It is not news to anyone that the Covid-19 pandemic has been hard on nonprofits, many of which are working with the communities hardest hit by this disease. In the past month, many nonprofit organizations have been on a pause. Others have had to rethink or sharply curtail their services, even as they face unprecedented demand. As a result, nonprofits have seen unprecedented numbers of layoffs, furloughs, and closings. We may not have a full accounting of how many for months yet, as the economic storm continues to rage.
Right now, though, one thing is clear: It took only a month for a significant proportion of the nonprofit industry to come unglued financially. This is partly because, structurally, nonprofits are not encouraged — maybe not even allowed — to have glue.
We have just become painfully aware of what happens when nonprofit organizations do not have capital reserves. In a recent survey of foundation-funded grantees by the Center for Effective Philanthropy, most nonprofits reported they had either failed or risked failing to cover essential costs in the past three years.
The sad irony is that many nonprofits seek to help low-income individuals gain the kind of financial literacy that helps them get out of the cycle of living paycheck to paycheck. Yet for too many nonprofits, operating without reserves is a way of life.
There are at least three reasons for this:
- Some grant makers see reserves that appear in an organization’s financial statements as a source of immediate revenue and therefore will not fund organizations that have money in the bank.
- Many grant makers, even those that support efforts to build the management capacity of nonprofits, will not allow the use of their funds to build strategic reserves. (Notably, some nonprofits, like universities, must have reserves in order to be considered good investments. Why should that be true of one class of nonprofit and not another?)
- The overwhelming number of foundation grants are project restricted, and they’re often single-year. It is unrestricted, large (six-figure and above), multiyear grants that allow nonprofits the flexibility to build reserves, but only about 10 percent of foundation grants check all those boxes.
This approach to funding is not an incentive for good management. Even in the most meticulously budgeted work, as the end of a funding timeline nears there are often surplus dollars that could be set aside as project reserves. Such unexpended funds are typically put to some ephemeral use — extra supplies or short-term personnel — because nonprofit leaders know they must spend them by the deadline and cannot set those funds aside for a future strategic investment in the project. While foundations are doing more to demonstrate they trust nonprofits to do what is right with their funds, flexibility in repurposing funds usually extends only to moving funds between lines, not to creating unrestricted reserves.
A New and Strategic Approach
The current situation suggests, powerfully, that it is time for a new and more strategic approach to cash reserves for nonprofits. Many social-services nonprofits have been either dismantled or bailed out this spring. Had they been allowed to create cash reserves over time, the onus would have been on them, as it should be, and they would have had a fighting chance to manage their way out of the situation rather than hoping to be rescued. And our economy needs nonprofits to be able to manage well: Nonprofits account for 12 percent of the work force, the third-largest segment after retail and accommodation/food service and roughly equivalent to manufacturing.
Obviously, many grant makers would still be concerned about the wise use of cash reserves. Absent a catastrophic downturn like the one we are now enduring, they might ask: Would nonprofits not simply use such funds to build up cushions that either go unused or are used in unintended ways?
To be clear, the argument for nonprofits to be able to create stronger reserves is not an argument for an endless fount of unrestricted funds with no questions asked, nor is it a case for reduced scrutiny. In creating reserves, nonprofits should be asked to develop the operating baseline that will make them a going concern and demonstrate adherence to it.
Moreover, across the nonprofit world, organizations are held to — and hold themselves to — very public accounting standards. The expectation of a reasonably sized reserve should become part of those standards. And even if an organization never suffers an economic blow that drives it to dig into its reserves, that cash on hand might provide the small margin for innovation and discovery that is the only means a grant-driven organization has to develop new projects.
What It Takes
To move in the direction of healthier financial management for nonprofits, grant makers could take these steps:
- Require organizations that submit proposals to demonstrate that they have at least three months of reserves or a plan to get there, and be ready to allow the grantee to make an argument about building those reserves using some part of the grant — for instance, interest income or reinvestment on underspent lines.
- Do not penalize well-run nonprofits that can demonstrate viability and sustainability. Recognize that an operating surplus is not a slush fund. Be willing to engage the organization in a conversation about the policy and purpose for reserves.
- Commit to sharply increasing the proportion of large, multiyear, general operating support grants and encourage grantees to put some of these funds in reserves. Just as grant makers have come to understand the necessity of overhead, it would be good to have a frank and open conversation about capital reserves.
Even grant makers with massive capacity want to be confident that they are investing in going concerns. If a foundation believes sufficiently in a cause and an organization to provide support in the first place, then key benchmarks should include not just effectiveness but also ongoing viability.
This is not a conversation that should be driven underground. The most vulnerable among us, who are being disproportionately affected by Covid-19, are also often the people who depend most on thinly capitalized nonprofits doing vital work. The continued financial resiliency of these organizations should be of paramount concern to us all.