Field Notes: Stewarding Mission Through Risk Management

The ongoing conversation on the particular challenges of nonprofit finance has a new contribution: a recent report from Oliver Wyman and SeaChange Capital Partners on building a solid foundation for nonprofits through risk management. Released after the fall of New York’s nonprofit giant FEGS and based on a study of New York City-based nonprofits, the recommendations are meant to help nonprofits remain risk-averse while maximizing success in delivering on their missions.

Citing structural challenges like high-quality staff recruitment and retention, overwhelming reliance on government funding, and the colossal job of nonprofits in tackling some of the world’s greatest problems, the report points to underlying challenges in the financial models of many nonprofits:

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.

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.

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.

Through interviews with nonprofit leaders and research on for-profit companies, the report offers risk management practices that could lead to a healthier nonprofit sector. Nonprofits should also reassess long-term trends in the operating environment, compare financial performance to peers in the sector, and set financial stability targets annually:

Since earning the requisite capitalization is so difficult, organizations must think creatively about how to build the necessary reserves. Ideas might include one-time capital campaigns and pledged funds from trustees for use in a crisis. Organizations should put in place monitoring and governance processes to ensure that reserves are not inadvertently used to fund operating deficits.

Large organizations are also urged to change the way they report their financial statements:

Larger organizations should summarize their financial and programmatic results in a short plain-English report similar to the management discussion and analysis section of the SEC’s Form 10-K. This report should also cover their opportunities and risks in the context of internal and external conditions. Creating this type of report would give a sense of urgency to the underlying processes. It could also help reassure stakeholders such as trustees, banks, and regulators that organizations are doing all they can to ensure long-run sustainability.

The challenge of managing the economics of a nonprofit human services organization has been chronicled over several decades by sources such as Nonprofit Quarterly and the Nonprofit Finance Fund. Arguing that some gift horses are more of a Trojan Horse, Heron’s Clara Miller underlined in 2004 that risk-management practices are core to successfully balancing mission, capacity and capital [PDF]:

If any one side of the triangle changes, the other two must change. This takes place whether it is planned or not, whether the giver intends it or predicts it or not and, above all, whether anyone wants it to happen or not! In that the recipient is often more anxious to receive than the giver is to give, the momentum of the transaction is from the giver to the receiver. Therefore, the giver has more power to carefully consider and potentially re-steer what might be a dangerous course… The more restricted a gift, the lower the net positive financial impact, and therefore the higher the draw, most immediately on capacity and eventually on capital and mission.

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