Thursday, August 13, 2009

Weathering The Storm - Financial Health standard

We’re all too familiar by now of nonprofits having to shut its doors because of lack of funds. Although we in the nonprofit sector know that it’s always a struggle to keep enough money coming in to make sure the work continues, the recent tough economic times put even more pressure to make ends meet.

At the Council we often say that trust is the life blood of a nonprofit. If a donor trusts that a nonprofit is accomplishing worthy results and is sustainable, they are more likely to give. The Financial Health standard is meant to help donors get a handle on whether or not an organization has the financial base to weather an economic storm. There are a lot of ideas around about what are the key indicators to gauge this. Because of that, we brought together financial experts to help us think this through and came to a compromise that focuses on unrestricted net assets. Specifically, the standard looks at whether a nonprofit has had 3 consecutive years of unrestricted net asset losses and whether the cumulative unrestricted net asset balance over 3 years is positive.

Now this standard doesn’t take into account how a nonprofit invests its unrestricted net assets and we have gotten feedback that this matters. If a nonprofit has a sizeable portion of its assets invested in a risky portfolio, one could argue that it isn’t “using its resources prudently” as the philosophy states. This argument has gotten even more credence in the aftermath of the Madoff scandal.

So our questions are twofold. First, is it a good enough indicator of financial health to be tracking unrestricted net assets? And is there a need to bolster this standard with something that addresses investment policies?


Sara Leiste said...

This one confuses me. I'd like to see more specifics. How do you plan to measure "Has a positive trend in its three-year cumulative unrestricted net asset balance."

mwera said...

Good questions, thanks for asking for clarification. Here's an example. Say a nonprofit has the following year-end unrestricted net asset balances:

Year 1) $-10,000
Year 2) $15,000
Year 3) $-20,000

This nonprofit would meet the first part of the standard (having at least one year with positive unrestricted net assets), but wouldn’t meet the second part since the cumulative total over the 3 years is negative ($-10,000+$15,000+$-20,000=$-15,000). In order to meet this standard, an organization would have to meet both aspects. This is a bit more stringent than our current Financial Health standard (which looks at total net assets), but the financial experts we worked with on this standard all agreed that unrestricted net assets is what one should look at.

mwera said...

One quick change to what I posted earlier. The thrid sentence should read, "...a nonprofit has the following unrestricted net asset gains or losses over the last 3 years:"