How to Research a Nonprofit’s Financial Strength—Moderate Approach
Is your potential grantee financially sustainable? In other words, can it reliably support its core programs and services? What is its financial track record? Where is it vulnerable?
Strong programs and demand for services do not automatically equate with adequate funding – to the contrary, “success” typically means more money is needed! Nonetheless, understanding an organization’s financial situation is critically important because doing so will give you a clear line of sight into its long-term prospects, its ability to put additional funds (yours) to good use, and a sense of where it would (or should) use your support.
This tool runs you through some helpful indicators. Among other things, you’ll be looking to see that your potential grantee isn’t overly reliant on a small number of funders, that it has enough cash on hand to weather an unexpected storm, and that it has robust financial reporting systems that support sound financial management. If you find that the organization is less financially mature, you’ll be considering whether its leaders have a solid plan to achieve a level of financial stability, and whether it has the capabilities it needs to put that financial plan to work. Finally, you’ll ascertain how well prepared its leaders are to handle changes in expenses and revenues, which often crop up unexpectedly in the nonprofit world.
Your comfort with different levels of financial sustainability will depend in large part on the role you hope to play in the organization’s trajectory. For example, you will likely find less financial sophistication and certainty from a small, entrepreneurial start-up than from a large, established nonprofit. But maybe you want to help that smaller organization get off the ground—or maybe you want to help the larger organization expand to new cities. What matters is that you learn enough about the organization’s financials to determine whether your support will be put to good use.
As you begin your financial research, you’ll first want to look out for signs of true financial peril. Is the organization in dire straits? Unless you really believe your support will help the organization make a dramatic turnaround, you will probably say no to supporting an organization in this situation.
Look for a few key warning signs before you spend significant time doing more intensive financial research. You will want to do this respectfully, understanding that financial troubles are a touchy issue. Instead of working directly with the organization’s leader, for example, you might ask first to see the organization’s financial statements. What can you infer by looking at those reports? You might also ask to be put in touch with a member of the nonprofit’s financial management team or board audit committee.
If you uncover no suggestions of financial jeopardy, continue to gather a more nuanced picture of the organization’s business model and how your support might be put to use.
Full financial assessment
An in-depth financial assessment examines three components of an organization’s financial health: financial management, sources of revenue, and cash position.
For a fuller picture of the financial trials nonprofits face, see Clara Miller’s excellent article, The Looking Glass World of Nonprofit Money.
Think of this process as one more way of getting to know your potential grantee. If you discover vulnerability in its financials, seek the root causes. Look for ways that your support could fundamentally strengthen the nonprofit’s financial position. For example, funding an investment in an IT system to provide better real-time financial information could open the door for better financial management; alternately, funding a development staff position might lead to a marked increase in the organization’s revenue.
Nonprofit financial management principles turn for-profit principles on their heads. In the nonprofit world, for example, increased demand for services often means an increase in costs (to provide those services) with no associated change in revenue. Such a scenario leaves an organization scrambling for funding to keep up with demand. What’s more, nonprofits don’t have access to the same capital markets as for-profit enterprises. That means that they do not have the option of selling shares to fund growth or weather tough times, but must find funds elsewhere. Given this challenging context, the strength of a nonprofit’s financial management team is one of the best indicators of its ability to survive and grow.
The size of the organization’s financial management team will vary. A large organization may have a dedicated Chief Financial Officer (and maybe even staff), with support from selected board members and/or board audit committees and the executive director. In a small organization, the executive director might be flying solo. There is no “magic number” of people or positions to look for; instead, you will likely form an impression of the quality of the staff through your personal interactions. Consider other means of validation as well—such as the confidence of other funders who have vetted the organization. Keep in mind that in younger organizations, sophisticated processes and procedures are less likely to be established, but the basics should still be in place to assure sound management.
Regardless of size, at a fundamental level you want to hear that the organization has a strong grasp of how its costs reflect the strategy it is trying to achieve. First, how are the organization’s priorities reflected in its budget? For example, if the organization emphasizes the importance of its advocacy work in its strategy, but you see only minimal expenditures on advocacy, that is a red flag.
Second, what does it actually cost the organization to achieve results? Understanding how the organization thinks about this is a great way to see how it translates its strategy into action. This line of inquiry doesn’t necessarily require a complex calculation, but it is a good idea to gauge how management thinks about costs on a “per beneficiary” or “per outcome” basis. If the numbers they share seem wildly high or low, dig deeper to understand more about the feasibility of the organization’s goals.
The organization’s financial team should be able to answer a few additional questions (listed below), and provide you with the documents you request. They should also be comfortable seeking input from the board when appropriate. If team members have difficulty with your requests or seem uncomfortable communicating with directors, that’s not necessarily a negative indicator; instead, it’s an opportunity to ask yourself, “Could I structure a grant to help the organization hire or train to fill this need?”
Ask the following questions to inform your perspective on an organization’s financial management:
Financial leadership’s strength and ability to support the nonprofit’s strategy
- Who, currently, is responsible for the organization’s financial strategy? What type of formal education and work experience do they have?
- Can you share how your strategic priorities are reflected in your budget?
- Does the organization have detailed budget projections based on what is required by the strategy?
- Does the organization have a clear understanding of its operating costs (for example, has it conducted a “true cost” analysis, where it has estimated allocations of its central costs to its programs)?
- What resources or programs would you add or cut if your revenue grew or shrunk by 10 percent? How flexible are your expenses (for example, do you have significant capital expenses or debts that require servicing?)
Strength of the nonprofit’s financial processes
- Do the organization’s financial reporting systems provide the necessary information in a clear and timely way?
- Does the organization have systems in place to evaluate its financial progress and refine its budgets and plans? (These might include management reports, or other documents that provide an overview of current financials against plan, such as monthly dashboards.)
- How is the board involved in monitoring the organization’s financial position?
- If the organization has over $500K in revenue, check to make sure it has a recent audit and that you understand the comments.
If after this assessment, you still have questions, click here for a method of reviewing an organization’s revenue sources and cash position.
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