Making a Profit for Nonprofits

From Janet Brown from her blog Better Together

Grantmakers in the Arts is in the midst of presenting Conversations on Capitalization and Community in five cities over two months so my mind is a bit warped with an excess of nonprofit financial health talk. Making a profit for nonprofits isn’t easy because we fight public perceptions that we should have no profits, funding criteria that punishes profit and a professional norm that encourages any profit be spent on making the product of the nonprofit better.

I’ve written before (and I’ll probably write again) about the need for cash or operating reserves. Every organization, whatever the size, needs a savings account that is unrestricted. The only way we get to put money into our savings account is by netting a profit at the end of the year. Income less expenses = net profit. Net profit gets to be carried over into the next fiscal year and the next year you can build on it some more. Eventually, you have a savings account that can protect your organization from unexpected downturns in income or could actually be used to do something that is new or risky. Doesn’t this all seem so simple and easy to do?

We’ve done an analysis of the financial health of arts groups in the twelve cities where we’ve presented our funders’ capitalization workshop. On average, for small, mid-sized and large organizations, we see the weakest liquidity amongst large groups. In some cities, mid-sized and major organizations have, on average, negative liquid net assets. This means, they don’t have a dime to pay the electric bill should money stop coming in the door today. They may have large restricted endowments but they are cash poor. In all cities where the average liquidity is in the positive number, the typical organization has between one and three months of operating reserves in the bank. So they can pay their light bill for three months.

This is not a good state of affairs. This is a result of decades where growth was God, buildings were the answer to audience development and many funders required budgets that broke even. Organizational behavior is highly influenced by institutional grantmaking criteria. The words “they don’t need our money” coming from a grant panelist or program officer has perpetuated a culture of fear amongst nonprofits that they shouldn’t even attempt to budget for profit or have cash on hand because they will be penalized for it.

On the organizational side, many arts groups have a tendency to under estimate overhead and salary costs as they pertain to projects. This is part of the myth that nonprofits should operate with nonexistent administrative costs. I’m exaggerating but not totally. I remember the day when you couldn’t have more than 10% of the project be administrative. I remember the day when you couldn’t apply to the National Endowment for the Arts for staff salaries. This is the perception that every dime raised by the nonprofit needs to go towards the service provided by that nonprofit or something is amiss. This principal (driven by fear of thievery) has contributed many nonprofit managers thinking that if funders knew what it really cost them to keep the lights on, have computers, rent space, pay the people who do the programs, they’d never get funded.

There is a great deal of controversy around Dan Pallotta"s Ted talk but he makes some really relevant points about how our society perceives nonprofits and about how we are hesitant to invest in our own companies by increasing fundraising personnel and budgets. I remember Clara Miller, the founder of Nonprofit Finance Fund, taking about this; that organizations should not be taking out loans to pay debt but rather taking out loans as an investment to get out of debt. Investing in making money by employing more people in development, increasing the technology tools needed to expand contributions and properly accounting for overhead and salaries are all actions that would benefit nonprofits.

Here is an interesting study that came out a few months ago entitled “Underdeveloped: A National Study of Challenges Facing Nonprofit Fundraising,” a joint project of CompassPoint and the Evelyn and Walter Haas, Jr. Fund.

Writing about how to fix the financial woes of the nonprofit world in a blog is a bit ridiculous. There are lots of reasons why our sector isn’t more financially healthy and there are many organizations that are doing just fine. But there is still an underlying fragility to our sector that scares me. At the expense of becoming known as the Suze Orman of the nonprofit arts world, I believe organizations can save money. To do that, they have to budget income correctly (not easy in a chaotic market), include real costs of overhead and salaries, and budget expenses accordingly in order to see a profit. They also have to be assured that funders will reward their good financial management and not punish it.