Nonprofits and the “Bucket system”: from cash management to investment returns

It can be tempting for nonprofits to focus solely on near-term strategy.  The grant environment is challenging, and competition for donor dollars has never been fiercer.  Keeping a plan on track that supports financial health is often a year-by-year exercise.
That exercise, though, varies widely depending on how the organization brings in revenue. Those that receive significant funding in waves can take a different approach than those that are solely dependent on programmatic or cost reimbursable fees.  Cash on the books can create more than operational confidence – it can open the door to cash management and an investment strategy that will help keep the future as secure as the present. But keeping the door of opportunity open also requires a shift in the traditional non-profit mindset.
Charitable giving has been steadily on the rise since 2009, enabling some nonprofits to enjoy growth.  As margins expand and Boards find more resources on the balance sheet, they have an obligation to maximize the potential of that cash.
Ideally, that means evolving the financial outlook from cash management to an investment strategy. Leaders can start by following a “Bucket system” that separates cash reserves into three segments: working capital, stability and other reserves, and long-term investments.
Working capital comes first, as all Executive Directors and nonprofit CFOs will attest: the organization needs adequate funds to operate on a day-to-day basis.  How much is required depends on how the nonprofit earns revenue.  If funding comes via annual subscriptions or tuitions, the “working capital” bucket may be full at the beginning of each fiscal year.  For those with a fee for service model, more working capital may be needed – and it may take more time to fill that bucket.
When cash builds to a point that it can cover more than immediate operational needs, organizations can then begin to develop stability or other reserves.  These reserves are critical to long term health, and they can indeed mean the difference between surviving a rough patch or being forced to wind down. Strategic plans should have a strong focus on reserves, allowing organizations to be sustainable, to grow, and to someday be in a financial position to have an endowment.
How the reserves are used in the short term may vary widely depending upon cash flow, the type of services provided, and near-term goals.  In the case where funding is uncertain and the organization provides a core service that should not be disrupted, reserves can be directed to protect cash flow.
Project Bread, for example, is a nonprofit that offers programs to assist those in need of food – and much of its annual revenue is raised during the noted Walk for Hunger event.  The money raised is then distributed through grants that support soup kitchens, food pantries, and food security programs across Massachusetts.  When the fundraiser does not meet expectations (i.e., due to inclement weather on the day of the event), reserves may be critical to keeping the organization’s mission intact: without this “rainy day fund”,” food support for communities throughout the state of Massachusetts would suffer dramatically.
Organizations with different types of assets and programs may need reserves for other purposes. Those that own a facility may need cash on hand for unexpected maintenance or replacement reserves, and those that focus on Research & Development may set aside funds to ensure they can finance those efforts as desired.
Once working capital and other cash reserves have been designated, nonprofits can then begin to consider strategies for funds that may not be needed for 3 to 5 years or longer. These funds can function as an endowment with an objective of providing an annual funding source for operations, as outlined in a spending policy.
Before starting a long-term investment account, though, leadership should weigh the size of the portfolio against the work and cost it will take to manage the effort.  Investments can require some heavy lifting in terms of administrative maintenance and investment oversight, as well as administration fees; organizations should determine a balance between operational costs and the ability to provide meaningful annual support. Ideally, a portfolio will contribute 4 or 5 percent of its total principal value to the spending budget each year.
Growing nonprofits face exciting challenges as they progress from one level of funding to the next.  As their operations become more sophisticated, Executive Directors and Boards should change their mindset from one of cash management (how do we optimize our cash on hand?) to one of investment management (how do we expand existing assets into a reliable source of annual funding?).  The shift calls for close consideration of each bucket and an understanding of how restricted funds factor into the equation.  By creating buckets for working capital, reserves, and long-term investments, nonprofits can build on stability with investment income that sets the stage for continued growth.
If you have any questions about cash management or investment strategies, please contact your AAFCPAs’ partner, or Joel Aronson, CPA, PFS, at 774.512.4114, jaronson@nullwealth.aafcpa.com.