March 15, 2016; Politico New York
In an insightful report from SeaChange Capital Partners and Oliver Wyman entitled “Risk Management for Nonprofits,” the full force of the array of financial risks faced by government-funded nonprofits is laid out in detailed but excruciatingly simple terms, followed by recommendations for risk management by boards. The report was done in the wake of the meltdown at FEGS, the largest social service agency in New York but most readers even from nonprofits that are not government funded will find the report disturbingly resonant. To provide a taste of the quality of this report, we have excerpted just one section about the structural challenges faced by many nonprofits. The authors say that many trustees do not understand all of the conditions inherent in overseeing a nonprofit and its budget.
- Tackling the hardest problems: Nonprofits address economically intractable and politically unappealing problems. This is true even though charities arose long before government social programs and have helped shape the public agenda.
- Cost-minus funding: Most nonprofit funding, especially in health and human services, comes in the form of government contracts or restricted grants that virtually guarantee a deficit. Government contracts also create working capital needs because funding arrives after expenses are paid. These funds are also subject to unpredictable delays in payment.
- One-way bets: Nonprofits face contingent liabilities that can swamp them financially. These include claw-backs for disallowed expenses, after-the-fact audits, and unilateral retroactive rate reductions.
- Zero-sum philanthropy: The total supply of philanthropy is largely fixed. Large organizations working in difficult issue areas will always be overwhelmingly reliant on government funding.
- Cost disease: Nonprofits provide face-to-face, labor-intensive services that do not get more productive from technology. The real cost of these services has risen substantially over time and is likely to do so in the future.
- Recruiting and retention: Nonprofits face structural challenges in recruiting and retaining high-quality staff in finance, accounting, technology, and back-office functions. Factors driving this situation include the small size of many organizations, the challenge in providing career development, and competition from higher-paying for-profits.
- Gales of creative destruction: Nonprofits operate in a dynamic environment. Challenges include demographics, funding fashions, political priorities, and real estate costs. The weak financial position of many nonprofits can make it difficult to respond.
It is no surprise that many nonprofits are always living close to the edge.
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Clara Miller described the odd financial realities of many nonprofits a decade ago in “The Looking Glass World of Nonprofit Money: Living in For-Profits’ Shadow Universe,” and many of her points are emphasized in this report.
The report goes on to make recommendations on risk management derived from other government-funded nonprofits that suffer from similar conditions. These would tend to apply to larger organizations but can be adapted for use by smaller ones very easily.
As with anything else except fundraising, risk management can become a board obsession, but as the authors point out, once a large government-funded nonprofit becomes financially distressed, it can quickly move into a death spiral, as FEGS did.
Again, this report should be read in its original form because it will gain nothing from our translation. And pass it on!—Ruth McCambridge