May 16, 2022
Is investing right for your nonprofit?
What Is a Nonprofit Organization?
According to the National Center for Charitable Statistics, there are more than 1.5 million nonprofit organizations in the United States. If you're reading this, you have no question about whether you are a nonprofit but many nonprofit leaders have a key misconception about what it means to be a nonprofit.
Can a nonprofit make a profit?
The simple answer is yes and it should. A nonprofit that fails to raise or earn more than it spends will eventually cease to exist.
Many nonprofit professionals mistake the term nonprofit with the idea that the organization should not make any kind of profit meaning that at the end of the year, their revenues should equal their expenses. This is, in fact, a very dangerous idea that is unfortunately very pervasive. If an organization makes exactly what it spends, that means that the very next day, they are operating from a deficit. While expenses increase over time, a nonprofit’s revenue does not necessarily correlate to its activities. Gifts can occur at any time (or not at all) and donor retention numbers have hovered around 45% for at least the last decade. This means, that an organization without some resources in the bank at the end of its fiscal year jeopardizes its ability to do its mission in the future. Ask yourself these questions:
• Does the staff deserve a raise next year?
• Do those we impact deserve better services next year?
• Will we need more resources to do the same work or even more work in the future?
• Should we be serving more people or the same people in more ways
Answering yes to any of these questions identifies the need for ‘profitability’ or revenues in excess of expenses.
What Does Nonprofit Mean?
A nonprofit organization is different from a business because it’s designed for a public good, not a private interest. If I open up a pizza parlor and the line is out the door every day and I make $1 million in net revenues at the end of the year, I can pocket 100% of that (after paying taxes, of course). If my organization is a nonprofit, however, I cannot pocket that money. I can be paid a reasonable salary and the money made can only be used for the public benefit. A board governs the use of those funds and is ultimately accountable to the public through regulatory agencies like the Internal Revenue Service for the proper use of those funds.
How Much Should A Nonprofit Make?
Every organization should consider what type of financial cushion is right for them to weather upswings and downswings in philanthropic giving and earned revenue. Likewise, a good strategic plan and budget will identify opportunities for mission impact that will require prudent financial management.
In general, we recommend that every nonprofit begin by creating a one-month reserve if they haven’t already. This operating cash is held in a separate savings account and is used in case of an emergency. For an organization with a $120,000 annual budget, this is a $10,000 reserve. The best way to accomplish this is to trim expenses for a year or as needed until this threshold is met.
Once the organization has a one-month reserve, the board, staff, and advisors can assess the organization’s ability to withstand volatility. Some questions to consider as you think through your next reserve threshold:
• Does your organization rely on a small number of major donors or on a single large event for operating revenue?
• Does your organization rely significantly on one type of giving such as corporate or foundation grants?
• Is your donor retention rate low or are you unaware of, not tracking, or otherwise not managing retention of donors?
• Could your earned income be adversely impacted by circumstances outside of your control?
If you answered yes to any of these questions or have other reasons to be concerned about the risk to the income side of your budget, your organization might need six months or more of liquid reserve funds.
For other, stable organizations with diversified fundraising systems and sources, a three-month reserve or less may be more appropriate. Once your liquidity (immediate-access) fund needs are met, you should still prioritize raising more philanthropic revenue and/or earned income to fund the future needs of your organization. Whether it’s as simple as cost-of-living increases for staff, meeting repair and maintenance needs, or funding new projects and programs, a constantly evolving reserve account helps organizations meet their financial sustainability needs.
Can nonprofits invest in the market?
Another similar misconception among leaders is whether nonprofits can or should invest in the market. While market investments are certainly not appropriate for all nonprofits at all times, we are surprised when investments are characterized as ‘gambling.’ Nonprofit board members have a fiduciary duty that requires them to do what is in the best interests of the long-term future of the organization. Therefore, it’s important that each board member and the board collectively identify the risks and opportunities their organization faces.
When it comes to making market investments, an advisor who specializes in nonprofits and understands how to balance those fiduciary duties with the needs of the organization is essential. Boards should typically not try to do this themselves unless they possess this specialized knowledge that includes investment specifics for nonprofits, state law governing nonprofit investments, and policies that should be in place to ensure internal and external controls.
However, it is important to note that every small and mid-sized nonprofit has access to the same tools and opportunities as mega-nonprofits that have billions of dollars invested in the market.
A good investment strategy will have broad market-based exposure, meaning it will represent a large section of the economy. This makes the portfolio (your investment) as resistant as possible to huge ups or downswings. This also means that the likelihood of losing all of your investment is reduced. Unlike blackjack where a single hand (or even several hands) could wipe out your funds, it would require a broad-based market collapse of apocalyptic proportions to wipe out a diversified market strategy.
A bad investment strategy would be dependent on a single stock, asset class, or even a fixed-income approach. Worse yet, a strategy that does not address high inflation eats away at the nonprofit’s spending ability in the future and represents a significant opportunity cost to the organization’s sustainability.
A conservative, diversified market portfolio can be a pathway for longer-term or permanent funds to support today’s mission and create additional opportunities in the future.
If you have questions about your current budget, the investment opportunities available to you, or want a review of your current investments, please reach out to us!