Friday, December 02, 2011

How to Run Out Of Cash

(Note: This post comes directly from my new book Smart Stewardship for Nonprofits: Making the Right Decision in Good Times and Bad, to be released in February 2012 by John Wiley and Sons. You can pre-order at Amazon by clicking on the link above.)

Almost all nonprofits have too little cash on hand at any given time. Sometimes this is the result of funder policies not letting the nonprofit keep what they earn (or tut-tutting when a nonprofit has 2 dimes to rub together), sometimes a result of poor long-term management on the part of the nonprofit, sometimes caused by a short term crisis, or a combination of the above. And, if you don’t have any cash cushion, as CEO, you lose a lot of sleep.

I know a CEO who has been in her position for 20 years and who has fretted about making payroll twice a month for every one of those 20 years. When I asked her a few years back about why she hasn’t built up any reserves, she looked like I had hit her: “We can’t do that. People are in need. It’s immoral for us to carry any money from one fiscal year to the next.” So, her organization is intentionally cash poor.

While I understand her sentiment and admire her empathy for the people her organization serves, this is not Smart Stewardship. The quality the space where the organization provides services is appalling, her staff turnover is high, there’s no website (thus impacting her fundraising efforts) and the next longest serving employee has only been there three years. And, any delay in payments from key funders, or reductions in donations, and the doors close.

Not every nonprofit falls into the trap of being cash poor, but if you feel your organization is chronically cash short, you cannot, let me repeat cannot grow. Growth sucks up cash like a giant vacuum cleaner. And you need cash.

Here’s the key takeaway for this issue. CASH = OXYGEN. Cash buys you time to think, is insurance against funding cutbacks, let’s you sleep at night assured you can make rent at the beginning of the month. Cash lets you manage rather than just survive.

And growth? Growth is funded by cash. Remember my mantra earlier in the book: Money enables mission, but profits enable growth. Without profits (and profits that are retained, not immediately spent), you can’t grow.

Let’s do the numbers using a not all that unusual example. A funder, who loves your services and has been a strong supporter, calls you and says,
“We have a one year grant opportunity for you. We want you to expand ServiceX for the next year and measure the impact.”

You are intrigued and excited: More mission! And, ServiceX is your core competence and serves your highest priority demographic. More high priority, high quality mission! The funder continues.
“You need to shoot me a financial projection, but we know you and trust your management. Also, send me a number of units of service based on a one year, $1million grant. We’ll go from there.”

You are nearly speechless. $1million? ONE MILLION DOLLARS? And full reimbursement? There’s no risk! Then, you think, where’s the catch?

The funder continues, “No worries about match. We want to get this project going, so we’ll reimburse your costs fully. We’ll reimburse you each month within 45 days of your billing us. Get back to me by the end of work tomorrow and we can make this month’s contracting and approval cycle. Have a nice day.”

Now there’s an understatement, you think...a nice day....this is the best. day. ever. You shoot out of your chair to go share the news that your mission growth just went off the charts.

How does all this sound to you? Awesome? Unlikely? Yes on both counts of course. But while you have visions of mission growth dancing in your head, let’s look at this amazing, high priority, no risk mission opportunity in a bit more depth.

Let’s assume you start the service at the beginning of the next month, which we’ll call June 1. Let’s also assume you can just start doing more mission from a standing start--no upfront expenses like more space, licensing, training, etc. You and I both know we always have those expenses, but for now, just keep them in the back of your mind to add in later.

So, June 1 you start doing a LOT more mission. On June 30, if you’re like most nonprofits, you bill the funder, and the 45 day reimbursement clock starts. If the funder actually gets you the reimbursement in 45 days, that means you get paid on August 15, or 75 days after you started the expanded mission.

During those 75 days, what has your organization done? LOTS of great, high priority mission. You’ve helped LOTS of people.
And spent LOTS of cash. LOTS. How much? Let’s do the math.
Take $1,000,000. Divide it by 365 to get a cash cost per day. The result is a daily cost of $2,739.73. Then, multiply the daily cost by the 75 days you have to wait for reimbursement. $2,739.73 times 75 equals $205,479.45.

That’s a lowball calculation of the amount of money that goes out before you get paid. Ouch. And that’s real cash going out the door, money that can’t be used to pay rent or insurance or other staff payroll. Remember that the $205,000 does NOT include the startup costs we pushed aside earlier. So in nearly all cases the number would be higher, perhaps much higher than $205,000.

Moral? To afford this no risk, high priority mission opportunity you need more than 20% of the grant total in hand, in cash, before you start. This money is called working capital, and it’s the money you need between the time you make a product or provide a service and get paid. The more you grow, the more working capital you need, even if it’s not in big, one time $1,000,000 increments. The longer the funder takes to pay you, the more working capital you need. The higher your startup costs are, the more working capital you need.

Where does this working capital come from? From prior years earnings. If you haven’t put funds aside, you can’t take advantage of opportunities as they arise. And, by the way, no bank is going to lend you funds to cover this grant’s working capital. Loans are paid back by profits, and this grant, while fully reimbursing your costs, does not include a profit. And, you can’t sell stock in your nonprofit--that’s only for for-profit firms. So, you need to be making a profit to grow.

Remember, money enables mission, but profit enables more mission. And here we are with a perfect example. Your nonprofit’s prior profits allow you to take the $1,000,000. If you haven’t made the profit and set it aside, all you’re doing is running out of cash.

This is why so many nonprofits who have a budget goal of breaking even and, like my CEO friend, feel that making a profit is wrong, are always out of cash as they grow, even if that growth is minimal. They make the mistake of thinking that if there income and expense report shows a break even that they should have enough cash to pay the bills. Fatal error. Accrual and cash are different, and a break even P&L does not mean that your cash in and cash out match for the fiscal year.

Again, my point here is that growth, any growth, sucks up cash. Your organization already has working capital invested in your operations now. Even if you grow organically, you’ll need more. Conversely, if programs end, it frees up working capital for you.

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