Cash Flow Strategies E-Book

Richard Linzer

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 472

Veröffentlichungsjahr: 2008

Beschreibung

Cash Flow Strategies offers nonprofit organizations an innovative approach to financial management. In this companion to The Cash Flow Solution, the authors, Richard and Anna Linzer, reveal their approach--which emphasizes the use of cash flow concepts that enable an organization to have the working capital it needs. The book is filled with illustrative examples and includes the tools and templates needed to make these concepts immediately applicable to any institution. Note: CD-ROM/DVD and other supplementary materials are not included as part of eBook file.

Leseprobe

Table of Contents

Title Page

Copyright Page

Acknowledgements

THE AUTHORS

Introduction

What’s In Store

PART ONE - COMPREHENDING AND USING FINANCIAL INFORMATION

CHAPTER ONE - THE CASE FOR CASH FLOW THINKING

Key Questions

Looking Ahead

CHAPTER TWO - BEGINNING WITH BUDGETS—CONVENTIONAL AND CASH FLOW

Practical Financial Matters

Uses of Cash Flow Budgeting

CHAPTER THREE - HOW FOOTNOTES MAKE THE CASH FLOW BUDGET EVEN MORE USEFUL

Why Footnotes

How to Set Up Footnotes

How Footnotes Help

CHAPTER FOUR - FORECASTING IN A FRACTION OF TIME

Forecasting the Future

Cash Flow Curves

Preparation and Adaptability

Rolling Forecasts as an Alternative to Static Predictions

Getting Started with the Cash Flow Forecaster

Dealing with Unusual Events

Long-Range Forecasts

Strategy and Cash Flow Forecasting, Together At Last

CHAPTER FIVE - MONITORING A Key Element in Developing Financial Strategies

Monitoring as Assessment

Allocating Monitoring Responsibilities

Monitoring and Financial Strategy

Monitoring as a Form of Navigation

The Limited Power of the Past

CHAPTER SIX - CASH FLOW ANALYSIS AS A STRATEGIC TOOL

The Relative Cost of Capital

Deciding What Money to Use

Cash Flow Principles and the Bottom Line

CHAPTER SEVEN - CASH FLOW ANALYSIS FROM THE FUNDING COMMUNITY’S PERSPECTIVE

What’s Wrong with the Current Situation

Cash Flow Analysis and What Funders Want

PART TWO - ESTABLISHING FINANCIAL SECURITY

CHAPTER EIGHT - CASH FLOW STRATEGIES IN TODAY’S ENVIRONMENT

Capital Accumulation in the Nonprofit Sector

CHAPTER NINE - CASH FLOW OPENS THE DOOR TO A NEW RESOURCE

Key Questions

Terms of the Trade

Purposes of Borrowing

The Value of Credit

CHAPTER TEN - BANKS, CREDITHOLDERS, AND CASH FLOW

Collateral, Collateral, Who’s Got the Collateral?

Getting Started

CHAPTER ELEVEN - USING CREDIT TO MANAGE FLUCTUATING CASH FLOW

The Street Angels Case Study: A Line of Credit for Stabilizing Cash Flow

How Street Angels Set Up the Creditholder Campaign

CHAPTER TWELVE - USING CREDIT FOR DEALING WITH DEFICITS

What to Do When an Unexpected Deficit Appears

Moving Forward by Looking at Cash Flow

Protecting Your Reputation

The Northwest Folklife Case Study: Addressing a Major Financial Shortfall

CHAPTER THIRTEEN - WINDFALLS AND OTHER SURPLUSES

Key Issues and Questions

Final Thoughts on Endowments

CHAPTER FOURTEEN - USING CREDIT FOR VENTURE

Case Study: West Sound Academy

A New Facility for West Sound Academy

Review of the Case

CHAPTER FIFTEEN - OWNING VERSUS LEASING Real Estate Strategies

Key Questions

Alternatives to Ownership

Using the Real Estate Calculator to Support Decisions

CHAPTER SIXTEEN - DEVELOPING EFFECTIVE STRATEGY FROM CASH FLOW TOOLS AND PRINCIPLES

A Symphony in Trouble

Orchestrating a Cash Flow-Based Strategy

PART THREE - FINANCIAL FUTURES IN THE CURRENT WORLD OF PHILANTHROPY

CHAPTER SEVENTEEN - EARNED REVENUE AND DISCOUNTS

Subsidizing the Lack of Working Capital

Why Offering Discounts May Not Be a Good Idea

CHAPTER EIGHTEEN - CASH FLOW STRATEGIES AND PHILANTHROPY TODAY

The Track Record of Philanthropy

Defining Issues in Modern Philanthropy

The Downside of Investment-Powered Philanthropy

Cash Flow Perspective

CHAPTER NINETEEN - CASH FLOW STRATEGIES AND PHILANTHROPY TOMORROW

Changing One Rule of the Game

Access to Credit and Social Benefits

Role of the Proposed Legislation in an Overall Plan

A Better Tomorrow

NOTES

ADDITIONAL READING

INDEX

Copyright © 2008 by John Wiley & Sons, Inc. All rights reserved.

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Library of Congress Cataloging-in-Publication DataLinzer, Richard. Cash flow strategies: innovation in nonprofit financial management/Richard and Anna Linzer. p. cm. Includes bibliographical references and index.

eISBN : 978-0-470-45439-8

ACKNOWLEDGMENTS

It takes courage to try new ideas. Over the years our clients have shown great courage. They shared their concerns and problems; we offered our counterintuitive advice. As one client noted, “It’s heresy, but it works.” That our ideas have flourished and been helpful is very gratifying.

Our thanks to Michael Herschensohn, Irene Namkung, and John Ullman at Northwest Folklife, and to Edward Frodel, James Kolb, Terry Webster, and Nellie Baker at West Sound Academy for allowing their experiences to be used as case studies. Special thanks to James Kolb, who took a keen interest in this approach and worked closely with us to make it succeed for his school.

The senior staff of the Pennsylvania Council on the Arts: Philip Horn, Brian Rogers, Heather Doughty, Karl Blischke, Charon Battles, Amy Gabrielle, and Michael Faison have provided thoughtful comments and a keen willingness to put these new ideas to the test.

Our editor Jesse Wiley was keen-eyed and crystal clear. His insights and persistence made this a much better book. The production staff at Jossey-Bass were indulgent and kind even when we got tangled up in cross-platform computer shuffles. Our agent, Carol Franco, provided worldly wisdom and graceful wit that helped ensure smooth sailing as the passage of this publication progressed.

Special thanks go to Carl Morgan, who translated our hypotheses into the first format for the Cash Flow Forecaster. Alan Bicker brought his financial expertise and computer literacy to the development of the Real Estate Calculator. Both Carl and Alan’s efforts will benefit nonprofit decision makers for years to come.

Warren Cook researched a difficult accounting problem and found the right answer, for which we are grateful. An extra helping of ice cream to Martha Perry, who offered our ideas to her colleagues in the foundation community. Thanks to Professor Henry Hansmann for a footnote that sparked one of the most crucial ideas in this book.

And, speaking of ideas, intuitive or counterintuitive, we courageously take full responsibility for them as well as for any errors and omissions.

THE AUTHORS

Richard Linzer provides consultation for businesses, nonprofit organizations, and government agencies. He works with organizations in the areas of financial management, board development, group facilitation, institutional analysis, and strategic planning. Since 1965, Richard Linzer has consulted with more than five hundred businesses, government agencies, and nonprofit institutions in the arts, humanities, education, health care, social services, and environmental fields.

Anna Linzer is a poet and writer and long-distance cold-water swimmer. Her novel, Ghost Dancing, was published by Picador of St. Martin’s Press and received an American Book Award in 1999. In addition, her poetry and stories have appeared in literary magazines and anthologies, including Kenyon Review, Carolina Quarterly, and Blue Dawn, Red Earth.

Richard and Anna are coauthors of The Cash Flow Solution: The Nonprofit Board Member’s Guide To Financial Success, It’s Simple! Money Matters for the Nonprofit Board Member, Money Matters! A Kit for Nonprofit Board and Staff Members, and It’s Easy! Money Matters for Nonprofit Managers. It’s Simple! received the 2000 Terry McAdam Award, Honorable Mention, for outstanding contribution to the advancement of the non-profit sector from the Alliance for Nonprofit Management.

Richard and Anna Linzer work together as cofacilitators. They have developed a method of facilitation for retreats that uses sequences of exercises in the form of kits and workbooks. The five publications that Richard and Anna have designed to be used as organizing structures for retreats and meetings are: The Board Retreat Kit, The Board Development Kit, The Corporate Retreat Kit, The Collaboration Workbook, and The Strategic Planning Kit for Public Agencies.

Richard and Anna Linzer live on Dabob Bay in Washington State. (Visit their Web site at www.linzerconsulting.com.)

INTRODUCTION

Money makes the world go round. And money matters occupy a lot of our thoughts, particularly in the nonprofit sector. Raising money, earning money, saving money, spending money, the financial drumbeat seems to go on forever. Financial management is a primary consideration for all nonprofit institutions. Some managers have said that after mission, money is the most time- and energy-consuming aspect of organizational life.

You are about to take a fresh look at financial management in the nonprofit sector. New themes and unconventional ideas await you. Since we are practitioners who work with nonprofit clients every day, the prose is tailored to your interests, the information is focused on the operational and strategic aspects of financial management, and the tools and templates provided are designed to make new concepts immediately applicable to your institution.

Since we know that you are busy—leaders in the nonprofit world are rarely idle—our response to the press of time is to offer you methods and tools that simplify and clarify your money matters. To that end, we keep technical terminology on a short leash and provide you with plenty of illustrative examples to match up with your experience.

In The Cash Flow Solution, we focused specifically on the questions that nonprofit board members frequently ask us. In Cash Flow Strategies, we have expanded the scope to include case studies, forms, and agreements, as well as software for implementing our approach to financial management. This book is meant for board members and staff of organizations and institutions that receive donations, earn revenue, and engage in the host of activities that are defined by a public service mission. However, it is important to understand that our cash flow principles are also applicable to a wide variety of institutions, including NGOs (nongovernmental organizations) and religious institutions, as well as other noncommercial entities that seek to provide benefits to society.

This book presents our approach to fiscal matters, the tools and techniques we use with our clients, three case studies drawn from our practice, and some thoughts about the future. The attached CD includes two programs that will make your life easier:

• Cash Flow Forecaster: Automates cash flow budgeting, forecasting, and fiscal monitoring

• Real Estate Calculator: Allows you to compare and contrast different strategies for dealing with real estate questions

The steps outlined here are tried and true. Our clients have tested them for you. The challenge of using our approach to cash flow financial management is that it requires a shift in perception. You will need to think about money in a different way. Our job is to show you how thinking about money differently can assist you in achieving a successful financial future.

What’s In Store

Our approach to money matters in the nonprofit sector is very simple: understand and manage your cash flow, learn how to bridge gaps or deal with surpluses effectively, and work to make all the resources in the nonprofit world flow more efficiently. That’s a one-line prescription for administrators, board members, donors, consultants, and others with an interest in the financial health and welfare of organizations in the nonprofit world. There it is in a nutshell. But, as some say, the devil is in the details, so together we need to take a longer look at all those devilish little particulars.

Our intent with this book is to offer you a simple and easy approach to using cash flow for budgeting, forecasting, and monitoring. As you will see, this approach will make the financial side of your operation understandable to all decision makers. We will show you how cash flow analysis can resolve complex problems and allow you to formulate strategies that will enable your institution to achieve more mission for less money.

We describe a whole new category of volunteers in the nonprofit sector: the creditholders, people whose effortless assistance will open the door to the use of fully secured credit. Credit provides the key to dealing with gaps in income, and curiously enough, it also can help you deal with surpluses. It seems counterintuitive, but it works, and this book shows you how.

Finally, we discuss a means to make all the resources in the nonprofit world flow more efficiently.

Like ancient Gaul, this book is divided into three parts. Each part explores two overarching issues about money matters that have emerged over the years as a focus for our work as consultants.

Part One is all about understanding and managing your cash flow. These are the two overarching issues in Part One:

• Too many board and staff members of nonprofit organizations find budgets and financial reports difficult to read and understand.

• Financial projections and reports requiring a great deal of time and energy to produce often fail to assist decision makers in making strategic choices.

Part Two looks at new ways to bridge gaps and deal effectively with surpluses, so that you establish true financial security. These are the two overarching issues addressed in this section:

• Ensuring financial security for nonprofit institutions in an uncertain environment poses a difficult challenge to administrators.

• Cash reserves, endowments, and other forms of capital accumulation often fail to enhance a nonprofit’s ability to fulfill its mission.

Part Three examines how administrators and board members can work to make all the resources in the nonprofit sector flow more efficiently. And these are the two overarching issues in this section:

• Nonprofit institutions need to obtain higher levels of working capital to fulfill their mission.

• Nonprofit institutions must reach beyond the world of philanthropy to a much broader basis of societal support.

Addressing these issues over the past four decades has convinced us that revamping the relationship of nonprofit institutions to money matters starts with establishing a cash flow-based system for budgeting, forecasting, and monitoring as a supplement to conventional approaches.

In Chapter One we discuss the benefits that cash flow concepts and tools bring to administrators and their boards. Cash flow thinking is a strategic approach to financial management. We examine the incentives for using cash flow strategies to deal with the ebb and flow of income and expense each year. We make a few critical distinctions regarding access to capital to demonstrate why nonprofit institutions are different from businesses.

Chapter Two graphically presents financial statements based on conventional budget formats and contrasts them with cash flow budget formats. We use the experience of one of our clients to illustrate why cash flow budgets provide more strategic information than conventional budgets.

What would the world be like without words? Chapter Three introduces the use of financial footnotes as a way to enhance cash flow budgets. Footnotes bring fiscal insights for those on the board and staff who are more comfortable with language than with numbers.

Imagining the future can provide a direction toward which a nonprofit organization can move and align itself. The key question is how much time and energy should be allocated to trying to predict an unknowable future. In Chapter Four we show you a quick and easy method for forecasting that uses the Cash Flow Forecaster on the attached CD.

In Chapter Five we show how cash flow budgets lend themselves to greater participation in monitoring by all decision makers. Analysis of fiscal information yields unexpected outcomes, as demonstrated in Chapter Six, where we discuss the importance of cash flow analysis in the context of the challenge conventional financial materials pose for conducting research and comparative analysis. In Chapter Seven, we explore ways donors and granting agencies can use the information that cash flow thinking generates to improve their understanding of nonprofit institutions.

Alas, this book can’t be all wine and roses. Money matters have their own dark side. Chapter Eight looks at the troubling circumstances in which nonprofit organizations operate today. Strategy is a balancing act in which an institution’s strengths and weaknesses are weighed by decision makers and then matched up with the opportunities and obstacles the environment presents. In this chapter, issues of income and asset allocation in the nonprofit sector provide a context for strategic action by nonprofit institutions dedicated to being more self-sufficient.

Help is on the way in Chapter Nine. Cash flow budgets and multiple-year cash flow forecasts can create access to a new resource for working capital: the prudent use of fully secured borrowing. We will show you how credit can be a powerful tool for short-term and long-term financial stability. To get credit from banks you need collateral. To get extra credit you need terrific collateral—and collateral has always been something of a problem for most nonprofits. In Chapter Ten, we demonstrate how cash flow presentations can be used to enlist the services of creditholders (individuals who support an institution’s mission by placing assets, either their own cash or stocks and bonds in the bank, to trigger low-interest financing). Solving the puzzle of collateral in the nonprofit world opens the door to the use of conventional credit. We provide the instructions necessary for any nonprofit organization, from the smallest to the largest, to gain access to the working capital that it needs from commercial sources. Banks and bankers will never look the same to you after you read this section.

Chapter Eleven shows you how to apply what you now know about cash flow and credit to safely set up a fully secured line of credit. To make it clear that this really is possible, we present a case study featuring an organization that used our approach to obtain a line of credit. We also include letters and documents from the case study that you can use as the basis for your own efforts in securing a line of credit.

Chapter Twelve advocates the use of credit for coping with deficits, which may seem like a highly controversial approach for nonprofit organizations, but it works very well, and we show you how. Having a game plan ready and in place before shortfalls occur is wonderful, but if you don’t, this chapter will tell you how to respond when deficits happen. And, trust us, they do! The Northwest Folklife case study will show you how one organization, at a moment when it looked like every loan officer’s worst nightmare, was able to borrow safely and resolve its deficit.

In Chapter Thirteen we look at gifts and surpluses from a cash flow perspective. The results may surprise you almost as much as an unanticipated bequest from an unknown donor. We show you how to get much more mission for less money, even as you feel that you are rolling in dough.

Chapter Fourteen, which discusses the use of credit for venture, may not be for the faint of heart. We share with you a case study about a small private school that reveals how you can create a new institution with the help of your friends and your banker.

Owning versus leasing space is a question that is a never-ending issue in the nonprofit world. Truthfully, it is complicated and can be confusing. But consistent with our goal of making concepts simple and easy, we present some ideas that may help to clarify matters in Chapter Fifteen. With help from the Real Estate Calculator, the other new cash flow tool on the attached CD, we show you how to compare and contrast the advantages to nonprofit organizations of different real estate strategies.

Chapter Sixteen presents an example of how all the elements of our approach fit together to assist an organization in the midst of a serious financial crisis. This chapter includes a description of how a major cultural institution proposed to deal with its financial situation and the advice we would offer instead.

In Chapter Seventeen we take a look at some of the challenges to earned revenue that nonprofit organizations confront. Discounts are something everyone loves. But in the nonprofit sector discounts may have some less-than-positive consequences.

Chapter Eighteen inspects the track record of philanthropy and the way in which current investment practices by foundations and donor-advised funds may be undercutting the ability of nonprofit institutions to fulfill their mission. We also examine the money management policies of large institutions, particularly those with sizable endowments, from a cash flow point of view.

Is it possible for nonprofit institutions to exert more control over their financial destiny? Chapter Nineteen looks at philanthropy in the future. This chapter will lead you into the exploration of a philanthropic realm unlike any other in the field. The notion of a cash flow based future, with plenty of access to working capital enhanced by the securing of insurance and investment by the sector’s giants, creates a practical vision of a brand-new nonprofit world.

All nonprofits operate within the general framework of contemporary philanthropy. We believe it is time to change the rules of the game: the rules that dictate how funds are handled and disbursed by foundations, by donor-directed financial service businesses, or by endowments. The promise of these changes is an enormous increase in the amount of working capital available to nonprofit organizations to pursue their mission. Since none of the rules of the current system are mandated or carved in stone, the change is largely one of perception, with help from the simple piece of proposed legislation sketched in this chapter.

The actions outlined in this book will have an immediate and positive effect on nonprofit organizations that adopt them. Creating cash flow budgets, using cash flow forecasting tools, and carefully monitoring cash flow will make the financial affairs of a nonprofit institution clear to everyone. Organizing creditholders to provide collateral will enable nonprofit institutions to qualify to use credit from their bank. By familiarizing themselves with good practices in obtaining and managing credit, institutions not only obtain working capital for their own needs, they help to make the case for a national market to provide working capital for all non-profit organizations.

With legislative help, using the accumulated capital in the nonprofit sector from private and community foundations, financial service donor-directed programs, endowments, and other public service capital pools, access to working capital for all nonprofit organizations can be achieved.

Cash flow strategies provide the basis for some powerful innovations in non-profit financial management. We welcome you to join us as we explore these ideas.

Quilcene, WashingtonSeptember 2007

Richard and Anna Linzer

PART ONE

COMPREHENDING AND USING FINANCIAL INFORMATION

Budgets and financial reports are as basic as it gets for any nonprofit organization that has moved beyond keeping its accounts in a shoe box. Yet, time after time, we have observed administrators and their board members struggle with even the most rudimentary aspects of nonprofit financial management. And they are not alone. Foundation officials, donors, administrators of government agencies, and even consultants to the field often express frustration with financial materials that are opaque. Since this is a bedrock issue, one that affects all aspects of a nonprofit organization’s operations, we devote time in the first chapters to addressing this lack of clarity on financial matters.

• Too many board and staff members of nonprofit organizations find budgets and financial reports difficult to read and understand.

To address this issue, we examine both conventional budget formats and the system of accounting used in the field. Our solution is to propose the use of new tools to create cash flow budgets, forecasts, and reports and to use these documents and the information in them as a supplement to conventional financial statements.

As the size and complexity of nonprofit institutions increases, the amount of time devoted to planning and budgeting increases as fast or faster. Much of this effort is directed toward making financial forecasts. Since none of us can know the future with certainty, this raises the fundamental issue of whether too much effort is being spent in trying to interpret the future, time that might be better spent on other activities.

• Financial projections and reports requiring a great deal of time and energy to produce often do not assist decision makers in making strategic choices.

Our response to this issue is to propose new tools and methods for cash flow forecasting and monitoring that require much smaller and more reasonable inputs of information. The methods we suggest rapidly produce alternative scenarios that can enable administrators and their board members to move strategically into the future.

CHAPTER ONE

THE CASE FOR CASH FLOW THINKING

Cash flow thinking involves focusing on the arrival of revenues and the departure of expenditures that occur during an institution’s fiscal year. It’s simple to understand cash flow thinking, and it is easy to use it to address some of the toughest fiscal problems confronting decision makers in the nonprofit world.

First and foremost, cash flow thinking is a supplement—not a substitute—for the accrual basis accounting systems most nonprofit institutions employ. Cash flow thinking allows everyone at the board and staff levels to comprehend the financial position of their institution. By making the fiscal picture simple to grasp, the organization encourages greater participation. With cash flow thinking, more than just the members of the Finance Committee can be actively involved in decision making. This means that all board members are able to exercise their responsibility for due diligence, and it allows the staff an opportunity to understand and share the fiscal information that is vital to the well-being of the institution.

Nonprofit organizations are set up and run differently from commercial enterprises. As we show later in this chapter, the two types of organizations are just different enough to make cash flow thinking especially pertinent to nonprofit institutions. Which is not to say that cash flow is not a powerful driving force in business and in markets, but the special role that cash flow has in the nonprofit arena is what needs to be clearly understood.

Key Questions

Should we create a cash reserve or manage our risk with a fully secured line of credit with the bank? This is just one of a host of questions that cash flow thinking can answer definitively. We explore some of the other questions in this chapter and the answers later in the book.

Cash flow thinking creates a platform for the creation of budgets, forecasts, and reports that are easily generated and understood. It has also stimulated the development of tools such as the Cash Flow Forecaster and the Real Estate Calculator, and techniques such as the creditholder concept, which provides collateral for fully securing an institution’s borrowing. Finally, cash flow thinking opens the door to the analysis of a variety of topics that have a direct bearing on the fiscal health of your organization:

• Should we establish an endowment?

• Are we better off owning or leasing our facilities?

• What impact will earned income have on our budget?

Why does the simplicity and ease of cash flow thinking matter to leaders in the nonprofit world?

Cash flow is the term used to describe the revenues that flow into an institution’s coffers and the expenses that are paid out when bills are due. Cash flow implies a very literal approach to both money and time. This means that income has to be in hand before it is counted; promises that the check is in the mail don’t count. And bills are considered paid only when the checks really are in the mail.

We are advocates of concentrating on cash flow as one of the financial tools available to nonprofit decision makers. Over the years, we have encountered many decision makers and nonprofit professionals who did not fully understand their own institution’s financial statements. Adding to the problem, the same individuals who failed to grasp the meaning of their institution’s fiscal affairs often counted on someone else to be responsible for understanding the budget and the financial reports. Just talk to our accountant, or let the chief financial officer answer that question have often been the responses to our financial interrogations. And the situation in the boardroom is rarely much better.

Members of the Finance Committee—an eager stockbroker, an overworked CPA, an amiable local banker—are typically drafted to take care of business and to be responsible, while the rest of the board members focus on other issues. The problem is that all members of the board are equally responsible for the financial well-being of their institution, and they endure considerable liability in their capacity as board members. It is vital for everyone on the board to understand the numbers.

Trustee ownership and understanding of financial matters has been a running debate in the field. This issue has evoked a variety of responses ranging from suggestions to mandate financial training for executives and nonprofit board members to notions of designating specialists to work alongside board and staff to supervise and coach them in money matters.

While we appreciate the benefits of training and the obvious profit potential for consultants working as capacity builders to nonprofit institutions, we instead advocate starting out by making things so simple and so easy that anyone who sits on the board or in a managerial capacity can quickly grasp the essential financial issues confronting the institution.

The clarity of cash flow thinking starts to deliver positive benefits the moment you adopt it. Everyone will be able to read and understand your budgets, forecasts, and reports. For the numerically challenged, cash flow is straightforward in much the same way that a checkbook is immediately accessible. For those who like pictures, cash flow lends itself to helpful graphic images. English majors, who may hate numbers, will appreciate the almost poetic footnotes that accompany your materials.

Why is cash flow thinking particularly relevant to nonprofit organizations?

How many times have you heard a colleague or a board member lament that your nonprofit organization should be more like a business? It’s a refrain that we have heard from many people who are or have been successful in their nine-to-five business lives. For these people the importance of a cash flow approach to nonprofit institutions needs to be especially emphasized. These folks frequently see the nonprofit sector as just an underdeveloped version of the commercial world. And many translate their notion of good business practices directly into recommendations for financial policies for their nonprofit institution. While nonprofits can learn a lot from businesses, the differences between the financial practices of the two sectors need to be understood in the context of the very real differences between them.

For example, the cash flow concepts that we advocate place very little emphasis on the accumulation of assets by nonprofit institutions. This is often baffling to businesspeople. Yet it makes perfect sense once you grasp the importance of mission to the nonprofit sector, and the way restricted funds turn into smoke and mirrors for many institutions.

In both the commercial world and the nonprofit sector, cash flow is important, particularly as a tool for understanding operations. Yet, as anyone in business will tell you, the bottom line in the commercial sector is all about the assets and liabilities left at the end of the fiscal year. On the other hand, for nonprofit institutions, cash flow is uniquely important, because assets don’t always have the same impact on the bottom line as they do in commercial settings. Here are three reasons why things are different:

First, businesses are creatures of the marketplace; nonprofits are creatures of the IRS. After all, without a charter from the feds, tax-exempt organizations could not offer deductions for contributions and avoid most of the taxes businesses pay. Another way of looking at this issue is to say that while businesses are created by markets, nonprofits are often the creatures of market failure. Market failure occurs when customers are unable or unwilling to pay the full price of the services or goods they receive. In the nonprofit field this means that a third party, such as a donor, foundation, or government agency, is needed to supplement the cost of the activity.

Second, the ways in which the two types of organizations are allowed to raise money are not the same. The rules that apply to this money create some profound differences. Businesses sell equity (ownership) to investors in the form of stocks, bonds, partnerships, and venture arrangements. Once the equity has been sold, businesses have a great deal of flexibility in how and for what they spend their money. The notion that in business cash is king is just another way of paraphrasing Yogi Berra when he says: “Cash, why it’s just as good as money.”1

Yet in the remarkably regulated financial environment in which nonprofits operate, even cash is not always a liquid asset. Liquid assets consist of unrestricted cash, and of money in a mutual fund or savings account that can easily be converted into unrestricted cash. Restricted cash may be in the bank account but not available for any purpose other than the specific one dictated by the funding source. This alone can create a fiscal crisis for seemingly solvent nonprofit institutions.

Nonprofits are prohibited from selling equity to anyone. Instead, they are allowed to receive tax-deductible gifts and grants, which often come with strings attached. Businesses can use profits to pay for their activities. Nonprofit institutions are often contractually bound to observe government or foundation requirements that any funds left over from grants be returned to the source rather than switched into different budgetary areas.

Both businesses and nonprofit institutions can borrow money. So the major difference is this: businesses sell equity and distribute profits to investors and to the government in the form of taxes; nonprofits receive tax-deductible grants and gifts that are meant to be spent for the social purpose for which the organization was formed.

Third, businesses have a very different annual fiscal cycle from that of their nonprofit counterparts. Businesses mobilize money through the sale of equity, or they use profits or borrowing to provide the funds they need to operate. At the end of the fiscal year they distribute earnings in the form of dividends and taxes.

Nonprofit organizations are continually soliciting gifts and grants, attempting to earn revenue, and occasionally borrowing. But because they have no equity to sell, nonprofit organizations do not engage in distribution to investors and in many cases pay little, if anything, in federal, state, or local taxes. Therefore, the fiscal cycle for a nonprofit organization is only about cash flow: income in and expenses out. It is this characteristic of nonprofit institutions that makes cash flow thinking so relevant to understanding how they work.

Arthur Levitt, the former chairman of the Securities and Exchange Commission, states in Take on the Street that to understand the quality of the financial situation of an enterprise, you need to look at the cash flow report.2 We agree, which is why we focus on cash flow budgeting, cash flow forecasting, and cash flow monitoring. The assets and liabilities are important too, but in nonprofit organizations cash flow thinking needs to be accorded a special place at the table when fiscal decisions are made.

Why add a cash flow-based approach to supplement our existing system?

Before you read on, you may want to buy your bookkeeper a bottle or two of over-the-counter heartburn medication. Then it will be ready when you announce that you are considering adding another level of financial record keeping to that already busy schedule. You can imagine the warm embrace we receive from our clients when we strongly urge them to do just that. What we often hear in response to our request is that they already have a perfectly fine system of accounting that has been mandated by the Federal Accounting Standards Board (FASB).

Our answer to this objection is that cash flow budgeting, forecasting, and monitoring make it possible for everyone, not just the accountants and members on the Finance Committee, to understand what is going on. Using cash flow budgets, forecasts, and reports to complement an existing system of financial management may at first seem like an added chore. After all, having an accrual basis accounting system in place generates lots of information in the form of balance sheets, income and expense statements, statements of changes in net assets, and statements of cash flows. The difficulty is that not everyone is comfortable with the information provided.

Accrual basis accounting is a system that recognizes income when it is earned and expenses when they are incurred, rather then when cash actually changes hands. To someone versed in finance and accounting the accrual basis system is finely detailed and comprehensible. To those without a financial management background, accrual basis accounting can be something of a challenge.

Accountants and lots of other people understand accrual accounting and consider it the appropriate standard for all financial environments. Accrual basis accounting uses a system that identifies payables and receivables in a virtual time frame. So, if you have been notified that a grant has been awarded, your bookkeeper “books” the amount at the moment of the award. But if, as sometimes happens, the grant is slow in arriving, and your fiscal year ends, you still have the receivable on your books. You account for it within the fiscal year time frame, but you still do not have the money that was meant to be spent on the program for which the funds were designated. For folks who understand this approach, it makes sense; they have a mental model that allows for everything to balance in the institution’s accounts over time.

As that popular source “The Motley Fool” noted in November 2006: “Be Careful When It Comes to Accruals.”3 Unless you understand that the money in the last report may not be money in the bank, you can find yourself in financial trouble. The problem, as we see it, is that the way for-profit businesses almost universally use this system of accounting gives it a lot of authority, but people in business generally know that there can be a disconnect between receivables and sales. In the nonprofit setting the impact of booking third-party-payer revenues well in advance of receipt of funds can be much more problematical. The typical line we hear is, “Well, we got the grant, so what’s the problem?” Well, the problem is that if the grant or contact check has not arrived, or the funds are restricted—something that does not happen in business—then other funds on hand may not be available for either operations or programs. The same thing happens with endowments or restricted cash reserves. The money is there on the balance sheet, but that does not mean that it can be spent to deal with today’s expenses.

On the other hand, income and expense are empirical phenomena—that is, you can see them as they happen—in cash flow thinking. Everyone may be aware that money is coming, but until it lands in the bank, it is not booked. The same is true with expenses paid. This is familiar from daily life: the float attached to your credit card purchases means that you don’t feel the actual impact on your wallet until you write the check to pay off your bill.

Cash flow thinking requires reporting only those events that involve the exchange of cash. It acknowledges but sets aside any transactions that do not involve cash, such as depreciation or amortization. Cash flow budgets, reports, and forecasts merge actual time with real money. They are dynamic—unlike conventional budgets and balance sheets. A balance sheet is a snapshot of a fiscal moment in time. A cash flow budget, report, or forecast is like watching a movie in which income and expense costar with time to express the ebbs and flows of your organization’s financial position.

With accrual basis accounting, income and expenses are posted before they are received or paid. This creates a virtual world that can sometimes be confusing. For example, when multiple-year pledges that have been posted do not arrive on schedule, your organization can be much poorer than it looks on paper. Our cash flow approach focuses exclusively on the income that arrives at your door and the expenses that are recorded as checks as they sail off in the mail. A sense of practical reality accompanies cash flow thinking.

Because these two systems (accrual and cash basis accounting) treat money in relation to time differently, a cash flow approach must be kept separate from your accrual basis accounting system. To make the separation easy, simply use the Cash Flow Forecaster tool that comes with this book. That will be much better for the bookkeeper than all that heartburn medication.

Can thinking about cash flow answer our perennial fiscal questions?

In our approach to thinking about cash flow, this inherently simple system is also the key to an in-depth understanding of many of the most complex issues in nonprofit financial management. If this seems like a paradox, read on.

Here are some related questions many leaders ask:

• Should we stockpile cash in unrestricted reserves or a restricted endowment, or both?

• Should we own our facilities or should we lease them?

• Why should we establish a line of credit and pay the bank interest, when we could build a healthy cash reserve and collect interest ourselves?

• Should we be cautious before starting a money-making enterprise to supplement our other sources of revenue?

The list goes on and on, and in each case, thinking about cash flow can help to provide clear answers.

Most leaders in the nonprofit sector pay careful attention to the assets and the liabilities of their institutions. But in some cases that focus on the pluses and minuses can make it difficult to answer complex fiscal questions. For example, one of the difficulties some larger institutions face is that their balance sheets can look strong, particularly if they have endowments, while their access to spendable dollars is quite limited. Decision makers may be unclear about the financial position of their institution because the restricted assets provide a false sense of fiscal security. Decision makers ask us whether it is cheaper to have a cash reserve or a fully secured line of credit. We tell them that without doing a cash flow analysis and a direct comparison, you cannot establish the precise difference in benefits of one approach or the other.

The same concerns influence decisions about which dollar to use to cover which purpose in the budget. If all dollars cost the same, then it makes no difference. But dollars can have very different costs, and cash flow lets you focus on the differential cost of money. So if the bank account is low this month, it makes sense to use the cheapest dollar—namely the borrowed one—to fill up the tank, rather than those expensive dollars that have been earned at high cost to your institution.

The benefits of applying cash flow principles to financial problems are most clearly demonstrated in the area of real estate. Leaders in the nonprofit world spend countless hours each year trying to figure out whether it is better to own or lease space, or whether a capital campaign is the right approach to adopt, versus a host of alternative strategies for dealing with facility issues. The Real Estate Calculator that comes with this book will reduce these difficult questions into understandable alternatives that can be compared and contrasted quickly. The software does this by providing standardized terms to follow and by establishing a common cash flow basis so that comparison of different approaches is possible. Typically, real estate discussions swing between hard issues, such as costs and financial consequences, and soft issues, such as the desire to own rather than rent because the notion of ownership just feels better. Without a clear differentiation among the factors that drive the choice, real estate decisions are often more art than science.

Are there other incentives and benefits to thinking about cash flow?

Cash flow budgeting, forecasting, and monitoring set the stage for strategic thinking for leaders, particularly in the area of financial risk management. Understanding how a nonprofit organization works today, and how it is likely to perform in the coming years, is fundamentally rooted in an understanding of its cash flow. Ongoing awareness of when funds enter and leave the institution’s coffers is necessary to ensure the health and stability of the organization. Thinking about cash flow can set the stage for the use of credit to address both financial shortfalls and windfalls. It also makes it possible to communicate clearly with the individuals and institutions that will make the credit you require available to you. And in the process our recommended procedures for budgeting will dynamically illuminate your financial game plan.

Using cash flow tools such as the Cash Flow Forecaster makes generating useful forecasts or quickly preparing financial reports, and many other financial tasks, turn out to be much easier and far less time-consuming to perform. Our cash flow-based electronic tools enable you to generate useful forecasts in much less time—forecasts that can be easily advanced as you move through the fiscal year. The same tools make financial monitoring a breeze. These savings in time and energy may bring you back into the good graces of your bookkeeper.

Cash flow thinking can also help leaders analyze their financial policies in new and different ways. By using cash as a common basis, fiscal data from different institutions can be used for comparing and contrasting patterns and trends that would otherwise be inaccessible. These benefits of cash flow presentations can be shared with donors, foundations, and government agencies. Cash flow budgets can provide them with real insight into your circumstance—bolstering your requests—and bring a much-needed financial reality to discussions about their policies for restricting grants and gifts.

For example, some foundations have a policy that prohibits them from funding organizations that have incurred a deficit, even if it is only on paper and actually a matter of timing, not money. Other funders refuse to pay for the operational expenses necessary to administer their funded programs. Using a cash flow-based approach, you can control your own destiny by understanding the impact of these issues on your bottom line. You may not be able to convince the funders that you need more operational dollars to sustain their grants, but you will be prepared to take constructive action to mend this situation on your own through the use of credit.

Cash flow financial management alerts you to potential shortfalls and windfalls. Knowing in advance how the budget will be affected by these changes can be a lifesaver for administrators focused on fulfilling their mission. Cash flow thinking also opens the door to a new resource for nonprofit organizations, the use of fully secured credit to fill in income gaps or to hedge against future risks.

Why should board members support the use of cash flow thinking?

People sign up to be board members and staff of nonprofit organizations for a variety of reasons, but struggling with fiscal systems is rarely one of them. Just saying the words financial management to many people in the nonprofit sector evokes a wince. Yet, like it or not, all nonprofit board members are responsible for the financial well-being of their organization. They are legally liable for the finances, just as administrators, acting as agents for the board, are obliged to ensure that budgets and reports are accurate. Because fulfilling the mission is inherently dependent on good fiscal practices, it is important that financial reporting and analysis be comprehensible to all.

The case for using a cash flow approach begins with the clarity that cash flow concepts bring to budgets, forecasts, and reports. Everyone associated with a non-profit institution is more likely to grasp financial management issues when cash flow tools are used and shared.

The simplicity and clarity of cash flow has special applicability for the board members of nonprofit institutions. Cash flow budgeting and reporting means that board members are encouraged to participate more fully in problem solving and decision making.

Having clear, readable financial information means that board members, even those who are allergic to budgets and numbers, can assume their rightful responsibilities as trustees. These responsibilities include providing financial oversight and the problem solving and decision making necessary to sustain or attain financial health for their organization. Having the Finance Committee examine fiscal issues in great detail may be wonderful, but due diligence demands that all board members understand the implications and consequences of their votes on critical issues.

A solid grasp of the relationship between income and expense and the assets and liabilities of the institution is an important ingredient in nonprofit financial management. But for many board members, it is a challenge to understand the terminology and the relationships associated with nonprofit financial thinking. This is where cash flow tools and techniques, in the form we present them here, are so helpful. It is possible to use cash flow as a guide for performing the key fiscal functions asked of board and staff members.

And this is why cash flow budgeting, forecasting, and monitoring are so important in the nonprofit sector. Traditional accounting, with all the bells and whistles that pertain to nonprofit institutions, has an important role to play in generating periodic financial reports and the audits so often requested by funding agencies. But you still need to set up a cash flow budgeting, forecasting, and monitoring system to provide the supplemental information that leaders need to run things.

Why should nonprofit managers and administrators adopt the cash flow approach?

The case for cash flow is slightly different for administrators and staff than it is for board members. Cash flow concepts are inherently rooted in operational considerations. All nonprofit institutions, whether large or small, must integrate their money with time. This is most dramatically clear in situations that trigger shortfalls or windfalls. Interestingly, having too much money on hand is just as significant in terms of fiscal decision making as having too little. Of course, most of us would opt for the surpluses, the surprise gifts, or the mystery bequests, but the principle is the same. Having more or less money than your operation requires right now means that the issue of what to do with this money must be addressed. It is here that cash flow analysis really pays off. The decision of what to do with all that extra money—or the flip side, what to do when the cookie jar is empty—can be greatly enhanced if decisions are made using cash flow analysis.

Cash flow budgets, forecasts, and reports allow for nimble financial management. As we lay out in forthcoming chapters, strategy is an integral part of forecasting, balancing preparation with adaptability. Strategy involves making choices in a temporal context. So any decision—to advance, or to hold, or to retreat—has an awareness of time built into it. Since cash flow merges money with time, it sets the stage for strategic financial thinking. We have witnessed too many nonprofit planning sessions that simply did not take time into consideration, which is why we sometimes have heard the nonprofit sector called the land that time forgot. Cash flow thinking forces everyone to see things in relation to time because it is about actual cash that is only counted when it is in hand or out the door.

As time becomes increasingly precious, both in the office and in the boardroom, the essential requirements of accurate financial reporting by staff, along with comprehension and oversight by board members, remain the same. These functions will always demand attention, regardless of the size or complexity of the institution. Yet without an ongoing awareness of how funds enter and leave the institution’s coffers, annual budgets or records of past years, no matter how laboriously composed, offer little help in understanding how a nonprofit organization works today and how it is likely to perform in the coming years. An annual cash flow budget, starting with the cash in the bank and then divided into monthly segments, is arguably one of the most valuable tools that the administrator of any nonprofit needs to maintain the health and stability of the organization. Our approach to cash flow and the tools that accompany it dramatically reduce the time needed to prepare and use financial forecasts and reports.

Income is on everyone’s mind in the nonprofit world. One of the most compelling reasons that nonprofit institutions try to increase their earned revenue is that the surpluses thus obtained are unrestricted: they have no strings attached. There is a real need for unrestricted funds that can be plugged into operational categories, avoiding the restrictions that so often come with gifts and grants. Cash flow analysis and concepts can help you understand the impact of earned income. Knowing when to be entrepreneurial and when to stick to your knitting can be very valuable. Access to working capital is the single greatest challenge to non-profit institutions. Moreover, the key to confronting this daunting issue is to be found by thinking about cash flow. More about this in Chapter Nineteen, where we present some ideas for legislation that will increase nonprofit institutions’ access to working capital—those operational dollars that are now so scarce.

Looking Ahead

We are making some serious claims for thinking about cash flow as simple and easy. In the coming chapters we show you why cash flow thinking really is simple for everyone—and we substantiate these claims by making it easy for you to use these ideas. We provide case studies, sample forms, contractual agreements, and actual letters so that you don’t have to reinvent the wheel to get on board with cash flow.

Speaking of hopping on board, in Chapter Two we share with you the terrible plight of one of our clients’ chief financial officers. And we show you how a little cash flow thinking solved the problem for this gifted CFO by making it simple for her board to see their actual fiscal position.

CHAPTER TWO

BEGINNING WITH BUDGETS—CONVENTIONAL AND CASH FLOW