Inside the World of Nonprofit Finance
BOSTON, MA — Though nonprofits provide critical services to society there is little understanding of the way in which the nonprofit sector is hamstrung by irrational financial rules the for-profit sector doesn't encounter, according to a new article in the Spring 2005 edition of the Nonprofit Quarterly.
In "The Looking-Glass World of Nonprofit Money: Managing in For-Profits' Shadow Universe," Clara Miller, president and CEO of the Nonprofit Finance Fund (NFF), uses the following hypothetical illustration to show how for-profit and nonprofit financial practices operate in very different ways: "”¦ you're the owner of a restaurant. Your paying guest comes to pay the bill, offers a credit card, and prepares to sign the charge slip. But before signing, the guest says, "I'm going to restrict my payment to the chef's salary. He's great, and I just want to make sure I'm paying for the one thing that makes the real difference here. I don't want any of this payment to go for light, or heat, or your accounting department, or other overhead. They're just not that important. The chef is where you should be spending your money!"
Miller writes: "”¦ enter the nonprofit sector, and it's a new and irrational world, like stepping through a looking glass. The rules, when they apply at all, are reversed, and the science turns topsy-turvy. Not only are nonprofit rules that govern money - and therefore business dynamics - different from those in the for-profit sector, they are largely unknown, even among nonprofits and their funders. Or at the very least, they remain unacknowledged and unspoken. Some say they are a closely guarded secret. Even when revealed to for-profit cognoscenti, they are so at odds with the listeners' familiar world as to prompt confusion, disbelief, and related feelings of cognitive dissonance."
The article shows how seven commonly used business rules - including "any profits will drop to the bottom line and are then available for enlarging or improving the business" and "overhead is a regular cost of doing business, and varies with business type and stage of development" - do not apply today in most nonprofit situations. Instead, the sector tends to operate blindly without any clear approach to finance and is hamstrung by its own rules or limitations imposed from the outside, such as restricted funds that may not be used for general operations or fundraising.
Miller asks: "Why are these ”˜facts of nonprofit business life' important, or even relevant? For one thing, in light of these rules, it's fairly easy to see why executive leadership in the nonprofit sector is difficult to find and retain (and keep from burning out); why nonprofit self-sufficiency is in reality an ephemeral state in the tradition of Brigadoon and Camelot; why sustainability is so difficult for managers to attain without reaching substantial scale over many years; why keeping the promise of social enterprise is a complex problem for managers from Edison Schools to the PTA; and why economies of scale are so difficult for the sector to attain while maintaining program quality. All the good will, brain power, capacity-building, finger-waggling, standard-setting evaluation and impact measures will eventually be undermined by the way we finance these enterprises. The financial system we have put in place and support is the worst enemy, not only of the improvements everyone is trying to make, but of the socially critical programs and services this system is meant to sustain. All efforts to improve the sector will be merely palliative without essential, systemic reform of the way the rules of finance work."
Commenting on the article, Nonprofit Quarterly Editor-in-Chief Ruth McCambridge said: "Every now and then the Nonprofit Quarterly publishes an article like this -- an instant standard. This article takes on the reasons for cognitive dissonance we sometimes experience in finding, for instance, that organizational growth has restricted our ability to be effective. Quite simply, Clara says, money often works very differently in nonprofits than it does in business. There are different rules to be observed and variables to be considered. Not only is this a must-read for executive directors, but it is a must-pass-along to many others."
Miller's article ends on a positive note: "With self-discipline and a little creativity, we can improve the business environment for our sector, creating a more intelligent, nuanced system of finance for "social enterprises," and nonprofit services. This will work better than the current approach, which substitutes well-meaning but counterproductive rules of thumb for sensible, informed financial practices. And it will allow us to power sustainability, management improvement, and innovation in the sector by leveraging appropriately some effective and time-tested rules of business."
NFF specializes in providing impartial analysis and flexible (and, frequently, unsecured) financing that nonprofits typically are unable to get from other sources. Nationwide, NFF works with over 170 funders including financial institutions, foundations and government agencies to develop new ways of meeting the capital growth needs of the nonprofit sector. Established in 1980, NFF serves nonprofits in Washington DC, the San Francisco Bay Area, New York City, New Jersey, New England, nationwide through our partnership-based National Alliances Program, the Greater Philadelphia area, Detroit, and Chicago. NFF has loans outstanding in excess of $38 million and an overall cumulative record of over $100 million in loans made. Beyond direct lending, in partnership with others, NFF has also awarded $13 million to nonprofits for building reserves, cash reserves and endowments through its multi-year asset-building product; $1.2 million in loan guarantees; $10.1 million in 9/11 recovery grants; over $2 million in planning grants; and $6 million in capital grants. In total, NFF has leveraged more than $500 million of capital investment into its nonprofit clients.
Located in Boston, Massachusetts the six year old Nonprofit Quarterly is targeted at nonprofit leaders in the same way that local business papers, Harvard Business Review and the Wall Street Journal are for business leaders.