Reducing Risk In Nonprofit Operations

Reducing Risk In Nonprofit Operations

Nonprofits, like businesses, will run into big trouble if they lack sufficient operating reserves, detailed continuity plans and strong boards.

About a year ago, the New York nonprofit world hit an unhappy trifecta: FEGS, the largest social service nonprofit in the city, declared bankruptcy. The agency provided job services to people with disabilities and poor people. It was “praised by corporate titans and community leaders alike,” according to the New York Times. The news came on the heels of the New York City Opera’s collapse and financial turmoil at Cooper Union, the esteemed art and architecture school. All three were once-lauded nonprofits that fell on hard times.

Some important lessons have come out of that carnage, however, and they apply to Minnesota nonprofits. Prompted by the FEGS failure, Oliver Wyman, a management consulting firm, and SeaChange Capital Partners released a discussion paper, Risk Management for Nonprofits, earlier this year. The paper is a thorough introduction to a neglected topic and offers important advice that’s relevant to any nonprofit, of any scale and in any sector.

The paper’s premise is that hard times rarely come in one fell swoop. Problems develop over time and can be more or less successfully mitigated based on a nonprofit’s ability to analyze and deal with risk on a continuous basis. Further, the paper says we ought to care—a lot—about risk in nonprofits. Our social safety net, our medical care, our cultural assets, our educational system and our community development activities, to name a few, rely on healthy nonprofits that function at a high level and deliver on their missions on behalf of all of us.

The core of the report analyzes the performance of New York City nonprofits against the three core resilience factors that the authors urge nonprofit boards to monitor. These are:

  • Cash to cover immediate needs.
  • Unrestricted net assets—“the best definition of a nonprofit’s ‘equity’ that is available to bear losses or make investments.”
  • Operating reserves—“defined as the portion of the equity that is available in the short term.”
    Aggregate statistics compiled by the authors revealed that more than 10 percent of the nonprofits studied were technically insolvent (liabilities exceeded assets), with the highest percentage in health and human services, many of which are described as “limping along” with less than a month of cash on hand.

Further, about 40 percent had virtually no margin of error, with cash and reserves totaling less than two months of operating expenses. Data further showed that the larger human services nonprofits overwhelmingly relied on government funding sources, which can be fickle and/or subject to changes in regulations; and, while most nonprofits are small, the large ones provide the vast majority of services.

The report details eight best practices—and puts responsibility squarely on trustees’ shoulders for implementation and monitoring:

  • Governance and accountability for risk management. This is part of the board’s legal duties of care, loyalty and obedience. The suggestion is that this role is appropriate responsibility for the finance and/or audit committee.
  • Scenario planning. This should include contingency planning to address a running list of the major risks the organization faces, identifying both the likelihood of the risks and the expected losses.
  • Recovery and program continuity planning. This should account for continuing services in the event of a financial disaster. The authors propose that organizations develop “living wills” to allow faster transfer of programs, and recommend that organizations plan such actions long before a crisis hits.
  • Environmental scans. These should brief trustees on longer-term trends in the organization’s operating environment.
  • Benchmarking and self-rating. Trustees can use these to compare financial performance against peer organizations, using the publicly available tax returns in a peer or “watch” group.
  • Financial stability targets. These are created for operating results based on minimum and long-term needs. They could include targets for cash, unrestricted net assets, reserves and access to credit.
  • Reporting and disclosure. These would provide readily available summaries of financial and programmatic results, and should be proactively distributed to all of the organization’s stakeholders.
  • Board composition, qualifications and engagement. These factors should be combined to foster a functioning partnership between management and trustees. “Many organizations, particularly large complex ones, would benefit from having an experienced nonprofit executive on the board with firsthand experience of the programs and associated funding streams,” according to the report.

The report concludes with themes that emerged from research, summarized as avoidable “worst practices.” If you volunteer, contribute to or work in a nonprofit, see whether any of these sound familiar—and if they do, consider changes. These conditions made facing a crisis that much more difficult:

  • A poor track record recruiting and retaining a strong CFO.
  • Failure to do explicit scenario planning despite turbulent or inherently difficult situations.
  • Ill-informed trustees who do not discuss the impact of long-term trends either in financial performance or in the operating environment. Frequently these trustees were described as “focused on annual budgets and rear-view comparisons” and not on future stability and resilience.
  • Failure to provide timely, actionable information for trustees during the early stages of a crisis.
  • Indecisiveness— trustees taking too long to realize that there was a problem and delaying action even after they had decided it was necessary.

Which of Minnesota’s important nonprofits is operating too close to the edge? With thousands of people depending on our nonprofits to provide essential services, it’s critical that trustees and leaders face the possible scenarios that could disrupt continuity in operations or put them out of business entirely. Oliver Wyman does a service to the nonprofit sector by publishing its analysis and findings, and suggesting risk mitigation behaviors and practices. It’s a great, succinct read. It would be helpful to have a comparable analysis for our cherished and vital nonprofit sector in Minnesota, and to know that trustees and staff at nonprofits are aiming for the best, but preparing for the worst.

Sarah Lutman is a St. Paul-based independent consultant and writer for clients in the cultural, media and philanthropic sectors.