By Caroline Culler (User:Wgreaves) (Own work) [CC BY-SA 3.0 or GFDL], via Wikimedia Commons
December 21, 2015; News & Observer (Raleigh, NC)

Board members are satisfied because the nonprofit theatre they are overseeing has reported back-to-back surpluses in the previous two years, making a serious effort to reduce its long-term debt. Every month, the CEO and CFO meet with the finance committee, which includes four members with solid accounting and finance backgrounds. Numbers for the 2013-14 fiscal year are audited, and, as in previous years, no red flags are raised. The city, which pays the nonprofit hundreds of thousands of dollars every year to run its programs, conducts semi-annual reviews of the organization and attends most board meetings.

If you think that sounds like the ingredients for a relatively transparent nonprofit organization, albeit a not exactly financially healthy one, you would be right, as it hits many of the standard benchmarks for accountability that those in the philanthropic community have come to expect. So how exactly does it work that the historic theatre we’re talking about, Durham’s Carolina Theatre, has suddenly discovered that it is, in fact, more than $1.1 million in debt?

On the surface, and in the minds of board and staff members, things have been going along swimmingly. In recent years, the theatre has been working to expand programming in the 1,000-seat Beaux Art venue to more than 100 events a year, hiring additional staff and adding weekend matinees. So it no doubt came as a quite a surprise to audience members, not to mention donors, when the nonprofit’s leadership on Monday announced that, in addition to its negative fund balance of $225,000 at the end of its 2014 fiscal year, the theatre had run up an additional $800,000 in debt since 2013.

Chief executive Bob Nocek and board chair Scott Harmon attributed the situation to “faulty accounting,” not malfeasance or fraud, and in a statement put out by the theatre, they express confidence that the theatre can “turn this situation around in the coming years.”

While this “situation” speaks to the struggles among nonprofits in general to diversify their revenue streams, manage cash flow and maintain a positive fund balance, the questions remain: How did this go unnoticed? Under what kind of scenario is this in any way likely or plausible?

Board chair Harmon states that it’s “not unusual” for arts organizations to carry deficits. That is true, and nonprofit arts organizations in particular struggle to grow new audiences while competing in an increasingly brutal fundraising arena, competing with a host of other issues and interests. “We live hand to mouth and on the edge of our cash flow,” he says. Also true. But an accumulated debt of more than $1 million over the course of a year in a theatre operating with a budget of barely $5 million?

City Manager Tom Bonfield has indicated that the issue will be on the city council’s agenda in 2016. “We just have a lot more questions,” he said. Durham gives the theatre around $650,000 a year to run the venue and manage its rental activities. To address short-term cash flow, the theatre has now asked the city to give it an advance of $75,000 a year on each of the remaining eight years of its contract. In addition to a review of the theatre’s finances twice a year, the Community Development Department’s director attends most board meetings, along with a city councilwoman who sits on the board.

In a shockingly low-key response to the situation, Nocek assured his donors, audience members, and Durham taxpayers that the theatre is going to be “a little more sensitive to risk, and a little more selective in terms of what we present.” Moving forward, the theatre will pay down the debt by “achieving long-term profitability.” Exactly how that will play out remains to be seen. For now, the theatre plans to cut back its programming to sixty to seventy performances a year, and has already begun cutting staff, initially through attrition. In the theatre’s statement, officials promise that the steps it takes to resolve its financial situation will be “barely noticeable” to the theatre’s fans, and will not affect their “theatre-going experience.”

What’s not at question is the theatre’s popularity and artistic reputation, and one hopes that the city and corporate and philanthropic communities—which include Duke Energy, PNC, the A.J. Fletcher Foundation and the F.M. Kirby Foundation—will continue to support what is clearly a beloved institution in Durham. The bigger question is what the city and those donors will demand, rightfully so, by way of future accountability, as well as the legitimate questions they will want answered.

NPQ has seen a number of cases lately of organizations that have been unaware that they were running large deficits over years. All the trappings of financial oversight are there, but none of the substance. In this case, the CFO the organization chose had what is reported here to be a positive track record at other organizations, so what is going on?

Perhaps it makes good sense to have on hand, wherever possible, an outside contracted accountant reporting to the board who can judge when changes in financial practice have led to a lack of proper monitoring. In her article on spotting red flags, Kate Barr writes:

This question comes up all too often: People’s Health Clinics in Baltimore closed in June 2014 with almost $500,000 owed to the IRS for payroll taxes, a cancelled federal grant, unpaid rent and other bills. Locally, we’ve been following the troubles at Community Action of Minneapolis and St. Paul-based education services provider TIES’ critical audit report and financial challenges. Did the boards of these organizations miss the red flags like diminishing cash, ballooning debts, and recurring deficits? In each of these news stories there is documentation, audit reports, and other evidence of problems. If we can read about the information now, why didn’t the members of the board see the problems and address the problems?

Depending on the business model of the organization, small changes can result in a lack of clarity and that lack of clarity can lead to small and large disasters.