Navigating Change in the Nonprofit Sector

David Johnson January 8, 2014

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Overview • The challenges facing nonprofit organizations going into 2014 are

numerous.

1) Government funding sources, particularly at the local and state level, have become far less certain, challenging many long-standing operating models.

2) The individual donor community is changing, with high-end donors seeking more collaboration as well as increased reporting demonstrating a social return on investment.

3) In the drive to continue serving their mission, too many organizations have equated mission-focus with resistance to change, leading to disastrous results for all involved.

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Overview Cont. • Recent years have seen the bankruptcy and restructuring of storied

nonprofit organizations, including St. Vincent’s Hospital in New York, the Philadelphia Symphony, Girl Scouts of the USA, and others.

• Now is the time for nonprofit leaders to be proactive to ensure that their mission not only survives, but thrives in the new market environment. Increasingly, the status quo is not an option.

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CHALLENGES AHEAD

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Government Funding

• Government funding sources, particularly state and local government sources, are looking considerably less stable in the wake of the 2008-9 recession than they once did.

• In many niches, government funding sources are actively communicating a desire to have the number of nonprofit providers reduced, in some cases substantially.

• The impact of increased risk in the main source of funding for many nonprofit organizations is to challenge long-standing operating models.

• As painful as it may be, organizations must acknowledge that the government funding landscape has changed, that the change shows signs of being long-term, and make the necessary adjustments in order to thrive under new conditions.

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Donor Community

• A rising generation of individual donors have begun to look to their charitable donations in terms of “social return on investment”, and as such are challenging the nonprofit organizations they support to prove their efficacy in all areas served.

• The rise of analytics and their importance to prospective donors is likely to only increase in importance over time, and organizations should look carefully at their systems and personnel to determine how they will better present compelling, data-driven pitches to the donor community.

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Serving the Mission

• Too often nonprofit organizations have unwittingly embraced a short-term, tactical view of serving their mission, at the expense of the longer-term, strategic sensibility.

• In the coming years consolidation, partnerships, and substantial internal reorganizations will be necessary as the nonprofit community seeks to right-size itself for the challenges of the current environment.

• There remain considerable opportunities to grow in size and scope, but doing so will require disciplined leadership making fact-based decisions, and a willingness to move beyond outmoded operating models.

• No nonprofit organization, regardless of reputation, can afford to rest on the strength of prior accomplishments.

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DRIVING CHANGE

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Leading the Change

• Nonprofit CFOs are well-placed to take a leadership role in driving necessary changes in their organizations.

• The key outcomes that nonprofit CFOs should be aiming for are 1) to increase awareness of and ownership for budget numbers, 2) To foster a culture of questioning, and 3) To improve understanding of the connection between operational and financial performance.

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Leading the Change (Cont.)

• By adopting a more holistic approach to functions traditionally in their purview, CFOs can drive profound change in nonprofit organizations.

1) Budgeting. By driving a change to an ongoing, iterative budgeting process that takes in and utilizes feedback from multiple stakeholders, a CFO can increase a management team’s sense of ownership in a budget.

2) Variance Reporting. By moving beyond simply reporting financial performance and toward explaining what caused (good or bad) performance, a CFO can increase overall insight into the key drivers of an organization’s performance.

3) Metrics. Creating and broadly disseminating a metrics dashboard to the management team creates a common set of financial and operational measures that everyone quickly becomes familiar with. This both enhances the management team’s understanding of different aspects of an organization’s operations and increases the overall understanding of what operational measures drive financial performance (and what financial performance is necessary to support operations).

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The Budgeting Process • Robust budgets are developed with a bottom-up approach in which

assumptions are made regarding the key drivers of performance and the relationships between those key drivers.

– This approach, though more time-consuming, allows for managers to easily refine their budgets, and to test the impact of changes in key assumptions.

• It is not uncommon for managers to suggest that the time commitment necessary to develop a robust bottom-up budget is not worth the effort.

– This line of thinking generally presupposes that the identification of key drivers and how they interact is an overly complex exercise of limited value.

• It is important to understand that all budgets contain assumptions.

• Assumptions come in two forms: 1. Explicit assumptions which are detailed and highlighted by the developers of the budget 2. Implicit assumptions that logically follow from a detailed analysis of a budget

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The Budgeting Process (Cont.)

• Any budgeting process that seeks to trade the explicit assumptions of a robust, bottom-up budgeting process for the implicit assumptions of a top-down budgeting process is effectively sacrificing rigor for speed.

– It is up to individual managers to determine what is most important for their particular circumstances.

• Assumptions of one type or another will necessarily drive any budget. Working to minimize the impact of implicit assumptions is the job of every manager tasked with developing a budget.

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Budgeting Process

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Indentify Key Drivers

Develop Assumptions

Create Integrated

BudgetBudget Review

Test Assumptions

Variance Analysis

• First quantifying and then understanding the differences between actual and budgeted financial performance is a crucial aspect of the financial skillset of any manager.

– These are crucial skills that, while central to the accounting and finance functions of an organization, must be possessed by managers outside of those departments

• Variance analysis provides an invaluable check on the budgeting process by assessing the accuracy of the budget at discrete intervals (generally monthly, quarterly and annually).

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Variance Analysis (Cont.)

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Actual Forecast Variance$ %

a b c = a-b d = c/b

Sales 2,625,000$ 2,500,000$ 125,000$ 5.0%

Cost of Goods Sold 1,895,000 1,675,000 220,000 13.1%

Gross Profit 730,000 825,000 (95,000) -11.5%Gross Margin % 27.8% 33.0%

Operating Expenses

Selling Expense 195,000 165,000 30,000 18.2%

General and Administrative Expense 365,000 375,000 (10,000) -2.7%

Other (Income) Expense 80,000 65,000 15,000 23.1%

Other Expenses 47,500 35,000 12,500 35.7%

Depreciation Expense 55,000 55,000 - 0.0%

Total Operating Expenses 742,500 695,000 47,500 6.8%

Operating Income (12,500) 130,000 (142,500) -109.6%Operating Margin % -0.5% 5.2%

Non-Operating Expenses

Tax Expense - 45,500 (45,500) -100.0%

Interest Expense 22,500 20,000 2,500 12.5%

Total Expenses 765,000 760,500 4,500 0.6%

Net Income (35,000) 64,500 (99,500) -154.3%Net Margin % -1.3% 2.6%

EBITDA Add BacksInterest 22,500 20,000 2,500 12.5%Taxes - 45,500 (45,500) -100.0%Depreciation 55,000 55,000 - 0.0%

EBITDA 42,500 185,000 (142,500) -77.0%EBITDA Margin % 1.6% 7.4%

Variance Analysis (Cont.).

• The variance report on the prior page contains a great deal of interest to a manager. In particular:

– Sales exceeded the budget (forecast) by $125,000, or 5.0% – Both gross profit and gross margin were lower than forecast – Operating expenses were 6.8% above forecast, outpacing the increase in sales

• This variance analysis indicates that despite higher than forecast sales, Company XYZ underperformed in all profitability measures.

– Variance analyses can alert managers to emerging issues such as Company XYZ experienced in this case.

• The most important aspect of a variance analysis is the “Notes” section. – Getting beyond “what happened” and moving to “why did that happen”, is essential.

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Metrics

• A well-conceived metrics dashboard can be a powerful tool in fostering increased collaboration among a management team.

• By their very nature, metrics dashboards blend financial and operational measures, and as such are often among the only cross-functional outputs reviewed across an organization.

• Good dashboards will have a mix of leading and trailing indicators.

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Metrics (Cont.)

Indicators

• Leading: Measures that are effective predictors of future outcomes.

• Lagging: Measures that provide a useful framework for recent performance.

Representative Key Metrics

• Sales – (Lagging / Financial) • Donations – (Lagging / Financial) • Call volume – (Leading / Operational) • Website visits – (Leading / Operational) • Clients Served – (Lagging / Operational) • Revenue per Client - (Lagging / Financial) • Cost per Client - (Lagging / Financial)

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CONCLUSION

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Conclusion

• The central operating theses of many nonprofit organizations will be challenged over the coming years, as change continues to roil traditional sources of funding.

• In the current environment a desire to maintain the status quo is naïve and potentially dangerous. All nonprofit executives should be seriously considering what they can do to help ensure the continued success of their organizations through the current challenges.

• Nonprofit CFOs are logical change agents in many organizations. These professionals can look to improve collaboration and understanding throughout the management ranks by using areas in their purview to better answer the questions of: 1) What (Budgeting), 2) Why (Variance Reporting), and 3) How (Metrics).

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Speaker Biography • David Johnson is a founding partner of ACM Partners. His

advisory experience spans North America and ranges from pre-revenue startups to Fortune 500 companies.

• An active member of the Chicago business community, David currently serves on the board of directors of Gateway Foundation, a nonprofit organization focused on providing substance abuse treatment. Additionally, he is an active member in several professional associations.

• David’s writing has appeared in several industry publications, and he has lectured at the University of Chicago, Northwestern University, the University of Wisconsin-Madison, the University of Illinois-Chicago and Loyola University Chicago.

• David earned his MBA from the University of Chicago. His undergraduate studies were completed at Fairleigh Dickinson University.

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About ACM Partners

• ACM Partners is a boutique financial advisory firm providing due diligence, performance improvement, restructuring and turnaround services.

• David Johnson can be contacted at: – Email: david@acm-partners.com – Ph: 312-505-7238

• For more information visit: www.acm-partners.com.

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