Board Member Perspective – Signs that the organization may be toxic

Have you ever sat at a board meeting with a feeling that the Executive Director may be exhibiting unstable behavior or may be running the organization into operational or financial instability? I’ve learned to trust those feelings and to follow them up with requests for information. You may be surprised at how many times your suspicion leads to significant findings. But how do you follow up?

From my perspective, I have seen many times how the Executive Director’s management decisions creates instability which inevitably translates to financial problems. The auditors may not include these areas in their audit and may not address practices that can lead to financial instability.

However, there are two teams within the organization that are aware of many of the unwise decisions and activities and who have a wealth of unbiased information that you can request to start gaining a more comprehensive understanding. The finance team and the HR team come in close contact with management’s thought process and decisions and to what extent they stretch the legality or ethical comfort levels. Contact both of these teams to gather information directly from them. My favorite schedule is the following:

  1. Request a detailed list of personnel changes during the year: salary increases, bonuses, hirings, and terminations (including cause). Absent a logical reason, a very active list is likely to be a sign of problems. Were these salary increases approved by the board? Is the same person receiving more than one increase in the year? Who receives a bonus and why? Repeated bonuses for one person? Why are so many staff leaving at-will or being fired? Issues with the management style of the Executive Director will first show up with constant staff turnover. If management is creating a toxic environment, people will get sick, projects will fail, the best employees will quit and the organization will suffer tremendously.
  2. Ask for the Executive Director’s timesheets or ask about his/her absenteeism, whether recorded or not. We were recently working at an organization that had a Director who would be absent without letting anyone know, call in sick for weeks at a time, leave in the middle of the day without any notice and unable to attend scheduled meetings. Not even his closest assistants knew how or where to find him. He was creating an environment of uncertainty among his team.
  3. Ask about the rotation of financial service providers or HR service providers. If these two functions are outsourced, there may be reason for concern if the Executive Director switches companies regularly or out of the blue decides that the outsourced provider needs to be changed. These are positions that deal with a lot of legal and ethical requirements. Is the Director changing these providers because he does not want to hear “that cannot be done, its not legal (or ethical)”? If there was a recent change, reach out to the provider as part of your fiduciary duty and ask what prompted this change. You may be surprised with what you hear.
  4. Visit employee review websites like Glassdoor or Indeed to check out the reviews on this employer. I was very skeptical about this review process and how it may attract only disgruntled employees. But after seeing with my own eyes the situations that were described in the commentaries, I think they need to at least be considered.

Being on the outside of an organization, providing financial services and advice, I have been in the position at times of wishing a Board member would reach out to me to ask a few questions. My concerns may not rise to level of alerting the Board of potential fraud, but if I was a Board member, I would definitely like to hear about the reckless decisions and attitude of constantly pushing the legal and ethical limits that may lead the organization to a crisis.

Budgets for Nonprofits

Budgets for Nonprofits

Nonprofit organizations have complicated accounting needs. One common aspect of this is budget preparation. Budgets are such an integral part of your organization’s financial well-being – make sure you prepare it correctly. Each year, you prepare a budget for board approval. This budget is a map of how you want to make decisions during the year to not only comply with the direction set forth by the board, but also to have the planned results at the end of the year. Whether the plan is to break-even, have surplus, or a planned deficit, there are several traps that nonprofits need to beware of.

Accounting Basis – Your organization’s finances should be maintained in the accrual basis of accounting, a true measure of the results of operations. Accrual basis measures revenue as earned or promised (rather than only when received) and measures expenses when incurred (rather than when paid). Your budget should also be prepared on the accrual basis.  Doing so allows you to truly measure the results of activities and to properly compare planned to actual activity.

Restricted vs Unrestricted Revenue – Your financial statements make a distinction between restricted and unrestricted revenue, but restricted revenue may need to be recognized entirely when awarded or promised.  This can scramble the revenue side of your budget since part of the restriction may be lifted in a future year. If you are not careful, you can end up with a budget-to-actual comparison that shows that you brought in much more revenue than planned. The opposite can be true if the expenses planned for this year are based on revenue recognized in prior years, but your budget to actual for the current year does not show that restricted revenue. Make changes to your budget-to-actual report to show only unrestricted revenue plus the restricted revenue that is meant to be spent this year.

Understand the results of each type of activity – Activities in budgets are separated into three types: activities that can result in a surplus (membership, conference, fee-for-service); activities that must result in break-even (most grants that require an accounting of expenses); and activities that will result in a deficit (programs that need to be completed or that the board chooses to pursue). Understanding each of the components of these types of activities allows you to plan your entire budget properly.

Monitoring budgets at least monthly is essential to a healthy financial process.  If you have grants that are ending during the year and they need to be fully spent, then you need to monitor and perhaps adjust your budget more frequently. Monitoring using excel spreadsheets is a common practice, but most accounting software now allows you to monitor your budget performance online with real-time information.  You do not have to understand how to use the accounting software to have access to these reports. Your software administrator can create direct access to the report once you login.

We all know the consequences of not having a well-prepared budget and monitoring against that budget as the year goes by. One overlooked consequence is cash-flow problems. When you think about it, it makes sense. If your organization is not performing as planned, it will eventually run out of cash. So plan properly, monitor your performance to that plan, and enjoy your organization’s financial well-being!

Board Member Perspective – Questions to Ask When Reviewing a Budget

Have you ever received a budget for approval and are not sure what you need to be looking for or what questions to ask?  We have a few questions that you can ask next time you are in that situation.

What are the programmatic priorities being set by this budget?  If this is not clear in the budget document, then ask that it be clarified.  The board sets the priorities for the organization and the buckets where the organization spends its money are reflective of its priorities.  The board should have the opportunity to discuss these priorities and make sure they agree with them.

Does the budget result in a surplus, a deficit or breakeven?  A nonprofit organization can and should operate with a surplus.  Surpluses allow the organization to plan for the future by establishing reserves.  Reserves can be used for future projects that will generate a “planned deficit” or for lean years when the funding sources are not coming through as expected.  Deficits can be approved by the board if there is enough reserves to cover it and if it advances the organization’s mission. But these results need to be clear in the budget and need to be discussed as acceptable.

What results is each type of activity generating?  We like to divide the activities of an organization into grants (you must spend every dollar received), fee-for-service (you can deliver the services at a surplus), conferences and membership (as long as you deliver, it doesn’t matter how much you spend) and internal functions (these don’t have any specific funding but are covered by unrestricted grants, indirect cost recovery or surplus from other activities).  Understanding the results of each activity allows you to see how they cover each other and whether a desired surplus can be achieved by focusing on a particular activity.

Is there a personnel budget?  Personnel costs tend to be the largest line item expense for most organizations.  This expense has to be carefully planned in terms of positions, length of time, and salary.  Ask if the positions are compensated fairly and at market rate. The success of the organization is dependent on maintaining committed and capable personnel.  Each year’s budget should consider pay increases to help with staff retention.

Does the organization have a negotiated indirect cost rate?  Recovering indirect costs is crucial for funding internal operations.  This is an area where many organizations have problems. The indirect cost rate should be reflective of the organization’s true indirect costs and the organization should always request that grants reimburse at that level.  Anything less will make the cost of running the program(s) with that grant more expensive for the organization.

Being at a board meeting while a budget is being discussed can be a very intimidating experience. But having a discussion around the questions above can help you understand better the process followed in preparing the budget and trust that the numbers reflect not only an achievable goal, but also the priorities of the board for that organization.

Indirect Cost Rate Monitoring

Indirect cost rates fluctuate each year based on the results of your operations.  If the indirect rate decreases, it could be a sign that your organization is heading to a major cash flow problem to resolve.  Stay on top of your current year’s indirect cost rate to plan and prepare for any changes.  It is similar to your personal yearly tax planning to reduce taxes or prepare for the inevitable tax bill.  Your indirect cost rate is decided each year with the Negotiated Indirect Cost Rate Agreement (NICRA), which you prepare and submit to your cognizant agency after the closing of the year.  If the indirect cost rate calculated is different from the amount you have been using, you will need to adjust the indirect cost taken for the full prior year plus all months since the end of the year.

The best practice is to monitor your indirect cost rate monthly and quarterly.  As part of your monthly closing process, your organization should be calculating and charging the allowable indirect costs to each grant based on the grant’s restrictions each month and based on year-to-date.  For the most part, organizations calculate this monthly charge using an excel template. The template should be taking year-to-date expenses and properly reducing the direct costs by expenses that are not eligible for indirect costs based on the grant restrictions.  You can insert a calculation in that template, based on the calculation used in the NICRA which takes the totals year-to-date in the spreadsheet and calculates a preliminary rate for the year.

How much does the indirect cost allocated to admin (as a negative charge back) cover the year-to-date admin expenses?  Is it too much, too little? Either one could be an indication of a problem.

The calculation of indirect cost is extremely sensitive, meaning that adding or deleting expenses can make a significant difference.  There are decisions you can make to change the indirect cost rate during the year, such as hiring the admin staff you desperately need.  However, with the indirect cost rate you mostly have to estimate, plan and prepare for an expected outcome – much like tax planning. There is only so much you can do to influence the rate without going against the rules of your grant or creating cash flow problems for your organization.

Without proper planning and preparation, significant cash flow problems may arise if you are required to return funds that you had requested during the prior fiscal year and current year-to-date while using an inflated indirect cost rate.

Board Member Perspective – Questions to Ask When Reviewing an Audit

Question of an Audit

You are presented with the financial statements prepared by auditors.  Do you know what questions to ask? What will the auditors tell you only if you ask?  The process of auditing the financial statements of an organization is quite invasive not only on the transactions and balances that make up the financial statements, but also on the processes and controls of the organization. Asking a few questions can give you valuable insight on the audit report, and on how the audit was conducted. Of course, we begin with reviewing if there is an unqualified or “clean” opinion.  Otherwise, most of your discussion with the auditors will revolve around the reason for the qualification.

On the Statement of Financial Position – Is there a liability amount that the auditors believe the board should discuss further or about which they should ask for more information?  Are there suggestions for containing or reducing some of the liabilities that management and the board should consider? Is the make up of net assets a healthy mix?  Should the organization increase the net assets without donor restrictions? Does the organization have sufficient reserves?

On the Statement of Activities – Explain the results of each column and what it tells about the operations of the organization.  Does the organization have sufficient restricted net assets for future funding based on the type of funding that the organization is reliant on?

On the Statement of Cash Flows – What does this statement tell us about the organization’s cash flow situation?  Does it appear to be generating sufficient cash flow for its operations or are there issues with collecting receivables?

On the Statement of Functional Expenses – What method is used for allocating expenses and is this a reasonable method used by other organizations?  Is the organization recovering its indirect expenses? Is the management and fundraising expense reasonable for an organization this size?  What are the programs that have the highest expenses and are these in line with the board-set priorities? If the statement does not break out the individual programs, ask why.

On the Footnotes – Are there any footnotes that are most worrisome to a reader?  Explain the footnotes that may have financial implications that are not reflected in the financial statements themselves (such as pending litigation).

On the Management Letter (even if none is presented) – Was there an item discussed with management that could have made it to the management letter, but did not?  If there is no management letter, are there areas of improvement that the auditors can suggest?

On the overall audit process – What audit adjustments did you make and did their nature and amount concern you in any way? Were there any management practices that you found unusual, but not worthy of noting in the reports?   Were there any delays in the audit caused by management?

Use these questions to guide you through the review of the audit report and you will walk away with a better understanding of the organization on which you serve.  

Statement of Activities – One Column At a Time

Statement of Activities

Reading each column of your Statement of Activities gives you a more accurate and complete story of the results of your operations.  It is our tendency to immediately look at the total column on a report, but that can leave you asking many more questions, rather than understanding where you’ve been this year so far.  The Statement of Activities reports the results of operations of your organization. It is divided into three columns; net assets without donor restrictions, net assets with donor restrictions, and the total column.

The first column, net assets without donor restrictions, is the true results of your organization’s operations.  On the revenue side, it combines the unrestricted revenue received this year and the restricted revenue that has been released for use this year.  This is netted against the operating expenses to arrive at a net surplus or deficit from operations. This column alerts you to problems with the current year’s operations, it is the set of numbers that should be compared to the budget (assuming the budget is accrual and only considered current year revenue).  If you are not expecting a deficit, you should be comparing these numbers to your budget to understand where the corrections need to be made.

The second column, net assets with donor restrictions, tells the story of how much you have in restricted revenue reserves to last you through the current and future years.  This column begins by telling you how much restricted revenue has come in this year and how much restricted revenue you’ve used up (released) this year. The revenue you have used up can be a combination of revenue you received this year and in prior years.  The result is netted against the restricted revenue you had at the beginning of the year to arrive at how much restricted revenue you still have. What does a surplus in this column mean? That you have earned more restricted revenue this year than you have used, and that you are increasing your reserve of restricted revenue to be used this year and into future years.  A very large surplus could simply mean that you received a large multi-year grant this year that was recognized entirely this year but will be used in the next few years. What about a deficit? A deficit means that you have used more this year than has come in. But you may still have a large balance that will last you through several more years if you are just beginning to spend a multi-year grant.  Or maybe the grants you are expecting for expenditure next year are taking longer to commit. If you are running a deficit and you are depleting the reserve of restricted grants, you may need to put a plan in place for future year funding.

When you add the two columns together, the result will be influenced by the second column, assets with donor restrictions.  Beware of the panic that comes from a deficit in the total column.

We have seen deficits in that total column that do not indicate a cause for concern.  An organization increased its reliance on government and reimbursement grants, which are not reflected in the Statement of Activities until spent.  At the same time, they used up the small amount of restricted revenue, thus creating a deficit on column two. The total column is skewed by the second column, but there is no reason for alarm.  Another organization switched mostly to fee-for-service contracts and reduced their reliance on restricted grants, also resulting in a deficit on second and the total column. Understanding the reason for the deficit and focusing on the results of the first column will help you gain a better perspective.  

Chronic Cash Flow Problems

Cash Flow Problems

Have you considered that your chronic cash flow problems may be a result of a malfunctioning budget process?  You may suspect foul play, but most of the time it comes down to two issues: 1) not properly planning the activities of the year with a well-thought out budget and 2) not monitoring actual results in comparison with the  budget. In our experience, this is usually the root of the cash flow problems.

Cash flow problems can result from money that is owed to your organization (receivables) that is not paid timely or expenses that are laid out ahead of the matching revenue (such as with an upcoming conference). But these situations are usually clear to see, easy to prepare for, and usually short-lived. When an organization has chronic cash flow problems, the root may be the lack of proper planning and monitoring.

When you take time to carefully plan the revenue and expenses that your  organization will incur in the next year, you are considering realistic scenarios, setting goals, and planning for the largest expense you are likely to have – personnel.   If the numbers do not fit, as in having an unplanned deficit, you need to make difficult decisions before the year begins. This sets you in a position of control. When you monitor the planned activity to the actual results (through budget to actual comparisons) you are controlling the situation further by making decisions during the year based on the results of the budget-to-actual.  

Financial results tend to come in “waves”.  The results of a poor financial decision made today may not be felt immediately. Chronic cash flow problems usually result from lack of proper planning and lack of control over the results.  The wave effect continues until the root cause is addressed. To understand the effects of these waves, we recommend that you create and monitor a cash flow budget for the year. This cash flow budget is created from the organization’s annual budget.

We’ve had clients whose planning drilled down to each grant.  Upon close inspection, the grants were being overspent, and those expenses were eating into the admin budget.  In other cases, grants were being underspent, leaving money on the table. In most cases, the biggest expense was personnel, so controlling the amount of time that employees spend on the grant made a great impact on the fulfillment of the budget and therefore, the organization’s cash flow.

Preventing cash flow problems requires a multi-step approach:

  1. Create a well-thought-out budget for the fiscal year.
  2. Create a cash flow projection based on that budget.
  3. Monitor both the budget and the cash flow projection.  
  4. Anticipate and mitigate cash flow dips.
  5. With this information, make timely, well informed decisions that will maintain financial health.

When a new client comes to talk to us about controlling their cash flow situation and we discuss their budgeting process, we always get a nod of agreement that the planning piece has been missing.  Get ahead of this problem by implementing the ideas above.

Action plan

In Search for Balance & Purpose, Part II

So your books are balanced.  In fact, you have supported the major balances in your balance sheet and have traced the activity in your statement of revenues and expenses.  The reports are ready to be published.  Now what?  What is the purpose of these historical reports?

In my first article, I presented my opinion on balance and argued that it is simply a part of a larger process that leads to well-presented reports and financial statements.  In this article, I discuss the purpose and objective of these financial statements.

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In Search for Balance & Purpose, Part I

We are constantly looking for balance in our lives.  Balancing work and family is a popular concern, as is balancing our investments or even balancing our diets.  Can anyone ever claim to have successfully achieved balance in these areas of their lives?  Once we achieve it, can we maintain it? And then, how do we use it?

What about purpose?  Is there a purpose to everything we do, and can we successfully argue that our true purpose is ever-changing?  In this first article of a two-part series, I will give you my opinion on the value of balance in accounting, and in the second article, I will explore the higher purpose of accounting.

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Dashboard Reports Rotation

Only ten minutes into my call with the board’s treasurer and we had already brought up six different financial reports we could prepare and present at the next board meeting.  Each presented the organization’s achievements and shortfalls from a different perspective, and all presented information important for the board’s awareness and discussion.  But honestly, six reports, in addition to the regular financial statements presented at each meeting is, in my opinion, number saturation.  Particularly because many board members do not enjoy hearing about metrics, financial results, and other numerical values.

In my previous article “4 Fiscally-Responsible Changes You Can Make as a Board Treasurer,” I proposed that at each board meeting the treasurer should present a full set of financial statements and no more than two dashboard reports.  In this article, I propose that the organization prepare five different dashboards and a treasurer’s three-point report and rotate the dashboards at each meeting.  Here are the dashboard reports I have recently recommended to my clients:

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