In Cash There Is Opportunity

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For nonprofit organizations, cash is power. The nonprofit that has cash is well positioned to seize opportunities and cope with crises. The organization with no cash staggers. Historically, nonprofit organizations seem to expect to have little cash. In fact, the symptoms of cash strain define a part of nonprofits’ collective self-image: missed and nearly missed payrolls, frantic grant applications to head off a cash crisis, a pervasive sense of going without.

This is a story about how one nonprofit organization, Sunnyvale Elder Services (SES), improved its cash flow fairly dramatically over a five-year period–the organization is ficticious but the story is based on real experiences. The story is a mixture of familiar elements: hard work, planning, careful personnel selection and just plain good luck. Others can copy most of the elements of SES’s success one way or another.

In 1989, SES experienced a bad year. This organization with revenues of $5 million suffered a $194,000 loss, and its days’ cash ratio (see Cash Flow Box) was a mere 14 days. The organization’s books and records were in disarray and it could not officially close the fiscal year for seven months past the end date. Shortly thereafter, the chief financial officer abruptly resigned. Meanwhile, the agency’s chief funding source, the state government, was expressing open dissatisfaction with its financial performance.

Starting from that low point, the organization took a series of steps that produced almost immediate payoffs. SES’s turnaround can be attributed to a number of factors. Following are the important ones.

SES hired a new chief financial officer (CFO) trained in accounting and management information systems who had spent the previous two years working in a similar organization. He understood the special nature of nonprofit accounting and finance and was committed to the field. SES was wise enough—and lucky enough—to find the right individual.

A qualified CFO for a nonprofit organization is really the product of a number of factors. Obviously, academic training in accounting—or solid, extensive and verifiable experience in the field–is a must. Beyond technical qualifications, intangibles are perhaps most important. Can she communicate fiscal information and policies to all staff? Does she understand the role of a nonprofit? Most important, is she a leader?

The term “CFO” may be misleading; it may have connotations of something that only very large corporations can afford. But any nonprofit, no matter how large or small, needs to identify at least one person as primarily responsible for financial matters. The level of training and experience can and should vary according to a wide number of factors, but ultimately the responsibility is the same regardless of the size of the organization.

Most governmental contractual relationships, especially in this field, involve significant delays in payment. SES’s state government funder recognized that starving its service providers for cash ultimately weakens the services. It set up an alternative system of payments that allows providers to receive automatically up to 1/24th of the yearly contract amount at the middle and end of each month, with each end-of-the-month payment reconciled up or down to reflect fluctuations in use.

The CFO of SES and his assistant began doing regular cash flow planning. Starting with the existing cash balance, they would determine how much cash could reasonably be expected over the next few days or weeks and then compare that with how much cash they anticipated having to spend. That way, they were able to determine well in advance when their “crisis periods” would probably occur. Now that the procedure is routine, they need only a few minutes to estimate what cash inflow and outflow can be expected over the next day or two–or over the next several months.

More important, SES now has sizable cash balances, and its management has worked with its bank to develop conservative temporary investment plans. This step alone can mean thousands of dollars in additional yearly interest income when dealing with SES’s volume of cash on hand.

Inexplicably, some nonprofits struggle with cash flow while paying their bills within days of receipt. SES schedules its payables for action according to the vendor’s expectations for payment. If vendors expect payment within 45 days, they get paid within about 40 days. Conversely, if a vendor offers a discount for payment within a certain period of time, SES takes it. The CFO has even initiated negotiations with some vendors to offer discounts, thus using the agency’s good cash flow to lower operating costs.

Stretching payables is a perfectly valid cash flow strategy, but it obviously requires the nonprofit to work closely with its vendors. As the CFO says, “they have to be happy and we have to be happy, otherwise it doesn’t work.”

Profitability is the nonprofit manager’s most reliable source of cash. Unfortunately, there are a lot of myths and misconceptions around the notion of profit in a nonprofit, so it takes leadership and confidence for an organization to use this strategy.

Profits allow SES to do two things: weather crises and seize opportunities. If revenue begins to decline due to changes in funder policies–which has begun to happen as of this writing—SES’s elder clients have some measure of temporary insulation from the effects. No organization strapped for cash can hope to serve as a temporary buffer for its users.

SES can also invest in its own operations to support its overall strategic direction. For example, most serious analysts of elder services agree that case management will be an essential component of service in the future. Any case management system needs a good computerized information system. SES can now upgrade its hardware and software investment to support its ability to provide case management. Note that such an investment, in accounting terms, would not immediately be an operations expense but simply a change in the way assets are held, from cash to equipment. In short, SES has created opportunities for itself and its service users.

The cash flow issues facing SES are the same as those facing most nonprofits in this country. This particular mix of tactics and strategies may not be applicable as a package to every nonprofit, but the general themes of its success are quite relevant. A nonprofit’s cash flow is very manageable–with the right tools.

Many aspects of nonprofit management are hard to measure. Cash flow, fortunately, is not one of them. There are many measures of liquidity, one of which is the days’ cash ratio. In its simplest form, the days’ cash ratio offers an answer to a bleak hypothetical question. If all incoming cash were completely shut off and yet the organization continued to spend at its normal daily average rate, how long would the corporation survive?

Obviously this measure is purely hypothetical. No organization is ever likely to have its incoming cash completely shut off, and if it did, it would never continue spending at the previous daily average rate. Nevertheless, because everyone shares the same assumptions in calculating the days’ cash ratio it is a useful way to measure cash flow.

For the mathematically inclined, the formula for days’ cash is:

(Total yearly expenses – Depreciation) / 365 = X (Total Cash) / X = Days’ cash

Or, to express the same formula in terms of the appropriate line items on the IRS Form 990 that nonprofits complete each year:

(line 17 – line 42) / 365 = X

(line 45 + line 46 ) / X = Days’ cash

Note that we subtracted depreciation from total yearly expenses before calculating the daily average spending. Depreciation is not a cash expense, and we are only concerned about expenses that have to be covered by writing a check.