“Cash-Flow Forecasting in Non-Profit Organisations” – Patrick Hoermann

May 19, 2014

An illustration as to why cash-flow forecasts are an essential element in the financial planning of any non-profit organization.

Patrick Hoermann

 

Non-profit organizations have different performance goals and financial restrictions than for-profit organizations. Obviously, for-profit enterprises focus on maximising profits, whereas non-profits try to maximise their social impact and the benefits that they provide to the community (Harvard Business School, 1999). In for-profit organisations, generated profits can either be distributed to their capital investors or be invested for further growth. Non-profits lack this financial flexibility. Surpluses, grants and other resources must be spent on particular purposes, which are specifically identified by the donor or implied in the non-profit’s mission (Wacht, 1991).

Nevertheless, both non-profits and for-profits still have expenses. Although some non-profits use only volunteer labor, any sufficiently large non-profit is likely to require staff of paid full-time employees, managers and directors. Additionally, operating expenses such as rent and on-going program costs need to be covered. It is for these reasons that there is also a significant financial commonality between these two organizations: just like any for-profit organization, non-profits have to continuously stay financially solvent, as running out of cash will sooner or later result in financial difficulties.

So how can managers of non-profits ensure to stay financially solvent?

The key method when it comes to financial planning is cash flow forecasting. Cash flow forecasts provide a solid basis for the projection of a non-profit’s future financial situation. They allow these organizations to see when money is expected to be received and when that money will be spent. A cash flow forecast enables non-profit organisations to plan reinvestments from surpluses or the need to raising additional capital due to expected deficits.

So is it not enough to look at the balance sheets?

The simple answer is no. Balance sheets only reflect the position of a company at a certain period of time. Accounting methodology allows income and expenses only to be listed when they are incurred. Regular balance sheets are static and do not include anticipations of future events. Metaphorically speaking, a balance sheet is merely a “snapshot“ of a fiscal situation at a certain period of time. Cash flow reports and forecasts, however, are more like a “movie“ in which income and expenses are listed with time to express the financial development of an organisation (Liner and Linzer, 2006).

But why is cash flow forecasting particularly important for non-profits?

In contrast to for-profit organizations, non-profits usually do not have a regular inflow of money. Cash inflows for most non-profits typically fluctuate throughout the year. It is often the case that grants, donations and the income from fundraising occur throughout a year in discrete, rather than regular payments. It is due to the nature of these receipts and, in addition, the uncertainty of their cash inflow that a cash flow forecast is a critical planning tool for all non-profit organisations.

So what are the components of such a forecast? And how can it be practically done?

A cash flow forecast essentially consists of two components: Anticipated Cash Receipts and Anticipated Cash Payments. Both components can either be estimated through historic data or by calculating the most likely figure based on existing information.

In order to better illustrate cash flow forecasting methodology, let us consider a non-profit organization in the education sector. This organization provides disadvantaged children in rural areas of third-world countries with educational programs to increase their chances of a better life in the future. Let us call this organization “Better Education Charity” (BEC). BEC receives governmental grants of $20,000 in March, June and September, as well as grants from an endowment fund in the amount of $30,000 paid each year at the same time. The company scheduled four fundraising events, two of which are in the next half year. On average, the company gains $6,000 with such events. Membership income is $3,000 per month. Cash expenses such as staff salaries, operation costs and program expenses are based on BEC’s historic cost data. In order to obtain a financial overview for the next half-year starting in January, BEC decided to project cash flows on a monthly basis.

As seen from the calculations for BEC, anticipated Total Cash Receipts for next year are $270,000 and anticipated Total Cash Payments are $247,000. This leads to a projected annual Net Cash of $23,000, which means BEC can be content, as it will generate a surplus for the whole of the next year.

By looking at the monthly Net Cash from Operations, however, high fluctuations can be seen. In fact, in January, February, April and May, cash payments of the company are higher than cash receipts, which leads to negative Net Cash in these months. Most importantly, in February, the company is not only going to have a negative Net Cash from Operations but also a Total Cash Flow deficit of -$5,250, as this loss cannot be compensated by the beginning monthly cash balance. As a result, the company does not have sufficient money to pay the expenses, that is, the company will run out of cash in February.

How can non-profits handle such cash flow deficits?

One of the most common ways to manage a cash flow shortage is to use credit from a bank. Specially designed ‘working capital loans’ can help non-profits cover operating expenses while they are waiting for a grant or contract disbursement. Generally speaking, these loans are for the short-term only and it is expected that they be repaid as soon as the next grant is received (Zietlow and Seider, 2007).

Non-profit companies may also think about rearranging fundraising efforts according to individual cash flow needs. In this case, it would make sense for BEC to schedule the first fundraising event of the year one month earlier. The projected $6,000 from such an event in February would save the company from a cash-flow deficit in this month. Additionally, the company may ask grant givers for an upfront payment in advance of scheduled payments. In this case, this would make also sense in the long-term as BEC usually receives both Government Grants and Foundation Grants at the same time.

It may also be possible to try to delay payment to vendors. Perhaps bills that are due every month can be extended to 60 or 90 days. This would depend on BEC’s relations to its suppliers and partners.

If a non-profit has cash flow surpluses, how should they manage them?

In general, non-profits are by law supposed to spend any gained capital on their programs. With a continuous positive amount of cash, however, non-profits may also pay down outstanding loans or credits, if they exist, or consider bulk purchases of supplies in order to save the organisation money in the future. Overall though, there is a thin line between having the right amount of cash in reserve to prevent cash-flow deficits and stockpiling too much capital (CPA Australia, 2009). In addition, BEC has to critically evaluate their cash flow balances, as the company is projected to have both deficits and surpluses. It may be recommended, however, to rather keep the cash in the company in the short-term as cash tends to fluctuate. In the long-term, if BEC builds up cash, the company may consider increasing their program expenses to maximise their social impact in the sector they are operating in.

What can be learnt from this?

Cash flow forecasts are an important method in the financial management of any non-profit organization, as they help non-profit organizations to better plan for the future. Only with cash flow projections can non-profits accurately anticipate when surpluses or deficits will occur and identify strategies to deal with them.

As seen in the example of the non-profit organization “Better Education Charity”, the period frequency of such forecasts is critical. If BEC had only forecasted yearly cash flows, the company would not have realised that it was going to run out of cash in February.  To prevent financial difficulties, it is therefore not only crucial to forecast cash flows, but also to do this on a monthly basis, if not even on a weekly basis.

 

References

i  Harvard Business School, Harvard Business Review on Nonprofits (Harvard Business School Press, 1999).

ii  Richard Wacht, Financial Management in Nonprofit Organizations (Georgia State University Business Press, 1991).

iii  Richard Linzer and Anna Linzer, The Cash Flow Solution: The Nonprofit Board Member’s Guide to Financial Success (John Wiley & Sons, 2006).

iv  John Zietlow and Alan Seider, Cash & Investment Management for Nonprofit Organizations (John Wiley & Sons, 2007).

v  CPA Australia, Financial Management of Not-For-Profit Organizations (CPA, 2009).