Demystifying Charity Finances

Charities that run excellent programs, cultivate involved trustees, and attract generous backers still often struggle to pay the bills each month. That was the paradox facing

Norma Hurlburt, head of the Chamber Music Society of Lincoln Center. As she prepared for two major milestones — a 40th-anniversary celebration and the opening of a refurbished concert hall — she was also scrambling to cover a $2-million budget shortfall.

“In the arts the ideas always outrun the means,” she says.

Hearing of her dilemma, the Robert Sterling Clark Foundation gave Ms. Hurlburt a grant to hire the Nonprofit Finance Fund, in New York, to analyze the music society’s operations. The Nonprofit Finance Fund specializes in lending money to housing groups and provides financial advice to charities of all stripes through its Nonprofit Business Analysis program.

Brent Copen, an associate director at the fund, translated the music group’s finances into colorful slides that showed where each dollar came from and where it went. With $5-million in annual revenue, the chamber society had been expanding by performing new works and staging concerts for children.

But the results of the study were somewhat startling to Ms. Hurlburt, a pianist by training, and her board. To pay for the anniversary celebration, an expanded schedule of 115 concerts, and the opening of the new hall, it would need to raise about $2-million more. Or it needed to scale back.

“It made you realize precisely how much harder you had to work,” says Ms. Hurlburt, who chose to raise more money from foundations and individual donors.

Ms. Hurlburt’s experience is typical of charities on the receiving end of a review by Nonprofit Business Analysis. The program is aimed at organizations with budgets of $500,000 to $10-million that are contemplating growth. Clara Miller, who started the Nonprofit Finance Fund in 1980, developed the business-analysis service after finding that the reviews it had been doing as a lender were also valuable to the organizations’ boards. Since 2002 about 600 organizations have undergone such analysis as part of the program, at a cost of $10,000 to $25,000 each.

Financial Advice

The Nonprofit Finance Fund began with the modest goal of advising charities on how to save money on their electricity bills. It evolved over time, moving into consulting projects. Its main business is lending money to housing organizations, about $160-million to date. Most of its work is paid for by grants.

As the organization has moved into the business of reviewing charity finances, it has spotted several themes that run through the organizations: Charities can be analyzed according to their “business lines,” growth can be financially devastating to nonprofit groups in the short term, restricted money from grants or an endowment can be a mixed blessing, and spending money on overhead is not necessarily a bad thing.

“If you put a dollar on a child’s forehead, that child will not learn to read. You need something in between,” Ms. Miller says.

That “in between” is what the business-analysis program seeks to understand.

Charities tend to learn about the program through workshops or from foundations. To participate, boards must approve the six- to eight-week review. During that process, a two-person team at the Nonprofit Finance Fund collects five years of audits, and the charity’s executive director writes a paper detailing the group’s challenges and opportunities. The numbers are then analyzed and put into a format that maps out how resources are being used.

A crucial point of the review is to deduce how the financial structure of a group relates to its mission. After completing the initial analysis, the Nonprofit Finance Fund sets up a meeting with the executive director and the group’s staff members and presents its findings in the form of slides that show various facets of a group’s finances and operations and how they relate to each other.

After the meeting, the slides are given captions and edited, and a final document of 40 pages or so is produced. The Nonprofit Finance Fund then presents the document to the organization’s board of directors.

“It’s the ‘aha’ moment for the board. There are exclamations of ‘Hallelujah,’” says Geeta Pradhan of the Boston Foundation, which is spending $250,000 on financial reviews for 30 urban social-service agencies that it supports.

Understanding Money

The idea behind the reviews is to help charities understand the financial implications of the decisions they have made as they carry out their charitable programs.

Phoebe Boyer, head of the Tiger Foundation — a New York organization started by the hedge-fund manager Julian Robertson — says the need for such financial studies increased after the 2001 terrorist attacks forced many New York charities to consider cutbacks. The Tiger Foundation has paid for 20 Nonprofit Business Analysis reviews so far.

“We look at cost per enrollee, per graduate, per job-placement candidate,” she says. The Nonprofit Finance Fund helps standardize that process.

Rebecca Thomas, one of the consultants who does the charity reviews, says the process helps organizations shift gears before getting too deep into a financial hole.

For instance, Ms. Thomas says she worked with the Loft Literary Center, in Minneapolis, which had been offered a major gift toward its endowment. The group realized that if it took just 5 percent a year from the endowment gift — the standard many groups use — the amount would have made only a marginal difference to the operations of the group, which suffered from constant short-term cash shortages.

After Ms. Thomas presented the executive director and board with the financial review, the charity was able to convince the donor that instead of creating an endowment, it would be better to set up a cash reserve, to be controlled by the charity’s board members.

“When an organization embarks on an endowment campaign, it sucks resources away,” Ms. Thomas says. “Meanwhile normal fund-raising activity drops off a cliff and you can’t make payroll.”

In another case, a youth-counseling organization in Connecticut, which the Nonprofit Finance Fund declined to identify, expanded rapidly into three new cities. But government money lagged and then declined. The group ended up pulling out of two of the cities.

During the financial review, it became clear that what was really weighing down the operation was not so much the new programs as a large building the organization owned. The charity had an office in the building, but also acted as a landlord, an effort that brought in relatively little income for the charity.

The review found that by selling the building, the charity could free up a lot of cash that could be used as a cushion to support future growth. The group ultimately agreed and created a healthier financial structure.

Facilities Questions

Real estate comes up a lot during Nonprofit Finance Fund’s reviews.

In one case a Montessori school realized that by spinning its building into a separate nonprofit group and becoming a renter it could lower its operating costs and keep tuition low.

The fund’s Mr. Copen tells another story of a housing group that ran a program to lend money to low-income buyers. If the buyers defaulted on the loans, the group foreclosed and then spent money to renovate the properties before selling them. Until the financial review, the group did not realize that every single time it went through this process, it was a net drain on the organization because sale prices were not covering the renovation costs.

While every analysis is substantively different, one common thread is that the presentation of the review by the Nonprofit Finance Fund is visually appealing and easy to understand — even to number-phobes, say charity leaders who have participated in the program.

“You can’t run an arts organization by the numbers. Numbers have to have a gentle reality,” says Ms. Hurlburt of the Chamber Music Society.

The analysts who do the reviews try to be soft in their delivery, rarely criticizing decisions charities have made about their programs or even making specific financial recommendations, such as “sell that building.” The soft delivery and emphasis on the way information is presented often leads charities to the same conclusions that the Nonprofit Finance Fund’s consultants would make.

“You could bring any business person in to read the riot act, but that would have a different effect,” Ms. Hurlburt says.

Youth Speaks, a San Francisco group that trains young people to do spoken-word performances, recently got a financial review courtesy of a grant from the Doris Duke Charitable Foundation. Its charismatic leader, James Kass, a slam poet, had whipped up a lot of interest in Youth Speaks, and its annual budget grew in five years from $500,000 to $1.3-million. Its payroll increased from six staff members to 14.

“We had extraordinary growth and put the money into the programs, but not into the back end,” he says.

That meant that the burden on Mr. Kass to handle fund raising and finances, despite his lack of training in those areas, continued to grow. Grants came in, but they were usually earmarked.

The review, says Mr. Kass, was “very revealing. It showed a transition from unrestricted to restricted dollars.”

The group’s cash flow was also very erratic. Some years individuals would pony up the majority of the budget, while foundation support dropped. Or the reverse would happen, even as overall support grew.

The growth “was great for the programs, but not for the sustainability of the organization,” says Mr. Kass.

The review’s findings convinced Mr. Kass to make hiring a finance and fund-raising team a high priority so that Youth Speaks could continue to grow.

The financial picture now is more transparent — but cash is still tight. “That’s a constant,” says Mr. Kass.