Five Questions for... the people behind the Urban Institute research. In traditional interview format, our experts talk about the nature of their work and offer insights on what they've learned.
Thomas H. Pollak, coauthor of "Washington-Area Nonprofit Operating Reserves" answers five questions about local nonprofits’ financial health. This first-of-its-kind study looks at the operating reserves of public charities—from soup kitchens to job-training centers to local arts groups—as reported in their 2006 tax filings. The study found that most nonprofits had weak reserves before the downturn, leaving them vulnerable to effects of the recession.
July 13, 2009
1. Why are operating reserves a good gauge of financial well-being?
It’s like having money in your bank account. If you have a steady job and everything’s going along smoothly, you don’t need to draw on your savings because you’re getting a paycheck month after month. But if someone in your family gets sick or you lose your job, then it’s wise to have something to fall back on. The same holds true for charitable organizations. If revenue drops or funding stalls, they can rely on their reserves to maintain services and stay open. Healthy reserves are even more important for nonprofits whose funders don’t pay on time. The D.C. government, for example, was notorious for a number of years for late payments.
In the era of easy credit, nonprofits didn’t necessarily need a big cash cushion. If an organization had a good track record with its bank, it could secure a line of credit or get a loan. But with credit drying up, it’s very difficult for organizations to find new resources should they face unexpected problems.
The ideal operating reserve is at least three months. The exact amount needed varies with the stability and predictability of the nonprofit’s funding stream. Some government-funded organizations run the risk of having their funding eliminated with little or no warning. We’ve seen that happen to some local nonprofits! The organization’s expenses matter too. If you’re providing disaster assistance or emergency relief, you need a huge cushion because you can’t predict when your services will be needed.
2. Of the 2,658 charities in your study, 57 percent had operating reserves of less than three months; 28 percent had no reserves at all. Did these findings surprise you? And why did so many groups have low reserves?
Yes, the numbers were higher than expected, but the reality is that many nonprofits live hand to mouth. Many human service charities, such as homeless shelters, spend as much as they can on services so they don’t save as much as they ought to.
Also, many foundations will reimburse you only for direct program expenses, so organizations dependent on foundations have a tough time building up any sort of reserve. There’s been a lot of interest in the past four or five years—some of it springing from our work on overhead costs—in encouraging private and community foundations to relax their rules governing how funds can be spent. That would allow nonprofits more control over their funds, and they could direct money to general operating support, if necessary, freeing up other contributions for use in building a reserve.
Those at the helm of organizations with low reserves weren’t necessarily being irresponsible. Nobody expected the economy to fall as quickly or as far as it has. Revenues dropped faster than expected at the same time credit dried up. New organizations in growth mode may have been focused on getting off the ground, not necessarily on saving.
3. Your study looked at the expenses, revenue, and mission of organizations to see if certain traits make one nonprofit more vulnerable than another. What did you find?
Larger nonprofits and nonprofits that rely chiefly on government grants and program revenues tend to have weak reserves. About half of the organizations with less than $100,000 in expenses have less than a three-month cushion, compared with 70 percent of organizations with $5 million or more in expenses. Larger organizations may have better access to credit markets or a steadier cash flow, but they’re still vulnerable to downturns if they don’t have enough socked away.
When we looked at revenue sources, we found that nearly three-quarters of nonprofits rely mostly on government grants, and two-thirds of nonprofits that live off program service revenues reported less than three months in reserves. Maybe these charities’ grants or fees were tied to reimbursement for specific services. If so, they couldn’t put money away. That’s why unrestricted private donations are the best source of revenue—you can apply them to anything the nonprofit needs.
Some more sophisticated organizations may be able to negotiate a standard “fee” when receiving government or private contracts. This fee can be used as the organization sees fit, including for operating reserves. However, judging by the level of reserves for those relying on program service revenue or government grants—often treated as contracts by government—there’s no evidence that this has made any significant difference.
We didn’t see any major trends based on a nonprofit’s mission. No one type really stood out as stronger or weaker than another.
4. When you looked at data from 2000, 2003, and 2006 tax forms to see how public charities survived the 2001 downturn, what did you find?
Almost one in six organizations that filed a tax return in 2000 did not file in 2006. They either closed or shrunk so much that they didn’t have to file an annual tax return. Another 2 percent that filed in 2000 had gross receipts of less than $100,000 in 2006. The nonprofits that shut down or shrank had low reserves—a median of only 21 days worth of expenses. Nonprofits that survived to file tax returns in 2000, 2003, and 2006 had median reserves of two months.
The decline wasn’t as dramatic as I expected after 2001, but today the situation is far worse. Major foundations lost nearly 30 percent of their endowments between 2007 and 2008, state and local governments are cutting back, and private donations will likely be down substantially this year—just as demand for many nonprofit services are going up.
5. What recession effects are we already seeing in 2009?
Many nonprofits tell us that they may go out of business or merge—they just don’t have a lot to fall back on. With the large declines in foundation assets, many of the organizations that have historically relied on foundation grants can expect to see their accounts shrink or be eliminated altogether. The nonprofits cut loose are in a tough spot. It’s very hard to find new funders in this environment.
We’re seeing a lot of small organizations struggling. They don’t have steady sources of income and their contributions are declining. Larger organizations are struggling too, so they’re pinching pennies, cutting programs, and laying off staff. No organization is recession-proof, but we hope most will make it through.
Latest Research
Browse by Topic:
