BDO: Nonprofits face ‘starvation cycle’

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Not-for-profit organizations can fall prey to a “starvation cycle” in which their critical infrastructure and technology can be underfunded in relation to high program-related spending, especially if they don’t have the operating reserves needed to provide them with a financial safety net, according to a new report from BDO USA.

The report from the Top 10 Firm found that 63 percent of nonprofit organizations have six months or less of reserves, while 33 percent have between zero and four months of reserves on hand.

“A lot of the organizations are seeing an increase in funding and a revenue increase for 62 percent of the organizations that were surveyed,” said Adam Cole, partner and co-leader of BDO’s nonprofit and education practice. “The problem is that the demand is even greater. If you look around, in the various large cities, the demand for services — whether it be housing, food or behavioral health — has been on the rise, and the money to meet some of this demand has been there as well, but it's not dollar for dollar. The organization will get a $10 million increase in revenue to provide services, but the requisite overhead reimbursement is not there, whether it be 16, 17, 18 percent.”

Nonprofits find they lack enough funding to meet the increasing needs of their clients, even if they’re bringing in more money from donors. “They call that the starvation cycle,” said Cole. “You start to say, ‘OK, I got $10 million, but instead of putting $8.5 million directly in the program and $1.5 million to the admin, I’m now putting $9.5 million, so I'm not really getting any offset. I'm not hiring anybody to do the billing or enhancing my billing system. I'm just putting it all into the programs just to meet the demand and because the funding isn't there.’ So the fear is, when you stay too long in that paradigm, that you reach a point where you can't continue to grow. Your infrastructure can't support the size of your organization.”

Nonprofits may be underestimating the importance of having adequate liquidity. Sixty percent of the nonprofits surveyed said adequate liquidity is a low-priority challenge for their organization, or not a challenge at all. While 39 percent of the organizations said their top priority this year is to seek new sources of revenue or funding, 16 percent said it’s to update or revise programs, and 11 percent said it’s digital transformation.

The lack of operating reserves may need to change in the wake of a recent accounting standard from the Financial Accounting Standards Board, ASU 2016-14, Presentation of Financial Statements of Not-for-Profit Entities.

“One of the new requirements in the financial accounting and reporting model change that was applicable for this year is the disclosure about liquidity and availability of resources,” said Laurie De Armond, partner and co-leader of BDO’s nonprofit and eucation practice. “That ties very nicely into the question that was asked about how many months of operating reserves not needed for current operations does your organization currently maintain. In that question, 63 percent of all organizations maintain six months or less of operating reserves. I think the disclosure requirement asks for how much financial assets an organization has to meet current operations within the next year. We do suspect there are quite a few organizations that have six months or less of operating reserves. We are seeing in practice that disclosure is generating a lot of conversation with boards. Although some did not express concern about their levels of liquidity in this survey, one of the requirements the FASB wanted in the standard was to highlight organizations that are having liquidity challenges. We suspect that over time users of nonprofit financial statements will become more aware of the liquidity challenges that nonprofits are facing because of the FASB’s ASU.”

Nonprofits are investing in technology to help them deal with liquidity and other challenges, but they’re focusing on technology that can produce an immediate return on investment, as nonprofits typically lack the human and financial resources of for-profit businesses that are able to buy and implement technology.

BDO found nonprofits favoring management software, including tools to help them with tasks such as fundraising and social media (66 percent), data analytics (56 percent) and automation (33 percent). Nearly two-thirds (63 percent) said the time and effort to deal with government regulations and legislative changes will be a high or moderate challenge this year, up from 45 percent last year.

Nearly half the organizations surveyed by BDO have increased salaries between 3 to 4 percent. Employee training and development is a top issue, with 68 percent of organizations considering it a moderate to high challenge.The majority of organizations don’t consider flexible work to be a significant challenge. Sixty-three percent offer flexible work schedules and nearly half either offer flexible work arrangements or the option to telecommute.

Despite some positive signs, the nonprofit sector is still facing challenges, including some from the new tax law and the ability of taxpayers to claim charitable deductions now that there is less incentive to itemize thanks to the doubling of the standardized deduction.

“For the most current tax year that ended, most organizations I've spoken to did not see an impact that they could directly tie to the change in the standard deduction,” said De Armond. “However, I have heard from several organizations recently that are still concerned about that because there is a general sense that a lot of people really didn't know what the impact of tax reform was going to have on their tax return filing for 2018 until they went to actually file their tax returns. So there is one thought out there right now that we haven't seen it yet, but that we may at the end of 2019 because people now have a better understanding of whether or not they will be itemizing or not.”

No matter what the state of the economy is over the next year, nonprofits will always be in demand for their services. “I feel like this industry has been in a recession since the recession, and it hasn't really recovered,” said Cole. ”The industry itself is growing in terms of the demand and the services, but not at the same margin.”

“We didn't specifically get feedback relative to concerns about a downturn in the economy, but the increased demand for services and concerns about revenue streams being inconsistent were definitely highlighted by the survey,” said De Armond.

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