As the year draws to a close, not-for-profit organizations find themselves at a critical juncture: reflecting on the past and planning for the future. A key area of focus? Cash flow management. With the unique challenges of delayed grant reimbursements and seasonal revenue patterns, the upcoming year presents an opportune time for not-for-profits to fine-tune their financial strategies.
Common Cash Flow Challenges
Not-for-profit organizations often encounter distinct financial challenges due to their unique dynamics, such as inconsistent revenue and expenditure patterns. For example, educational institutions might receive significant funds in the fall and early winter, but expenses are incurred evenly throughout the year. Additionally, seasonality affects fundraising, with many not-for-profit organizations seeing a revenue boost in the year's final quarter. In addition to the mismatch in timing between income and expenses, many grants come with restrictions.
Most organizations are already aware of and plan for these financial dynamics through modeling, ensuring effective liquidity planning. To manage unforeseen deviations from their plans, they often maintain a minimum cash reserve, typically equivalent to 90 days of operating expenses, as a buffer against uncertainties. Additionally, some organizations opt for a line of credit to manage these financial fluctuations, allowing them to keep more funds invested.
However, holding a cash reserve may now be more beneficial than relying on credit given recent increases in interest rates, which make lines of credit costlier. Additionally, there is the potential for generating some yield from idle cash with low risk. Ultimately, these financial strategies reflect a management philosophy, often backed by the board's support.
The determination of liquidity reserves, whether in cash or through lines of credit, should be based on several factors. These include the lowest points projected in financial models, historical events like government shutdowns and any unusual trends. Additionally, consideration should be given to how revenue is concentrated. For instance, if an organization relies heavily on a few donors, it's important to conduct liquidity stress tests that prepare for scenarios where major funders withdraw support.
Organizations with fixed short-term costs might need to maintain higher liquidity to manage such unexpected events. On the other hand, if costs are variable, an organization might plan to cut costs in response to funding shortfalls. This stress testing ensures the organization can operate smoothly without immediate financial strain during unforeseen events.
Overall, financial planning should include a comprehensive view of the organization's balance sheet, considering all assets, including investment accounts, for effective cash flow planning. Good planning involves preparing for various contingencies to maintain focus on the organization’s mission and outcomes.
Not-for-profit financial leaders can improve cash flow management through tools like Excel-based models and advanced forecasting software or by consulting with finance professionals. These resources can complement internal management, especially in organizations more focused on day-to-day operations.
Don’t Forget Your Other Cash Requirements
Cash flow planning involves more than just tracking the timing of income, expenses and donations. It's also essential for organizations to consider their debt service obligations, like principal payments on debts, which may be due monthly, quarterly or at other intervals. Planning for investments in facilities and equipment, as well as other financial and investment activities, is an important part of the equation. While incorporating these factors into financial models is relatively straightforward, they are significant and should not be overlooked due to their material impact on the organization's financial health.
Plan for the Longer Term
Another frequent issue for not-for-profits is the tendency to plan only for the immediate year ahead, overlooking longer-term dynamics that could significantly impact their organization. For instance, if debt service payments are set to increase, advance planning allows the organization to mitigate potential negative effects. Therefore, it's beneficial for organizations to adopt a more extended planning horizon, using three-year or five-year models. This approach helps them anticipate future pressures and challenges beyond the one-year mark, enabling strategic and proactive measures rather than merely reacting to issues as they arise.
Managing cash flow is essential for the long-term financial stability and success of your not-for-profit organization. At CBIZ, our finance professionals recommend that you develop robust tools, models and scenarios. These resources are designed to help you navigate variability and uncertainty in a positive and proactive manner. We welcome the opportunity to share ideas and best practices with your team to enhance this aspect of your financial planning and thinking. Connect with a team member today.
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