Richard Linzer is nationally known consultant and facilitator who works with a cross section of nonprofit organizations, businesses, and government agencies. With nearly forty years of experience, he specializes in the use of cash flow budgeting and credit by nonprofit organizations.

Anna Linzer is an award-winning poet and writer who, with Richard, leads retreats and sessions on nonprofit financial management. Her book of fiction, Ghost Dancing, received the American Book Award in 1999.

Cash Flow Strategies

Innovation in Nonprofit Financial ManagementBy Richard S. Linzer Anna O. Linzer

John Wiley & Sons

Copyright © 2008 Richard S. Linzer
All right reserved.
ISBN: 978-0-7879-8147-1

Chapter One

THE CASE FOR CASH FLOW THINKING

Cash flow thinking involves focusing on the arrival of revenues and the departure of expenditures that occur during an institution’s fiscal year. It’s simple to understand cash flow thinking, and it is easy to use it to address some of the toughest fiscal problems confronting decision makers in the nonprofit world.

First and foremost, cash flow thinking is a supplement-not a substitute-for the accrual basis accounting systems most nonprofit institutions employ. Cash flow thinking allows everyone at the board and staff levels to comprehend the financial position of their institution. By making the fiscal picture simple to grasp, the organization encourages greater participation. With cash flow thinking, more than just the members of the Finance Committee can be actively involved in decision making. This means that all board members are able to exercise their responsibility for due diligence, and it allows the staff an opportunity to understand and share the fiscal information that is vital to the well-being of the institution.

Nonprofit organizations are set up and run differently from commercial enterprises. As we show later in this chapter, the two types of organizations are just different enough to make cash flow thinking especially pertinent to nonprofit institutions. Which is not to say that cash flow is not a powerful driving force in business and in markets, but the special role that cash flow has in the nonprofit arena is what needs to be clearly understood.

Key Questions

Should we create a cash reserve or manage our risk with a fully secured line of credit with the bank? This is just one of a host of questions that cash flow thinking can answer definitively. We explore some of the other questions in this chapter and the answers later in the book.

Cash flow thinking creates a platform for the creation of budgets, forecasts, and reports that are easily generated and understood. It has also stimulated the development of tools such as the Cash Flow Forecaster and the Real Estate Calculator, and techniques such as the creditholder concept, which provides collateral for fully securing an institution’s borrowing. Finally, cash flow thinking opens the door to the analysis of a variety of topics that have a direct bearing on the fiscal health of your organization:

Should we establish an endowment?

Are we better off owning or leasing our facilities?

What impact will earned income have on our budget?

Why does the simplicity and ease of cash flow thinking matter to leaders in the nonprofit world?

Cash flow is the term used to describe the revenues that flow into an institution’s coffers and the expenses that are paid out when bills are due. Cash flow implies a very literal approach to both money and time. This means that income has to be in hand before it is counted; promises that the check is in the mail don’t count. And bills are considered paid only when the checks really are in the mail.

We are advocates of concentrating on cash flow as one of the financial tools available to nonprofit decision makers. Over the years, we have encountered many decision makers and nonprofit professionals who did not fully understand their own institution’s financial statements. Adding to the problem, the same individuals who failed to grasp the meaning of their institution’s fiscal affairs often counted on someone else to be responsible for understanding the budget and the financial reports. Just talk to our accountant, or let the chief financial officer answer that question have often been the responses to our financial interrogations. And the situation in the boardroom is rarely much better.

Members of the Finance Committee-an eager stockbroker, an overworked CPA, an amiable local banker-are typically drafted to take care of business and to be responsible, while the rest of the board members focus on other issues. The problem is that all members of the board are equally responsible for the financial well-being of their institution, and they endure considerable liability in their capacity as board members. It is vital for everyone on the board to understand the numbers.

Trustee ownership and understanding of financial matters has been a running debate in the field. This issue has evoked a variety of responses ranging from suggestions to mandate financial training for executives and nonprofit board members to notions of designating specialists to work alongside board and staff to supervise and coach them in money matters.

While we appreciate the benefits of training and the obvious profit potential for consultants working as capacity builders to nonprofit institutions, we instead advocate starting out by making things so simple and so easy that anyone who sits on the board or in a managerial capacity can quickly grasp the essential financial issues confronting the institution.

The clarity of cash flow thinking starts to deliver positive benefits the moment you adopt it. Everyone will be able to read and understand your budgets, forecasts, and reports. For the numerically challenged, cash flow is straightforward in much the same way that a checkbook is immediately accessible. For those who like pictures, cash flow lends itself to helpful graphic images. English majors, who may hate numbers, will appreciate the almost poetic footnotes that accompany your materials.

Why is cash flow thinking particularly relevant to nonprofit organizations?

How many times have you heard a colleague or a board member lament that your nonprofit organization should be more like a business? It’s a refrain that we have heard from many people who are or have been successful in their nine-to-five business lives. For these people the importance of a cash flow approach to nonprofit institutions needs to be especially emphasized. These folks frequently see the nonprofit sector as just an underdeveloped version of the commercial world. And many translate their notion of good business practices directly into recommendations for financial policies for their nonprofit institution. While non-profits can learn a lot from businesses, the differences between the financial practices of the two sectors need to be understood in the context of the very real differences between them.

For example, the cash flow concepts that we advocate place very little emphasis on the accumulation of assets by nonprofit institutions. This is often baffling to businesspeople. Yet it makes perfect sense once you grasp the importance of mission to the nonprofit sector, and the way restricted funds turn into smoke and mirrors for many institutions.

In both the commercial world and the nonprofit sector, cash flow is important, particularly as a tool for understanding operations. Yet, as anyone in business will tell you, the bottom line in the commercial sector is all about the assets and liabilities left at the end of the fiscal year. On the other hand, for nonprofit institutions, cash flow is uniquely important, because assets don’t always have the same impact on the bottom line as they do in commercial settings. Here are three reasons why things are different:

First, businesses are creatures of the marketplace; nonprofits are creatures of the IRS. After all, without a charter from the feds, tax-exempt organizations could not offer deductions for contributions and avoid most of the taxes businesses pay. Another way of looking at this issue is to say that while businesses are created by markets, nonprofits are often the creatures of market failure. Market failure occurs when customers are unable or unwilling to pay the full price of the services or goods they receive. In the nonprofit field this means that a third party, such as a donor, foundation, or government agency, is needed to supplement the cost of the activity.

Second, the ways in which the two types of organizations are allowed to raise money are not the same. The rules that apply to this money create some profound differences. Businesses sell equity (ownership) to investors in the form of stocks, bonds, partnerships, and venture arrangements. Once the equity has been sold, businesses have a great deal of flexibility in how and for what they spend their money. The notion that in business cash is king is just another way of paraphrasing Yogi Berra when he says: “Cash, why it’s just as good as money.”

Yet in the remarkably regulated financial environment in which nonprofits operate, even cash is not always a liquid asset. Liquid assets consist of unrestricted cash, and of money in a mutual fund or savings account that can easily be converted into unrestricted cash. Restricted cash may be in the bank account but not available for any purpose other than the specific one dictated by the funding source. This alone can create a fiscal crisis for seemingly solvent nonprofit institutions.

Nonprofits are prohibited from selling equity to anyone. Instead, they are allowed to receive tax-deductible gifts and grants, which often come with strings attached. Businesses can use profits to pay for their activities. Nonprofit institutions are often contractually bound to observe government or foundation requirements that any funds left over from grants be returned to the source rather than switched into different budgetary areas.

Both businesses and nonprofit institutions can borrow money. So the major difference is this: businesses sell equity and distribute profits to investors and to the government in the form of taxes; nonprofits receive tax-deductible grants and gifts that are meant to be spent for the social purpose for which the organization was formed.

Third, businesses have a very different annual fiscal cycle from that of their nonprofit counterparts. Businesses mobilize money through the sale of equity, or they use profits or borrowing to provide the funds they need to operate. At the end of the fiscal year they distribute earnings in the form of dividends and taxes.

Nonprofit organizations are continually soliciting gifts and grants, attempting to earn revenue, and occasionally borrowing. But because they have no equity to sell, nonprofit organizations do not engage in distribution to investors and in many cases pay little, if anything, in federal, state, or local taxes. Therefore, the fiscal cycle for a nonprofit organization is only about cash flow: income in and expenses out. It is this characteristic of nonprofit institutions that makes cash flow thinking so relevant to understanding how they work.

Arthur Levitt, the former chairman of the Securities and Exchange Commission, states in Take on the Street that to understand the quality of the financial situation of an enterprise, you need to look at the cash flow report. We agree, which is why we focus on cash flow budgeting, cash flow forecasting, and cash flow monitoring. The assets and liabilities are important too, but in nonprofit organizations cash flow thinking needs to be accorded a special place at the table when fiscal decisions are made.

Why add a cash flow-based approach to supplement our existing system?

Before you read on, you may want to buy your bookkeeper a bottle or two of over-the-counter heartburn medication. Then it will be ready when you announce that you are considering adding another level of financial record keeping to that already busy schedule. You can imagine the warm embrace we receive from our clients when we strongly urge them to do just that. What we often hear in response to our request is that they already have a perfectly fine system of accounting that has been mandated by the Federal Accounting Standards Board (FASB).

Our answer to this objection is that cash flow budgeting, forecasting, and monitoring make it possible for everyone, not just the accountants and members on the Finance Committee, to understand what is going on. Using cash flow budgets, forecasts, and reports to complement an existing system of financial management may at first seem like an added chore. After all, having an accrual basis accounting system in place generates lots of information in the form of balance sheets, income and expense statements, statements of changes in net assets, and statements of cash flows. The difficulty is that not everyone is comfortable with the information provided.

Accrual basis accounting is a system that recognizes income when it is earned and expenses when they are incurred, rather then when cash actually changes hands. To someone versed in finance and accounting the accrual basis system is finely detailed and comprehensible. To those without a financial management background, accrual basis accounting can be something of a challenge.

Accountants and lots of other people understand accrual accounting and consider it the appropriate standard for all financial environments. Accrual basis accounting uses a system that identifies payables and receivables in a virtual time frame. So, if you have been notified that a grant has been awarded, your bookkeeper “books” the amount at the moment of the award. But if, as sometimes happens, the grant is slow in arriving, and your fiscal year ends, you still have the receivable on your books. You account for it within the fiscal year time frame, but you still do not have the money that was meant to be spent on the program for which the funds were designated. For folks who understand this approach, it makes sense; they have a mental model that allows for everything to balance in the institution’s accounts over time.

As that popular source “The Motley Fool” noted in November 2006: “Be Careful When It Comes to Accruals.” Unless you understand that the money in the last report may not be money in the bank, you can find yourself in financial trouble. The problem, as we see it, is that the way for-profit businesses almost universally use this system of accounting gives it a lot of authority, but people in business generally know that there can be a disconnect between receivables and sales. In the nonprofit setting the impact of booking third-party-payer revenues well in advance of receipt of funds can be much more problematical. The typical line we hear is, “Well, we got the grant, so what’s the problem?” Well, the problem is that if the grant or contact check has not arrived, or the funds are restricted-something that does not happen in business-then other funds on hand may not be available for either operations or programs. The same thing happens with endowments or restricted cash reserves. The money is there on the balance sheet, but that does not mean that it can be spent to deal with today’s expenses.

On the other hand, income and expense are empirical phenomena-that is, you can see them as they happen-in cash flow thinking. Everyone may be aware that money is coming, but until it lands in the bank, it is not booked. The same is true with expenses paid. This is familiar from daily life: the float attached to your credit card purchases means that you don’t feel the actual impact on your wallet until you write the check to pay off your bill.

Cash flow thinking requires reporting only those events that involve the exchange of cash. It acknowledges but sets aside any transactions that do not involve cash, such as depreciation or amortization. Cash flow budgets, reports, and forecasts merge actual time with real money. They are dynamic-unlike conventional budgets and balance sheets. A balance sheet is a snapshot of a fiscal moment in time. A cash flow budget, report, or forecast is like watching a movie in which income and expense costar with time to express the ebbs and flows of your organization’s financial position.

With accrual basis accounting, income and expenses are posted before they are received or paid. This creates a virtual world that can sometimes be confusing. For example, when multiple-year pledges that have been posted do not arrive on schedule, your organization can be much poorer than it looks on paper. Our cash flow approach focuses exclusively on the income that arrives at your door and the expenses that are recorded as checks as they sail off in the mail. A sense of practical reality accompanies cash flow thinking.

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Excerpted from Cash Flow Strategiesby Richard S. Linzer Anna O. Linzer Copyright © 2008 by Richard S. Linzer. Excerpted by permission.
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