The When and Why of Outsourcing Your Financial Management

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Certain core management functions, most people would agree, should always be performed by salaried staff, who are presumed to have more loyalty and a longer term commitment to the organization than outside consultants. This category includes such responsibilities as program planning, staff management, and board communications. In most nonprofits, it also includes day-to-day accounting and overall financial management. But should it? Are there circumstances when it makes more sense for this work to be farmed out to a professional service provider?

The nonprofit sector as a whole is becoming more sophisticated about financial management. Yet a great many smaller, thinly funded, highly valuable organizations serving our communities are engaged in a constant struggle to develop and sustain high-quality financial management systems. Many of these groups would do well to consider contracting out part or all of this function to enable them to better focus their energies on core programs.

In this article, we provide an overview of the most common types of contracted financial services available to nonprofits, a guide to help you determine which, if any, of these services might be suitable to your organization, and some tips on selecting a provider.

We recognize that in some areas of the country, there may currently be a dearth of quality financial service providers. One solution to this problem may turn out to be Application Service Providers, or ASPs. This relatively new type of service uses the Internet to deliver services via powerful software well beyond the means of individual organizations to purchase and maintain. According to Thomas McLaughlin, who consults and writes widely on nonprofit financial management, “Application Service Providers hold promise for nonprofits at some point in the future, especially for smaller organizations without the resources to maintain a fully staffed back room. But new technology of this sort typically takes a while to target the nonprofit market, and many nonprofits may not find generic ASP packages useful enough in the meantime. Also ASPs virtually demand more expensive high-speed Internet connections, and don’t work with less expensive dial-up modems. It adds up to a possible green light in the future, but a yellow light for now.”

What’s Out There? Categories of Contracted Services

(Note: If your group is not yet incorporated, skip to the discussion of fiscal sponsorship.)

Individual Practitioner: An individual practitioner is a professionally trained accountant, although not necessarily a CPA, who has multiple clients and charges an hourly fee, which can range from $35 to more than $100. Some practitioners work only with nonprofits; many have both for-profit and nonprofit clients.

What to look for:

  • Nonprofit experience with organizations similar in size, type, or mission to yours.
  • Several recent, local references. Check them thoroughly!
  • Demonstrated familiarity with your accounting software, or a strong rationale for converting you to a new product. Beware of practitioners who require you to switch to a new software program simply for their own convenience. If conversion does seem to make sense, be sure that the product being recommended meets your needs.
  • Compatibility with the culture of your organization.
  • Availability-how many clients does he or she already have? Will an associate or the principal do most of the work?
  • Interest in and ability to transfer knowledge and train your staff.

Shared Services: Two or more organizations can consolidate their financial or other administrative functions to increase efficiency. One of the parties may provide these services directly or they may be contracted to an independent third party or handled as a joint venture, which may mean setting up a separately incorporated entity. Shared administrative services can be cost-effective but there are a number of considerations in setting up these systems.

What to look for:

  • Mix of services matches your needs.
  • Systems to be used are compatible with yours (or are superior and you are willing to convert).
  • You are satisfied with the fairness and appropriateness of the overall structure of the arrangement, especially the degree of participation in decision-making your organization will have vis-a-vis staffing, policies, costs, etc.
  • Convenience-will shared staff be easily accessible? How quickly can you receive reports? Will your financial data be available online, in real time? Can you obtain customized reports quickly and easily?
  • If the arrangement doesn’t work out, is there a relatively painless way to withdraw?

Full-service Financial Management Vendor

A small number of vendors (for-profit and nonprofit) provide fee-based, “outsourced” financial management services to community based organizations. The service package typically includes CFO-level management as well as day-to-day accounting and bookkeeping services. If in-house financial management capacity is limited, or you are uncertain about your future staffing needs, outsourcing can be a good option. Pricing for this type of service is usually based on a percentage of either revenues or expenses and can range from four percent to 10 percent or more, depending on the size of the budget being managed-a smaller budget means a higher rate-and the mix of services provided.

What to look for:

  • Same as for individual practitioner, except that this type of vendor is likely to require that your accounting be done on their own (hopefully more powerful) system.
  • Assurance that you will get the reports you require in a timely way, online if feasible.
  • A commitment to knowledge transfer and training are especially critical here, because if you ever want to bring this function back in-house you will have a steep learning curve. Check the provider’s track record of having helped other clients make the transition back to in-house financial management.
  • A clear agreement that assigns the appropriate level of staff to do the work. Some large firms think of small nonprofit clients as training grounds for junior staff.
  • Low staff turnover. You don’t want your primary contact person to leave in six months.
  • Absolute clarity about division of labor between provider and in-house staff so nothing falls through the cracks.

All Types of Providers

The following questions and considerations apply to all types of financial management service providers:

  • Are there reliable arrangements for backup if your primary contact is out?
  • When selecting any financial (or other technical) service provider, be sure to ask for a proposal that lists all services and regular tasks included in the fee as well as any exclusions or additional charges.
  • Be sure to spell out in detail in a scope of work document your expectations regarding specific tasks and deliverables and, if appropriate, the amount of time (per week or month) the provider will spend on these tasks.
  • Think of your auditor as an additional resource to supplement any outside financial service providers and to assist you in negotiating services with an outside vendor.

Which One is for You?

The table that follows is intended as a quick guide to help incorporated groups determine, first, if their internal staffing for financial management is adequate and, second, which type of outside financial services to consider as an alternative to in-house management. Note that although budget size is an important factor in determining whether and how to use an outside service provider, other criteria such as phase of organizational development, complexity of fiscal needs, competencies of existing staff, and your own management preferences also affect the decision.

What If We’re Unincorporated?

For small groups starting up, and for certain types of groups on a more long term basis, hooking up with a fiscal sponsor may be a better option than immediately setting up a stand-alone nonprofit corporation. Although groups need tax exempt status to receive grants from many funders, they may not wish to address the question of whether and when to incorporate (institutionalize their efforts) until they have tested their concept’s viability. Groups able to find a compatible nonprofit home during this period (no easy task) have less of a need to incorporate prematurely. See the box for an explanation of fiscal sponsorship.

Even if the budget is sizable, fiscal sponsorship can work well if there is limited financial capacity, if the staff wants to concentrate only on programming, if future funding is uncertain, or if the sponsor offers a generous employee benefit package. However, by the time your budget approaches $400,000 to $500,000, you should consider incorporating if you anticipate continued existence. Some groups make this choice for psychological rather than financial reasons. Others are more comfortable remaining under the wing of a fiscal sponsor in perpetuity.

Where Can I Find More Information?

On shared administrative services:

Kohm, Amelia, David La Piana, and Heather Gowdy. 2000. Strategic Restructuring: A Study of Integrations and Alliances among Nonprofits in the U.S. Report on Phase I. Chicago, IL: Chapin Hall Center for Children, pp. 11 and 24-26. (www.chapin.uchicago.edu).

On fiscal sponsorship:

Unfortunately, there is very little published information available on this topic. The only good publication we know of which deals directly with the topic is a slim volume:

Colvin, Gregory. 1993. Fiscal Sponsorship: Six Ways To Do It Right. San Francisco, CA: Study Center Press. It’s available from the San Francisco Study Center at (www.studycenter.org).

The Nonprofit Genie (www.genie.org) has an FAQ section on fiscal sponsorship. So does About (nonprofit.about.com).

For a for-profit perspective on the above two topics, see Morten T. Hansen, Henry W. Chesbrough, Nitin Nohria, and Donald Sull. 2000. “Networked Incubators, Hothouses of the New Economy.” Harvard Business Review Sept-Oct: 74-84.

What is “Fiscal Sponsorship”?

Fiscal sponsorship refers to a service by which a charitable 501(c)(3) tax-exempt organization “sponsors” an unincorporated community group by receiving grants, contracts and contributions from the public on its behalf and employing staff and administering funds for the group, usually charging the group for overhead costs, typically at a flat rate. Often, the sponsor and the community group have complementary missions. By providing a mechanism that enables groups to organize around community concerns without having to incorporate separately, fiscal sponsors free founders and organizers from the need to devote large amounts of time to administrative tasks.

There is risk in fiscal sponsorship for both parties. Sponsors are legally responsible for the activities of sponsored groups, so must protect themselves against unauthorized or negligent actions that might expose the parent organization to financial or legal risk. The groups, on the other hand, are dependent on sponsors’ systems and staff for receiving, managing, and reporting on revenues and expenses and for benefits administration and employee relations.

Unfortunately, fiscal sponsorship is a poorly understood service of widely variable quality and availability. Groups serving as fiscal sponsors are very diverse, including community agencies from the very small to the very large, churches, foundations, and umbrella organizations established particularly to nurture and build specialized responses to social issues. The quality and span of fiscal sponsorship is dependent on factors such as the sophistication of financial and human resource systems, the availability of shared space, and the groups’ orientation toward providing other supports such as mentoring, grant writing, general organizational development work, and so on. It behooves parties on both sides of the proposed sponsorship to be clear about joint expectations and to do a thorough due diligence review of their potential partner in advance of formalizing the relationship.

In 1995, Stage One, a children’s theatre group based in Louisville, Kentucky, conducted an artistically successful but financially disastrous national tour. With the organization $180,000 in debt, local funders refused to provide loans or funds, doubting the organization’s ability to prevent another financial crisis in the future. At this point, a partnership evolved between Stage One and the Kentucky Center for the Arts (KCA), a larger organization that already provided Stage One with theatre space and could also provide administrative support and oversight.

The president of KCA proposed administrative consolidation as a way to maintain the artistic quality and scope of programming while boosting Stage One’s administrative capacity. Stage One paid KCA a management fee, which KCA used to hire Stage One’s artistic director and managing director-thereby gaining oversight authority. KCA also began overseeing Stage One’s financial systems, sublet better and cheaper office space to it, provided maintenance and security at no cost, let Stage One use its accounting and phone systems and offered a wide range of technical assistance. The artistic and managing directors of Stage One joined KCA’s management team.

The staff at Stage One felt some trepidation that the partnership might threaten the group’s independence. But their fears were quelled when employees of both organizations met and voiced hopes and concerns about the partnership. Ultimately, staff felt satisfied that the arrangement provided fiscal oversight but no “program invasion.”

With the assurance of KCA’s backing and oversight, funders lent their support to Stage One. As time went on, funders needed the assurance less and less, so that now the two organizations plan to negotiate an affiliation agreement rather than a management agreement-ultimately the relationship will move toward one limited to Stage One contracting with KCA for various types of administrative support.

This type of arrangement clearly requires a lot of trust and maturity, but it is notable for the fluid way in which the partners were willing first to find a creative solution to a crisis that left one partner vulnerable, and then later to evolve to a different and more peer based solution. It’s a great model for the kind of organizational agility we will need to build not just our organizations but our fields of work over time.

Source: The Chapin Hall Center for Children Discussion Paper, Strategic Restructuring