to assess a grantee s financial health? Audited financial statements (compilation or review) Balance Sheet Statement of Activities Organizational budget (projections, if any) Current year actuals/forecast vs. budget Program-specific budgets (ideally full cost basis) NFF looks at three to five years of financial data 16

18 Using Financial Statements to Assess Financial Health Statement of Financial Position Statement of Cash Flows Assets Cash Liabilities Statement of Activities Net Assets Surplus / Deficit Revenue minus Expense = Surplus / Deficit Statement of Functional Expenses Understanding Operating Performance 17

19 Understanding Operating Performance: Statement of Activities Revenue Dynamics Where does the organization s money come from? Is it reasonably diversified or at risk? Do revenue streams appear reliable / consistent? Cost Dynamics How do expenses fluctuate over time? Are expenses adjusted in line with revenue changes? Which are direct? Which are indirect? Profitability and Savings Does the organization cover its costs? Are surpluses sufficient to meet balance sheet obligations? Is the agency saving? If so, is it enough? 18

20 Relationship of Revenue Restrictions to Operations 20

21 Where Do I Find the Bottom Line? ABC Center Statement of Activities Years ended June 30, 2008 ($ in thousands) Unrestricted Operating Activity Temp. Perm. Restricted Restricted Total Revenues, Gains and Other Support Support Foundations Government Corporations Individuals Total Support Investment Income 7 7 Tickets, Dues, Other Net Assets Released from Restriction Total Revenue, Gains and Other Support 1, ,016 Operating Expenses Program Services 1,004 1,004 Supporting Services Administrative Development Total Supporting Services Total Expenses 1,262 1,262 Change in Net Assets

22 Nonprofit Accounting Masks True Operating Results Determine true Operating Surplus / Deficit Non-operating revenue segregated and placed below the operating line ABC Center Statement of Activities Years ended June 30, 2008 ($ in thousands) Operating Activity Unrestricted Temp. Restricted Perm. Restricted Total Revenues, Gains and Other Support Support Foundations Government Corporations Individuals Total Support Investment Income 7 7 Tickets, Dues, Other Net Assets Released from Restriction Total Revenue, Gains and Other Support 1, ,016 Operating Expenses Program Services 1,004 1,004 Supporting Services Administrative Development Total Supporting Services Total Expenses 1,262 1,262 Operating Surplus/(Deficit) Non-Operating Activities Unrestricted Non-Op. Revenue/Expenses (e.g. capital campaign receipts/releases) Net gain (loss) on sale of assets Change in Net Assets

23 Non-Operating Dollars Hide True Operating Performance Unrestricted Revenue & Expenses (including non-operating) ($ in thousands) Operating Revenue & Expenses ($ in thousands) 1,800 1,800 1,600 1,400 1,200 1,600 1,400 1,200 1,000 1, Revenue B B Expenses (before depreciation) With revenue for capital projects below the line, this organization is not breaking even! 23

24 Operating Surpluses May Not Cover the Full Cost of Business 2,500 Total Cost of All Business Activity ($ in thousands) 2,000 1,500 Reserve, one month expenses Depreciation expense 1, B Purchases of property & equipment (P&E) Estimated debt principal payment Expenses (before depreciation) Revenue (including non- operating) 24

25 GROUP EXERCISE: The Center for Care The Center for Care is a social service organization whose mission is to empower clients to take charge of their health and well-being. Their programs and services often win awards for innovation and excellence. It is the only social service organization in its county whose mission is dedicated to serving women, children and families. The Center bought a building in 2003, utilizing $450K in debt financing. In June 2013, the organization will need to make a balloon payment of $300K. The organization has received a challenge grant of $350K for its HIV/AIDS work, with annual renewal for up to 5 years. It must raise an additional $175K to meet the challenge. (Total new revenue=$525k/yr) Your foundation is considering providing a large part of the match, potentially for all 5 years. We are currently in the beginning of FY2010, and their operating budget this year shows a breakeven budget. 25

26 GROUP EXERCISE: Understanding Operating Performance How would you interpret their 2008 and 2009 Statement of Activities? How large is the grant relative to 2009 revenue? What would be the new size of the organization? What changed between 2008 and 2009? What are the unrestricted operating results? What is the composition of revenue* and expenses? *For this audit, support is contributed dollars and revenue is earned dollars. 26

27 GROUP EXERCISE: Understanding Operating Performance How large is the grant relative to 2009 operations? $525,000 New Grant v. $720,940 FY 2009 Support & Revenue 72.8% growth in 2010 to $1,245,940 What changed between 2008 and 2009? Expenses decreased by $122,795 or about 14% Revenue decreased by about the same, resulting in another deficit What are the unrestricted operating results? Unrestricted Surplus/(Deficit): (10,856) As a % of expenses: (10,856)/731,790= 1.5% deficit What is the composition of revenue and expenses? Contributed/Support: 42,763/720,934= 6% Earned/Revenue: 678,171/720,934=94% Program Expenses: 668,092/731,790=91% Management and General= 9%, Fundraising=0% 27

28 BREAK SPONSOR 28

29 Financial Health: Uncovering the Financial Story Understand Operating Performance Determine Strength of Balance Sheet Assess Ability to Handle Risk and Pursue Opportunity Comprehensive Financial Analysis 29

30 Using Financial Statements to Assess Financial Health Statement of Financial Position Statement of Cash Flows Assets Cash Liabilities Statement of Activities Net Assets Surplus / Deficit Revenue minus Expense = Surplus / Deficit Statement of Functional Expenses Determine Strength of the Balance Sheet 30

31 What Can the Statement of Financial Position Reveal? Assets Liabilities Is the distribution of assets appropriate, given the core business, size, maturity, marketplace? Cash How much? How liquid? Receivables Are they slow to collect? Fixed Assets Are fixed assets being maintained? How leveraged in relation to assets? Balance Sheet Assets Liabilities Net Assets Net Assets & Reserves Line of Credit Is cash flow being managed through a line of credit? Appropriately? Debt Is there a plan for repayment? What is the composition of net assets? Unrestricted Net Assets Does the nonprofit own more than it owes? How much is liquid? Temporarily Restricted Net Assets Do they fully support core programs? Reserves Any reserves? Suitable to needs? 31

32 Reading the Balance Sheet: Looking for the Story From 7/1/07 to 6/30/08, ABC Nonprofit engaged in operations reflected on the Statement of Activities. Statement of Financial Position FYE 06/30/07 ($ in thousands) Assets Cash Liabilities 296 Payables 131 Receivables 612 Debt 0 Prepaid Exp. 22 Other 29 P&E (Net) 256 Long-term receivables 39 Total Assets $1,253 Total Liabilities 131 Net Assets Total Unres. 325 Temp. Rest 797 Perm. Rest 0 Total Net Assets 1,122 Total Liab./Net Assets $1,253 Statement of Financial Position FYE 06/30/08 ($ in thousands) Assets Liabilities Cash 191 Payables 57 Receivables 55 Debt 114 Prepaid Exp. 41 Other P&E (Net) 760 Long-Term receivables Total Assets $1,047 Total Liabilities 171 Net Assets Total Unres. 771 Temp. Rest 105 Perm. Rest 0 Total Net Assets 876 Total Liab./Net Assets $1,047 What changed? What might this mean? 32

33 Financial Health: Uncovering the Financial Story Understand Operating Performance Determine Strength of Balance Sheet Assess Ability to Handle Risk and Pursue Opportunity Comprehensive Financial Analysis 33

34 Measures of Nonprofit Liquidity Cash Is cash available? Working Capital Are current assets greater than current liabilities? Total Net Assets What is the net worth of the organization? Is it positive? Liquid Net Assets What is the liquid portion of net assets that can support operations? Is it positive? 34

35 Measuring Liquidity Months of Cash = Total Cash (Total Expenses / 12) Months of Liquid Net Assets = Unrestricted Net Assets (PPE PPE Debt) (Total Expenses / 12) Working Capital = Current Assets Current Liabilities 35

36 How Do We Measure Liquidity? Months of Liquidity Represents the number of months an organization could operate with current cash and near cash To calculate, divide short-term liquidity at some point in time by average monthly operating expenses What is the right amount for a nonprofit? NFF encourages most organizations to aim for three months through a combination of cash (and near cash) on hand and access to cash through a line of credit Heavily government-funded nonprofits sometimes have to make do with as little as one month (or less) Organizations need more or less, depending on stage of development, cash flow cycles, capital needs, etc. 36

37 Examine Net Asset Composition Statement of Financial Position FYE 06/30/08 ($ in thousands) Assets Liabilities Cash 191 Payables 57 Receivables 55 Debt 114 Prepaid Exp. 41 Other P&E (Net) 760 Long-Term receivables Total Assets $1,047 Total Liabilities 171 Net Assets Total Unres. 771 Temp. Rest 105 Perm. Rest 0 Total Net Assets 876 Total Liab./Net Assets $1,047 Ice: Receivables Rocks: Property & Equip Water Bottle: Board Reserves Water: Unrestricted Cash 37

38 UNDERSTANDING NET ASSETS: ABC Theater Company Is this a healthy organization? 2,000 Total Net Assets ($ in thousands) 1,800 1,600 1,400 1,200 1, Unrestricted Temporarily restricted Permanently restricted

39 UNRESTRICTED LIQUID NET ASSETS ARE ESSENTIAL 2,500 Unrestricted Net Assets ($ in thousands) 2,000 1,500 1, Liquid -500 Property & equipment (P&E) -1,

40 Calculating Liquidity Statement of Financial Position FYE 06/30/08 ($ in thousands) Assets Liabilities Cash 191 Payables 57 Receivables 55 Debt 114 Prepaid Exp. 41 Other P&E (Net) 760 Long-Term receivables Total Assets $1,047 Total Liabilities 171 Net Assets Total Unres. 771 Temp. Rest 105 Perm. Rest 0 Total Net Assets 876 Total Liab./Net Assets $1,047 Months of Cash Total Cash/ Average Monthly Expenses = Months of Cash Liquid Net Assets Total Unrestricted Net Assets Unrestricted Board Designated Unrestricted P&E = Liquid Net Assets ($ In Thousands) $191 $ ($ In Thousands) $771 $0 $760 $11 Average Month Expenses = $1,262,000/12 = $105K 40

41 GROUP EXERCISE: Determine the Strength of the Balance Sheet It s your turn again. Refer to The Center for Care s Statement of Financial Position for 2008 and What changed from 2008 to 2009? What is their balance of unrestricted liquid net assets in 2009? (Hint: debt is facility-related) Calculate months of liquidity for 2009 (both cash and liquid net assets). What are The Center s full costs (balance sheet needs)? (Examples: reserves, facility reinvestment) How do you feel now about The Center s breakeven budget? How might The Center be managing cash flow?* *The Center does not have a bank line of credit. 41

42 GROUP EXERCISE: Determine the Strength of the Balance Sheet What changed from 2008 to 2009? Decrease in assets, liabilities and net assets Increase in cash but decrease in receivables What is balance of unrestricted liquid net assets in each year? 2009: 211,847-(646,041 PE-391,009 PE Debt)= (43,185) Calculate months of liquidity for Months of Cash: 8,852/(731,790/12)=.15 months 2009 ULNA: -43,185/60,983 monthly expense= -.71 months 42

43 Different Kinds of Capital Address Different Needs Capital Types Working Risk & Opportunity Change Recovery Facilities & Equipment Endowment Function of each: Allows the organization to bridge revenue timing gaps Absorbs unforeseen funding losses or unexpected, extraordinary expenses Funds investments in infrastructure and capacity associated with changes in business model, may cover deficits until programs and operations can support themselves Allows an organization to address a historical mistake or chronically undercapitalized operations Supports acquisitions or upgrades, or can be used to accumulate reserves to meet future facility and equipment needs Provides ongoing operating funds through investment income Addresses: Liquidity Adaptability Adaptability, Durability Durability Durability Durability 43

44 What Is TCC s Full Cost of Business? New Revenue Needed for Operations Structural Deficit $10k Match $175k Total $185k/year Capital Needed for 3-Year Balance Sheet Goals To fill in the hole $50k Year 1 To save $300 Balloon in 3 years $100k Year 1, 2, & 3 To get 1 month ULNA by 2013 $33k Year 1, 2, & 3 Total $183k Year 1 $133k Year 2, 3 To get 3 months ULNA by 2013 $66k Year 1, 2, & 3 To create facility reserve $25k Year 1, 2, & 3 Total $274k Year 1 $224k Year 2, 3 44

45 GROUP EXERCISE: Wrap Up Growth changes overall capitalization and full costs, altering an organization s surplus needs. New sources of revenue, like the large matching grant, can fundamentally change an organization s business model. Ensuring that a new funding source is sustainable may require investments in new skills and tools. Ignoring or delaying balance sheet needs over time (like saving for a balloon payment) will ultimately inhibit an organization s ability to scale when the opportunity presents itself. 45

46 What if audits aren t available? Can we use Form 990 data? Organizations with revenue>$200,000 and assets> $500,000 must fill out Form 990, which can be accessed on Guidestar. IRS Form 990 is the tax document that tax-exempt nonprofit organizations file each year with the IRS. The 990 allows the IRS and the public to evaluate nonprofits and how they operate. Which organizations are not required to file Form 990? Nonprofits that have not received tax-exempt status from the IRS Most faith-based organizations State institutions (e.g. a university) Subsidiary organizations covered under a group return filed by the parent organization 46 46

47 An Important Note on Surplus/Deficit Results on the 990 The Form 990 shows whether an organization s revenue for the year was in excess of its expenses (surplus) or failed to cover operating costs (deficit). Form 990s do NOT distinguish revenue that is non-operating, restricted or otherwise unusual. BUT it s the best widely available data that we currently have. When we don t analyze an organization s unrestricted, operating surplus we re not getting a true, accurate sense of their performance for that year. Most Important: 990 data requires additional context to understand whether restricted, non-operating revenue is included. 47

48 Working with 990 Data Organizational Dashboard: Five years of key financial trends and ratios for a selected organization Graphs & Explanatory Text: More detailed overview of the nonprofit s: Expenses Revenue Profitability Balance Sheet Liquidity Guiding Questions: Help understanding and interpreting results Peer Comparison Dashboard: Comparison with up to five peer nonprofits you select 48 48

49 Peer Comparables Dashboard 49 49

50 Tips for Working with Internal Documents Restrictions may not be registered until end of year. Because most accounting software is designed for the for-profit sector, nonprofits must update restricted net assets manually and may only do this once a year. Receivables may be underestimated. Receivables may not be recorded immediately after receiving the award letter. Depreciation may not be included. If depreciation is not included in internals, P&E may be artificially high and ULNA artificially low. Operating and non-operating may be combined. Most internal statements do not pull non-operating expenses below the line. Internal documents rarely show expenses by Program/Admin/Fundraising categories. Such categories are reported for the 990, but internals will likely show itemized expenses such as personnel, occupancy, etc. Very Important: A glimpse into their financial mgmt systems! 50 50

51 Tips for Assessing Budgets Ask what Carryover Funds are. This term means different things to different people. Could be net assets released or carried from the prior year into the current year. This is revenue. It should be in the budget. Could be savings (or a prior year s surplus) that is being spent in the current year either because that was the intention or because it is needed to plug a deficit. This is not revenue. It should not be in the budget. (It is savings, a balance sheet item.) Determine if any planned revenue is non-operating. Budgets should include only operating dollars. Nonoperating dollars can be placed below the line. Ensure that budget is based on revenue rather than cash. Budget should include revenue- which may or may not be in cash form yet. Revenue can also be in the form of receivables. Most Important: The difference between a plan and a report! 51 51

52 Agenda Welcome & Introductions Challenges of Nonprofit Finance Best practices that inhibit nonprofit health Assessing Financial Health Understand Operating Performance & Full Cost Determine Strength of Balance Sheet Evaluate Liquidity Condition Discuss Implications for Risk and Opportunity Wrap Up This presentation is generously sponsored by 52

53 Wrap-Up: Key Takeaways Know what to look for: Having access to reliable, accurate and timely financial data over a multi-year period is a first step to understanding your grantee s financial story. Understand what it means: Even with good data, it is important to know what to look for. Your grantee can help you understand the story behind the numbers. Consider the implications for the future: Your investment should be made in the context of the grantee s financial wherewithal to meet its obligations and goals, current and future. Match your money to the plan: Organizations needs buyers who support program delivery year in and year out. If you choose to be a builder, remember scale requires a sizeable infusion of flexible capital. 53

54 Takeaway: Comprehensive Financial Analysis Includes a Dialogue with Grantees The hard data can only take you so far Through discussion with grantees, learn whether: Management and board understand the organization's financial condition and how it relates to program decisions Management sets and manages against revenue targets that cover the full, all-inclusive costs of the nonprofit s services Leadership can articulate how they will build and manage the balance sheet to meet the organization s future needs 54

55 What You Can Do: Identify What Stands in the Way of Open Dialogue As an Executive Director, why might you resist an open dialogue with your funder about your financial health? 1. Feeling of personal failure/ blame 2. Fear of being rejected for a grant 3. Fear of airing their dirty laundry or looking bad in the community 4. Not capable of interpreting/ communicating their financial health (or fear of exposing this area as a weakness) 5. Don t understand why the funder wants to talk about these issues 6. Belief that it s in appropriate to talk about money 7. Other? 55

56 What You Can Do: Encourage Your Funder To Overcome the Barriers to Dialogue How can funders help an Executive Director feel comfortable about having this dialogue? 1. Find common ground in the flawed system 2. Explain why you want to have the conversation- and how it fits into your grantmaking process 3. Explain what level of confidentiality he/she can expect 4. Ground the conversation in the numbers; use specific data points 5. Ask the leadership to tell you the story behind the numbers 6. Invite the right people to the meeting 56

57 NFF Funder Services: Informed by Our Philosophy on Nonprofit Finance Capital Access Services NFF Philosophy Innovative Practice Groups Research & Fact Finding Philosophy and Guiding Principles Embrace whole enterprise perspective Provide access to all kinds of capital Integrate financial / economic context into grantmaking strategy Build knowledge of social capital markets Capital Access Services Program- and Mission-related Investment Services Syndication and Participation Loans Philanthropic Equity Services NFF Build/Buy Funding Method SM NFF Capital Partners: Customized Support Catalyst Funds Building for the Future SM Innovative Practice Groups Full or Half-Day Workshops Two-day Hands-on Financial Clinics Research & Fact Finding Portfolio Scans and Cohort Analyses of selected nonprofit subgroups, based on geographies, subsectors, budgets, etc. Research and Thought Leadership 57

58 Thank You to Our Sponsor 58

59 Thank You! To Stay Connected Learn More Twitter Facebook Our Blog Sign Up RSS Get in Touch! nonprofitfinancefund.org twitter.com/nff_news facebook.com/nonprofitfinancefund philanthropy.com/blogs/money-and-mission nonprofitfinancefund.org/sign-up nonprofitfinancefund.org/news/feed David Greco, Vice President Ext. 13 Nicole Simoneaux, Director Ext