Nonprofit Accounting Basics

When Too Much Money Can Disrupt an Organization

Author: 

Eric Fraint

Your Part-Time Controller, LLC

It sounds counterintuitive, but many nonprofit organizations face situations where getting too much money in the form of grant and contract revenue can threaten their ongoing viability.

Take for example a foundation grant restricted to the direct costs of operating a program. Assume the grant, as is often the case, fails to provide any funding, or provides insufficient funding, for general infrastructure and overhead support. It is quite possible that if the organization gets too much restricted funding of this type, the operating needs of the programs will outpace the ability of the organization to support them. This could destabilize the organization and, if the situation gets too severe, can cause the organization to collapse.

To illustrate, assume a hypothetical organization that provides after-school services for children. It has a building with classrooms, administrative staff, and teachers to run its programs. The organization has carefully analyzed all its costs and knows its current level of programming costs 30% of every dollar spent just to keep the doors open. At the end of the year, its financial reports show the following (assume all dollar amounts are in thousands):

Table 1

Program expenses$70070%
Fundraising, general & administrative$30030%
Total expenses$1,000 

The next year, a very generous foundation offers a new $1 million grant to expand the after-school programs. The grant stipulates, however, it will only pay for new direct costs. It will not pay for any existing or new general infrastructure to support the new programs. Somehow the organization, which is already operating at its optimum capacity, will need to accommodate a more than doubling of its program activities from $700 to $1,700.

The organization’s accountant prepares a preliminary forecast for the next year with this new grant assuming all else continues unchanged:

Table 2

Program expenses$1,70085%
Fundraising, general & administrative$30015%
Total expenses$2,000 

The forecast in Table 2 shows the organization’s support services at 15% of total costs will be woefully inadequate to support the new programs. Thirty percent is a more appropriate level for this organization. At 15%, the building facilities will not be adequate, and there will not be sufficient support staff, etc

The accountant does a second forecast in Table 3 of what will be needed to support the new programs and restore the 30% ratio of support service costs to total expenses:

Table 3

Program expenses$1,70070%
Fundraising, general & administrative$73030%
Total expenses$2,430 

The forecast in Table 3 shows $730 is needed instead of the $300 already being spent. That is in an increase of $430. Where will this money come from? Not from the foundation providing the additional funding because they specified their money is only to be spent on new direct costs and not on infrastructure. One way or another, this organization will have to raise an additional $430 in general operating support to allow it to properly run these programs, or risk destabilizing the entire operation.

The situation is somewhat similar to a lifeboat, filled to capacity, adrift in the ocean. Imagine the physical boat itself, and the crew member operating it, represent the support services. Now along comes a swimmer. The boat can probably accommodate an additional person without much of a problem. Now two more swimmers come by. The boat picks them up, but things are starting to get cramped. Three more swimmers come by. They scramble aboard. Now the boat is very unsteady. If any more swimmers come by and try to get on board, the boat may tip and sink. Clearly, additional support services in the form of a second lifeboat, and an additional crew member to operate it, is needed.

Moral of the story: enlightened funders understand the need to provide funds for infrastructure support. Yet even they may not provide enough. To combat this, nonprofit organizations need to do their homework by thoroughly understanding their cost structures. In addition to their program costs, they need to know what their general, administrative, fundraising, and all other infrastructure costs are. They need to know their fixed and variable costs, and their direct and indirect costs. This is the starting point of being able to properly manage their finances and to allow them to engage in educated conversations with their funders.