Integrating Financial Health Assessments into Your Organization’s Planning Process
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The markers for tracking and assessing a nonprofit organization’s financial health are not a mystery. The key elements of financial health (operating reserves, funding, and operational expenses) are generally easy to identify and understand. You just need a willingness to keep your eyes open and a commitment to pause and make an honest assessment of a financial picture that has most likely been changing.
The biggest challenge is making the commitment to periodically pause and judge which direction the key markers of financial health are trending (up or down). This is especially important during disruptive times, such as when strategic plans need to be modified, constituent needs have shifted, or when economic conditions have taken an unexpected turn.
In addition, when unexpected challenges appear suddenly, we naturally lower our commitment to financial health in favor of keeping service levels high and continuing operations without disruption.
We need to remember that for nonprofits the main purpose of having strong financial health is to help support, protect, and ensure long-term organizational sustainability and continuity. At the same time, we must recognize that this is a delicate balancing act, requiring organizations to react to changing operational and economic conditions and shift plans and priorities as necessary to protect the organization’s financial health.
To meet this challenge, make monitoring financial health a core element of fiduciary oversight and financial reporting practices, while also making this assessment process as easy as possible to perform on a regular basis.
Financial health can only become established as a high priority when programmatic and strategic planning includes an assessment of short-term and longer-term impact on financial health. This needs to become a natural as well as an expected behavior. Using this Financial Health Assessment and Implementation Framework worksheet will provide a visual tool to encourage monitoring and enhance awareness.
The worksheet includes a three-step approach to help you to step back and assess your organization’s recent financial position and set the stage for future planning:
Step One: Completing a financial health assessment
Step Two: Examining your organization’s current operating reserves position
Step Three: Noting proposed financial health enhancement items and implementations
The financial health assessment at the top of the worksheet is the first step, and the key building block in the process of integrating regularly financial health monitoring into your organizations planning efforts.
This section of the worksheet is divided into three columns:
Assessing the balance sheet (statement of financial position) and operating reserves
Recent past changes to funding, programs, and operations
Expected near-term changes to funding, programs, and operations
You are looking for changing signs of trends (up or down) and the underlying reasons behind the changing trends. Each column is further explained as follows:
1. Assessing the Balance Sheet and Operating Reserves
The financial health of an organization is best observed on the balance sheet. The single strongest factor to gauge financial health on the balance sheet resides in unrestricted net assets (net assets without donor restrictions) as “operating reserves,” which is often defined as the liquid portion of unrestricted net assets (unrestricted net assets less net noncurrent assets such as net fixed assets).
Most nonprofit organizations set an operating reserve goal equal to six to twelve months of their annual operating expense budget. When an organization has less than three months of operating reserves this is usually considered a weakened financial position. A strong financial position is when an organization has met or exceeded its operating reserve goal.
Observing operating reserves at a single point in time is meaningful but observing operating reserve status over multiple time periods will better reflect the trending strength or weakness of operating reserves and an organization’s financial prospects for the future.
For example, an organization that is sitting on 14 months of operating reserves at fiscal year-end might believe this is an advantageous position. But if the organization was sitting on 28 months of operating reserves just two years ago, they should be alarmed that half of their operating reserves have disappeared. Conversely, an organization that currently has only 4 months of operating reserves could be excited because two years ago the organization was underwater with a negative (deficit) two-month operating reserve position.
If operating reserves have materially declined during the last two years, there should be a higher emphasis on prioritizing operating surpluses in future budget planning. If there were recent increases in operating reserves, this could allow an organization to invest in growth opportunities, initiate new programs, and generally expand operations to meet future capacity needs and service goals.
It will also be helpful to consider other balance sheet positions such as availability of liquid cash vs. the status of accounts payable, which is a key indicator of an organization’s ability to meet current obligations. In addition, make sure to observe changing trends related to pledges receivable, deferred income, lines of credit, and other current assets and current liabilities to help raise awareness of improving or deteriorating financial health indicators.
2. Assessing Recent Past Changes to Funding, Programs, and Operations
Funding, programs, and operations are very sensitive to changes in constituent demand, volatility of external sources such as the economy, and internal changes such as changes to staffing. All of these factors impact service performance, capacity, and the success of an organization’s events and programs.
Thus, the second column examines changes to funding, programs, and operations over the past 2 years. The emphasis here is on recognizing the impact recent changing conditions have had on operations and capacity. Shifting planning, program priorities, and allocation of financial resources to align with recent changes to operational capacity will help management to more nimbly react to changing conditions.
3. Assessing Expected Near-Term Changes to Funding, Programs, and Operations
The third column addresses expectations for the near-term future, providing a chance to reflect and visualize how the organization can (and should) shift programs and operations to align with anticipated changing funding and constituent needs while also addressing changes to their operating reserve status. The goal of this exercise is to help organizations achieve more purposeful and sustainable planning for the future.
Planning Tip – Financial health assessments are more effective when they are regularly shared outside the senior management group. First, the financial health assessment should be made available to all staff members, and they should be encouraged to share their observations, comments, and ideas. After considering staff input and observations, share and seek feedback from the Board, finance committee, and other committees where appropriate. Finally, consider sharing financial health assessments with select funders, constituents, and recipients of services to gain their valuable insights, increase trust and confidence that transparency is important, and show that feedback is encouraged.
Financial health assessments work best when they are updated on a regular basis. If an organization is experiencing active periods of unexpected disruption and uncertainty, plan to prepare updates on a rolling six-month basis (or more often, if necessary). If there is strong confidence in future stability, plan to prepare updates annually just before starting assembly of the next fiscal year budget.
