Improving Cash Flow Management In Challenging Times: A Primer

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Cash flow

In the Winter 2002 edition of the Nonprofit Quarterly, in her article entitled “Spinning Straw into Gold,” Ruth McCambridge accurately summarized the difficult financial situation many nonprofits are experiencing today. After taking some of the actions described in the article, such as accelerating fund raising, the next step in financial planning is to improve budgeting and cash flow forecasting. Budgeting and cash flow are linked as very important parts of financial management.

Effective cash flow management is the step you take after you have a sound budget. Cash flow forecasting is about thoroughly understanding the timing of your organization’s actual receipt of cash, related to the income you identified in your budget, and the payout of cash relating to expenses identified in your budget. To convert your budgets to accurate cash flow forecasts, you need to add a time frame both to the transactions that generate income and to those that relate to paying expenses. In addition, you need to understand and identify transactions that affect cash flow, such as borrowing money or paying back loans.

The recession, which is more than three years old, has turned into a depression for some nonprofit organizations. Federal, state and local governments have curtailed funds for some programs, producing a cascade effect that reduces income and, therefore, cash flow. Depending on the location of your nonprofit organization, there may have also been great pressure for additional services. Corporate and private donors have cut back on their contributions, or may have retargeted them. Foundations have for the most part suffered their third straight year of declining investment portfolios, which directly affects the amount of money they have available to give away.

For the 35-plus years that I have been a member of the accounting profession, clients have consistently begun engagements by asking about one aspect before all others: How does my cash look? Have you got any ideas on how I can improve cash flow? Can you get the bank to give me a loan?

Optimizing cash flow management is one of the most important tasks in achieving overall financial health. This concept applies to individuals, businesses and nonprofit organizations alike. The current environment demands a well-planned, intensive and aggressive approach to managing cash flow.

Obviously, an organization’s success in earning income in excess of its expenses will be an important factor in its cash flow and overall financial health. Please note that it is legal and ethical for a nonprofit organization to have income over expenses. Creating surplus monies for your organization will help ensure its ability to prosper in the future. However, making money alone will not ensure satisfactory cash flow. An organization may be profitable, based on its financial statements, yet still be unable to pay bills when they come due.

Organizations that find themselves unable to pay their bills often have not devoted proper attention to planning and monitoring both the nature and timing of cash inflows and outflows. A cash flow forecast for a fiscal year should be based on the organization’s budget, adjusted for the timing of actual receipt and disbursement of cash for each item in the budget. An accurate, detailed cash flow forecast, especially when used in conjunction with a detailed operating budget, will allow organizations to anticipate potential cash flow difficulties and quickly take effective remedial steps. If action is not taken quickly, the organization may be forced to borrow money to continue operations. This will result in additional expenses (interest) that would have been unnecessary with better cash flow planning. Of course, it is far better to borrow money than miss a payroll.

The fact that nonprofits typically rely on more than one revenue stream makes cash flow management a complicated task. Cash flow management issues and the strategies developed to address these issues will be contingent on the types, characteristics, sources, restrictions and requirements related to the income within an organization’s cash flow. For example, nonprofits that depend on grants for their primary source of income will find that their budgeting, cash flow planning, and cash flow management will probably be easier than for organizations that rely primarily on contributions or membership dues.

The IRS reports that the majority of nonprofits in the United States count one or more of the following three sources as a primary revenue stream:

  • Grants, from both governmental and private sources.
  • Contributions, from both private donors and corporations, and involving both cash and non-cash assets.
  • Fees for services, also known as program service fees.

Nonprofit organizations also depend on income from interest income, rent, membership dues and special events. Each of these revenue streams has its own unique cash flow considerations.

Grants: Nonprofits can be given grants by private grantors and by governmental/public grantors to fund for general use or specific activities. Grant agreements can directly—or by reference—require nonprofits to meet broad requirements, each of which may affect cash flow planning and management, and must be considered in developing cash flow forecasts and budgets. One of the most important aspects of cash flow management for grant-funded organizations is a thorough understanding of all grant conditions. When policy changes or tax receipts fall, government grants can stop. If your local bank is acquired by one of the giant banks that now exist, you could lose that source of grants, for example.
Income from Gifts or Contributions: Many organizations receive significant income from donors. An important cash flow concern related to donations is that donors may place activity and timing restrictions on how a nonprofit uses gifts or contributions. Additionally, donors may make pledges of support that will not be received until a later date, and often only after the organization meets a specified goal or fulfills a condition. For example, those organizations that counted on contributions from Wall Street firms have found themselves with reduced contributions, as businesses have moved temporarily or forever to New Jersey or other geographical areas.

Thus, effective cash flow management in organizations that depend upon contributions will require the following capabilities and procedures:

  • The ability to identify and track individual donations, gifts and contributions for which use and/or timing are restricted.
  • Careful review of the organization’s past experience with their donors (becoming familiar with seasonal differences and other patterns in giving can yield a wealth of relevant cash flow information).

Program Service Fees or Fees for Service: Some organizations count income earned by providing goods or services as a significant revenue stream. This type of income stream may be one of the most complex in terms of cash flow planning and management. For example, organizations that generate fees for services must have financial management systems in place that can quickly and accurately perform billing and collections, information management, and reporting and analysis functions.

Budget a Surplus: The first step in improving your cash flow is to improve your budget planning and budget process. Be sure to be as inclusive as possible in putting together your budget team—in this way you will get more complete information about anticipated problems and you will get more participation in terms of fundraising and the ability to control the timing of expenditures properly.
In addition, make sure that you budget a surplus, especially in difficult times. We understand that this concept may sound difficult or impossible, especially in bad times. It is perhaps a difficult political decision to sell. How do you budget a surplus when you may be laying off staff or closing a program? How do you justify it?

Well, you justify it because you want to survive and prosper in the future. Note: If your organization only receives cost reimbursement-type grants, you cannot follow this advice, but we would offer different advice: diversify and get some unrestricted money, to augment your autonomy as well as your budgetary flexibility. If you do not spend a dollar in a cost reimbursement grant you do not earn it. It’s important to properly spend your entire cost reimbursement grants when possible. Such grants are less common than they were. Assuming that some of your money comes from non-cost reimbursement grants, the sale of services or merchandise, and donations and dues, you can legally budget a surplus.

By budgeting a surplus, you accomplish the following: if your income projections are off
10 percent, and if you have budgeted a surplus of 15 percent, then your organization will still have a surplus at the end of the year—if you did not overspend the expense budget. Budgeting a surplus will protect you from a bad revenue or cost projection, and build up your economic power over the years. Perhaps every year, if you budget a 10 percent surplus, you will eventually have enough money to buy a building instead of renting space. Budget an additional surplus of 10 percent to improve your working capital or to set up an investment account for those rainy days that come along in our private and organizational lives.

First Budget Policies, Then Cash Flow Policies: One key point we would like you to take away from this article is that budgeting and cash flow are different, interrelated disciplines, both of which demand proper attention. Review your financial policies in the areas of budgeting and cash flow.

You should have specific criteria in your policies that clearly determine when an item of revenue can be shown in the official budget and when it cannot. For example, an optimistic board member is positive that their employer’s foundation will be glad to give your organization $10,000 in the coming budget year. That money should not be budgeted until your organization receives written acknowledgement that the contribution is official, and not just a kind wish by your board member. Different types of income need to be evaluated in terms of their respective safety for budgeting. If last year you received seven major corporate or foundation gifts (and you have maintained good communications with them and they have confirmed another contribution), then you may feel safe in budgeting the money. Of course, if Enron was one of those seven contributors, we would suggest not putting that contribution in your budget.

We have heard a number of stories over the past year regarding grants being made at lower levels than originally agreed to, so it may be a time to be particularly cautious in your budget assumptions.

The next step in your financial planning is to develop clear cash flow policies. This means that you pay careful attention to historical data in regard to the timing of revenues and expenditures, and that you limit those situations in which you do not know when or how much revenue will come in or when expenses will need to be paid.

In terms of revenue, you need to also systematically ensure, for instance, that the letter confirming that wonderful new $10,000 contribution has a specific date by which payment will be made. If you think the award letter triggers a check to you, and that particular organization cuts checks only the day before its fiscal year ends, you may have inadvertently created a cash flow problem (for instance, by hiring too early for the program being funded). Similarly, you need to plan on lags in contract reimbursements. Policies about payments for work performed under public contracts can be very quirky. Always confirm expectations regarding the timing of cash receipts in writing.

You also need to document the flow of cash over time. For instance, you need to know what the timing was for responses to the direct mail over the last two holiday seasons or how membership dues tend to filter in or, if you are in a fee-for-service environment, when what proportion of bills are paid so that you can judge when that cash is likely to be in hand. In a situation where cash collections are sliding overall, of course, you need to be more conservative about what you expect. Keep an eye on what is happening around you.

Obviously, you also need purchasing policies that tie approval of purchased items over a certain dollar amount to what you are likely to have in your budget. It’s not productive to only monitor cash inflow without monitoring cash outflow.
Your cash flow policies should also identify the methodology and timing of your cash flow reporting.

Be Mindful of Restricted Funds: The word restricted has a number of different meanings in the nonprofit world. We cannot address all of them in this article. The main caution here is that many nonprofits have monies that are restricted for endowment or other very particular purposes. In the end, the donor’s stated intention—or in the case of an endowment, the legal instrument—will determine how these revenues must be used. Income from an endowment designated for a particular employee’s salary or to pay for capital improvements to a particular building must be used (usually under state law) for that purpose and no other. A donation to fund a summer youth program is supposed to be used for that purpose. So your budgeting, cash flow policies and accounting procedures need to ensure adherence to restrictions placed on donations.

While many training sessions for fundraising suggest that you quantify what specifically will be paid through a donation, these tactics should be used advisedly. Too much restricted money limits your flexibility. One fundraising strategy that has worked well is to quantify in the solicitation that half of your donation will go to the “Children’s Shelter.” So the balance can be used for other purposes necessary for the organization’s operations.

Monitor Performance: The first step in monitoring your financial performance is to prepare your budget (versus actual financial reports) each month. See Sample Management Report—Income and Expenses on page 42.1 The report, we hope, is self-explanatory, but we will make a few observations.

The first three columns give the users information on the performance of the organization which compares the total budget for the year versus year-to-date financial information. The second three columns compare the nine-month prorated budget to financial information for those nine months. These three columns are the most important, since budget items either under or over budget clearly inform management what is going on financially. For example, contributions are under budget by $23,235 and the organization is still showing a projected surplus of $17,152—because management seems to have under spent most of the expense categories, obviously having paid attention to prior reports, which indicated a shortfall in contributions.

Your software may not be able to emulate this design exactly, but should come close. Of course, if you export data to a spreadsheet, you could emulate the exact design. If your financial staff says that is too complicated, calmly replace them with competent people, since this is a simple design for a competent professional. If your financial records have been properly set up, this report is a simple monthly task.

Many other reports are illustrated in our book on budgeting. The exact design you ultimately choose will depend on your organization’s size and needs.

The next step is preparing a cash flow forecast. Please see Sample Quarterly Cash Flow Forecast on page 43.2 Again, the report is self-explanatory, and may need to be more carefully adapted to your organization’s needs than the first budget report. This report will take more than an hour to prepare, but since it’s only a quarterly exercise, it can still be done, and is imperative for good cash flow planning. We have a number of different reports in the actual Cash Flow Management book, which will help your organization whether you have a $100,000 budget or a $10 million budget.

Projections: The size and complexity of your organization should determine the exact time frames you will use in your monitoring of cash flow. If you have one checking account and a budget under $100,000, the bookkeeper should give you a daily or weekly cash balance. This one-page report should include, for example, when the next payroll is due and any significant bills which will come due in the foreseeable future. If you have a million-dollar budget and five different revenue sources, a formal cash flow forecast for six months or a year in the future would be a great tool. Essentially, a cash flow forecast is prepared by taking your budget and then ascribing to both income and expenses the timing of their actual receipt and payout. Of course, the longer the period you try to project, the more difficult the task. If you have a lot of cash, then cash flow planning is easy. If you’re chronically short of cash, you really need to dedicate more time and effort to doing a better cash flow projection.

Act Promptly: The first commandment of effective cash flow planning is to do it sooner rather than later. The old saying “A stitch in time saves nine” applies to this situation, because good cash flow projections provide an early warning system. As soon as you realize your contributions are coming in under projection, it’s time to consider what action you can take to increase revenues, but also what you will have to do if the trend continues. You will begin to sort such questions as “Do you we really need that small branch office we set up when things were going well?” and “Can we break the lease and eliminate a chunk of expenses without impairing the overall mission?”

Of course, you must always be careful that you do not cancel a program or location that is at the core of your mission. You will need time to think through alternatives, and good cash flow projections will give you that time.

Establish a Line of Credit: Since it’s difficult to always be accurate in projecting cash flow, we suggest our clients have a standby line of credit. Once the line is established and approved by your bank, you can draw it down as needed and pay it off when not needed, reducing interest expense. Never use a line of credit for a capital purchase unless you have a grant or guaranteed funding in the near future. Most banks demand that you reduce a line of credit to zero for at least one month each year. Of course, this discussion assumes that your organization will be approved for the line of credit by a bank, which of course is not always the case.

If Needed, Obtain Training: Helping nonprofits improve cash flow can be a complicated and labor-intensive task. It requires substantial knowledge of relevant environmental, organizational and financial issues. A key step in any cash flow improvement effort is for those directly involved in the process to obtain proper training and education. Beyond that, all staff, management and board members of nonprofits should focus and understand their respective roles in effective cash flow management. Staff members at all levels need to understand their decisions have a direct impact on the organization’s cash flow. This situation may be easily avoided when proper policy guidelines exist and when they are understood and supported by all staff members.

When nonprofits and their boards, consultants, finance and management executives, and all involved staff understand the relevant issues and actively participate in ongoing cash flow management, cash flow will always be significantly improved. Good Luck.

Box: Ideas for Avoiding and Dealing with Cash Flow Problems

  1. Review and revise budget, cash flow and financial reporting policies.
  2. Train all staff in those new or revised policies.
  3. Learn to budget a surplus.
  4. Learn to effectively monitor financial and cash flow activities on a monthly basis.
  5. Do the paper work to create a letter of credit or an actual loan or mortgage, depending on your financial circumstances.
  6. Ask your bookkeeping department to slow down bill paying as much as practical. Never stop paying required payroll taxes and fringe benefits.
  7. Consider keeping positions that are currently vacant open for a longer period.
  8. Instead of layoffs, consider asking employees to cut their hours, so perhaps four employees work the hours of three employees in normal times.
  9. Consider laying off part-time staff.
  10. Ask donors or grantors to accelerate payment of funds due you.
  11. Make sure reports required by grantors or clients are going out on time so you can be paid on time.
  12. Consider staff layoffs, or sales of property that you no longer need or use.
  13. Look for new sources of income.
  14. Consider closing branch offices.
  15. Consider stopping some elements of operations.
  16. Consider recruiting volunteers to handle certain staff functions.

Endnotes

  1. This budget report is reprinted from The Budget-Building Book for Nonprofits, (Jossey-Bass) co-authored by myself and Bill LaTouche. Also, please visit my website Dropkin.com for a free software product based on this book which was designed to help organizations prepare better budgets.
  2. This cash flow spread sheet is reprinted from The Cash Flow Management Book for Nonprofits (Jossey-Bass) co-authored by myself and Allyson Hayden.