2016 State of the nonprofit sector |Grant Thornton

The State of the Not-for-Profit SectorThird annual report 2016

FIND AND SHARE THE REPORT ONLINEThe State of the Not-for-Profit Sector in 2016 at grantthornton.com/stateofnfp2016.

Contents4 Enhancing stakeholder communications, transparency

8 Setting aside uncertainty in strategic planning

10 In focus: Museums and cultural institutionsWelcoming big data to your institution

12 Taking budgeting to the next level: Integrating the strategic plan

14 In focus: FoundationsAcquiring foreign alternative investments: Taxpayer beware

16 Utilizing data analytics to improve performance

20 In focus: Social services organizations Responding to increased strain on existing programs

22 Recognizing, averting risk of financial failure

28 In focus: Religious organizations Selecting an IT solution for practicality, effectiveness

30 Telling your story transparently: Putting disclosures to work

32 In focus: Associations and membership organizationsPreventing nexus from becoming your nemesis

34 Making your voice heard in elections: Taxes + political activity

36 In focus: Jewish and Israeli organizations Protecting your organization from fraud

38 Redefining defined benefit plans to meet challenges, improve exits

42 About Grant Thornton LLPs services to not-for-profit organizations

43 Grant Thornton not-for-profit 2016 webcast series

grantthornton.com/stateofnfp2016

IntroductionThe State of the Not-for-Profit Sector in 2016

This is a time that is both exciting and challenging for not-for-profit organizations. On one hand, the challenges of the past few years have only intensified. Increased scrutiny by stakeholders, heightened competition, changing constituent demographics, philanthropy that has not returned to previous levels, and even risk of financial failure are critical issues that not-for-profit leadership need to find ways to overcome. On the other hand, management and boards have new approaches and tools at their disposal to move their organizations forward toward ever greater success. There are increased opportunities to provide services; new techniques in constituent communications that can create enhanced affinity, perceived value, participation, donations and willingness to pay; data analytics tools that can improve financial and nonfinancial outcomes; and new approaches to strategic planning that can help ensure financial sustainability and mission achievement.

In our third State of the Not-for-Profit Sector report, our intent is to point the way to decision-making that will help sustain your organization, positioning it for long-term success. While we will continue throughout the course of this year to provide you with webcasts, training and articles of interest to leaders in the not-for-profit sector, the editorial purpose of this publication is to focus on key trending topics and offer experience-based viewpoints, approaches and solutions. As a leader in the not-for-profit sector, I believe it is Grant Thorntons responsibility to give back to this community we serve by providing these valuable insights.

Within these pages, you will find our thoughts on key industry developments and challenges facing not-for-profit leadership, with specific features for each of the key sectors that comprise our industry practice associations and membership organizations, foundations, Jewish and Israel organizations, museums and cultural institutions, religious organizations, and social services organizations (we cover our seventh sector, higher education, in a separate publication, The State of Higher Education in 2016 see grantthornton.com/highered2016). In the report, we describe issues and challenges and, as importantly, offer solutions and alternative approaches.

The articles in this report stem from knowledge gained through our professionals direct interactions with their clients. Rather than theoretical pieces, they are the result of practical, hands-on experience gained by more than 400 dedicated Grant Thornton LLP professionals serving approximately 900 not-for-profit clients. These insights are intended to be used by you board members, executives, management and other leaders in the not-for-profit sector.

Our Not-for-Profit and Higher Education practices are committed to helping organizations that do good achieve their mission. We understand that protecting your reputation and operating sustainably are essential to your organizations ability to achieve its mission and further its cause. Our not-for-profit experience is deep, and we offer it to assist you with the challenges addressed in this report.

On behalf of the partners and professionals of Grant Thorntons Not-for-Profit and Higher Education practices, I am pleased to present The State of the Not-for-Profit Sector in 2016. We hope that you find this to be a valuable resource. As always, we welcome your feedback and are available to assist management teams and boards in addressing the challenges discussed in this report, or any other issues your organization may be facing.

Sincerely,

Mark OsterNational Managing Partner Not-for-Profit and Higher Education [email protected]

http://www.grantthornton.com/issues/library/whitepapers/nfp/2016/SoHE-2016/State-of-higher-ed-2016-overview.aspxhttps://youtu.be/K9vQjQHqamM

4 The State of the Not-for-Profit Sector in 2016

Katrina Gomez, Senior Consultant, Advisory Services, Not-for-Profit and Higher Education PracticesJoseph Mulligan, Senior Manager, Advisory Services, Not-for-Profit and Higher Education PracticesMark Oster, National Managing Partner, Not-for-Profit and Higher Education Practices

Transparency is becoming a governance byword in the nonprofit sector. Stakeholders have come to expect even demand to be kept apprised of everything about an organization and its inner workings. When organizations are not transparent or there is a suspicion of withholding the truth, losing influential board members or donors is just the beginning of the fallout.

What exactly is transparency? Simply put, transparency is what interested parties are shown about an organization and its structure, plans, funding, activities, challenges and outcomes. What is disclosed means different things to different parties, but it is essential to present a clear message to all.

Transparency may sound like a buzzword, but it should be a key organizational strategy. Transparency in the nonprofit sector is of growing interest to government regulators and legislators, charity watchdogs, service recipients and other key constituents, funders, rating agencies and the media, among others.

Establishing and maintaining strong lines of communication with stakeholders are of critical importance for todays not-for-profit organizations. Constituents are developing an increasingly voracious appetite for timely, relevant and specific information, and they are voting with their feet and dollars for organizations that meet those needs. While certain financial and nonfinancial reports are mandatory, not-for-profit leaders are taking deliberate measures to go above and beyond by proactively disclosing fiscal and operational performance to demonstrate transparency and a commitment to the relationships between the organization and its stakeholders.

Most nonprofits constituencies are quite diverse, with each segment possessing its own unique needs. Whether addressing internal stakeholders (i.e., boards, employees, consumers, members, donors, administration, etc.) or external constituencies (i.e., funders, credit rating agencies, partners, municipalities, the media, volunteers, the broader community, etc.), organizations are deploying enhanced communication techniques to build awareness, increase engagement, earn trust and demonstrate goodwill. After all, a nonprofits reputation and stakeholders perceptions are largely shaped by the information brought to the attention of these constituencies.

Enhancing stakeholder communications, transparency

Transparency may sound like a buzzword, but it should be a key organizational strategy.

Engagement, reputation, trust and funding are on the lineIn an era of increased scrutiny, nonprofit leaders are under ever-greater pressure to differentiate from competitors, enhance the value and level of service delivered, and assure prospective funders and donors that the organizations future endeavors and aspirations are attainable. Meaningful engagement with constituents can significantly affect the perceived value of services rendered, the level of affinity generated, programmatic participation and willingness to pay. Strong communications and relationships with those just starting their affiliation with your organization can foster a feeling of belonging, and when sustained over the long term, can generate mutually beneficial value for all involved.

From a fundraising perspective, an organizations ability to engage donors, share relevant information and establish a tradition of giving has a tremendous impact on financial position. There are staggering differences in results between organizations that engage their board and most loyal constituents with effective messaging, and those that lack a formal constituent relations and development strategy. Overall revenue diversity and financing of future growth can frequently hang in the balance.

Since the definition of organizational success may vary from one constituency to the next, maintaining open lines of communication is key to generating dialogue and fostering mutual understanding. For instance, many organizations are in the midst of formulating or implementing transformation initiatives. It is critical to be proactive in providing information to those who will be affected by change, and to answer questions in a way that will build trust, demonstrate transparency and alleviate anxiety. Clearly articulating anticipated changes, expected benefits and implementation timelines enable leaders to set expectations for a broad range of stakeholders.


Clarifying financial position. Not-for-profit reserves planning has become a hot topic in recent years. Organizations and their finance leaders have increasingly found themselves in the position of having to demonstrate financial sustainability or justify the size of their balance sheet. On one hand, maintaining insufficient liquidity can be deemed financially irresponsible; on the other, a balance sheet that is too strong might be perceived as excessive, since hoarding assets prevents an organization from deploying resources for mission-related causes. Some nonprofits have made concerted efforts to cogently articulate the basis for their organizations financial position to provide assurance to government, constituents, debt rating agencies and creditors; demonstrate a need for ongoing financial support from donors and grantors; and indicate the organizations preparedness for the pursuit of strategic projects.

Implementing a fact-based, data-driven approach to determining an appropriate reserves target, while articulating a sensible policy for doing so, can help nonprofits reassure their constituents and strike an appropriate balance between the pursuit of mission objectives and long-term financial sustainability.

Organizations find that communication and transparency workOrganizations recognize that stakeholders expect more communications than in the past:

Taking an investor relations approach. Inspired by the standard to which publicly traded corporations are held regarding financial reporting and investor relations, Fedcap a New York-based nonprofit that strives to help individuals overcome barriers to economic independence implemented a semiannual stakeholder relations webcast/phone call to update constituents on its operational and financial performance. Fedcap President and CEO Christine McMahon, along with CFO Karen Wegmann, proactively seek to enhance the level and nature of financial and nonfinancial reporting to demonstrate transparency, increase engagement, respond to inquiries and exemplify stewardship. One year into this new approach, a broad array of constituents have voiced their satisfaction with the practice, while the organization and its leadership have benefited from the robust and meaningful conversations that have been fostered.

Garnering the support of donors, the local community and the faithful. In its 2015 publication, Catholic Impact, the Archdiocese of Washington [D.C.] sought to engage and inform a variety of stakeholders about the good work of the organization and its related entities. With an emphasis on the financial, spiritual and operational accomplishments of Catholic education, social services and health care, the publication is intended to build awareness of, and quantify, the organizations ministerial contributions. In addition to the 620,000 Catholics who reside within Washington, D.C., and the five surrounding Maryland counties that comprise the archdiocese, Catholic Impact targets the broader community including taxpayers and government entities to highlight the Churchs commitment to various social causes. The bilingual, multimedia-delivered content showcases the impact of donor support, quantifies the archdioceses impact on the broader community, and describes to taxpayers and municipalities the benefits that are provided without reliance on taxes or subsidies. For example, the archdiocese reports that one of its health care entities provided more than $200 million of community benefit over a five-year period. This clear quantification and articulation of organizational contributions has enabled the archdiocese to control its message and influence broader constituent perceptions.

http://adw.org/catholicimpact/

What does good look like? Not-for-profit organizations are improving transparency and sharing information in many ways. A few best practices stand out:

Timeliness: Provide data consistently and quickly after it is available or collected.

Appropriate level of information: Communicate the right level of quantity and complexity, based on each constituencys degree of interest. When burdened with too much unexplained data, the message can get lost. When information is meager, stakeholders have more questions and less trust.

Full disclosure: To build trust, share the good and the bad. Be forthcoming about challenges, crises and other less-than-optimal situations. Accompany these reports with a description of remedial actions or plans.

Utilizing reporting requirements: Leverage your Form 990 disclosures to explain and promote your activities and outcomes, not only to the IRS, but also to all other stakeholders. See in this report Telling your story transparently: Putting disclosures to work, by Kimberly Schrant and Dan Romano.

Open conversations: Make the conversation a two-way street; develop channels of communication so constituents can speak to you. Listen and respond.

Metrics that matter: Align metrics to a broader vision and strategy, and demonstrate how the organization is executing its key mission and values. However, understand that data alone dont explain anything. Provide analysis and accompany it with interpretation, and explain what the organization intends to do in response.

Partnering with your constituents is a foundation for your organizations success. As in any partnership, trust is earned through honesty and transparency. Earn your partners trust by maintaining meaningful, ongoing communication to tell the story of what has been done, what is being done and what comes next.


Brian Page, Partner, Audit Services, Not-for-Profit and Higher Education Practices

Uncertainty. The word describes not only the economic reality that not-for-profit organizations are facing, but also an emotion generated by that reality one that often prompts leaders to resort to short-term plans instead of minding important long-term strategies.

Leaders who take a longer-term perspective and seek to truly plan often ponder questions such as these: What impact will current economic changes have on future program viability? What will the business climate be like in three years, and how can we begin to position our fundraising efforts? In formulating a successful strategic plan, leaders also must realize that an analysis of external factors is just one component. At least as valuable are comprehensive internal and competitive assessments, perspectives on potential outcomes, and the ability to adapt to change.

All of these components require flexibility and a keen eye for trends. Until recently, boards and executive management did well to rely on long-standing strategic planning techniques, but in a dynamic environment giving rise to serious revenue challenges, these techniques need to evolve.

Consider these emerging approaches during the design, implementation and execution of your organization's strategic plan:

1. Holistically assess the state of the internal and external environments. Organizations of all kinds have a tendency to focus on immediate operational challenges, primarily during the assessment phase of a strategic plan. In recent times, this has led to prioritization of factors that can affect revenue generation. These factors should not be ignored and do carry significant weight, but they can also encourage a short-term focus. It is critical to take into account other important issues, including leadership competencies, competition for personnel, cost structures, program development, technology capabilities, risk profile, mission and culture.

2. Contemplate potential changes to the initial assessment.The not-for-profit sector no longer operates in a static environment. By the time an organization understands and documents the current state, the environment has most likely changed. It is difficult to prognosticate, but a thorough process needs to postulate a variety of outcomes or scenarios to stay nimble during the implementation phase. Bringing external perspectives from peer organizations or outside experts can be helpful in providing a well-rounded viewpoint of the future of the sector.

Setting aside uncertainty in strategic planning

3. Be wary of consensus during strategy formulation.Human nature is such that it is easy to adopt insular thinking. When individuals share similar experiences within the organization, discussions and decision-making can become groupthink, resulting in a more-of-the-same view of the appropriate way to progress. This can lead to a narrowly focused strategic plan and a limited ability to identify when course corrections are needed. To avoid this, welcome into the planning committee a variety of individuals with differing functional responsibilities and perspectives. Seek opinions contrary to the norm.

4. Link your strategic plan to your operational and tactical plans.An organization has plans that are much less encompassing than the strategic plan. They include program, property, budget, IT and development plans, to name a few. Often, day-to-day activities in support of these annual operating plans take place independently of strategic priorities. These activities were aligned with early strategic planning formulation, but as time went on, they drifted from the original intent or they were reactively executed in response to nonstrategic priorities. To ensure that resources are expended on strategic imperatives, periodically evaluate operational plans to ensure that they are fully aligned with the strategic plan.

5. Keep in mind that executing the plan is not linear.Agility in execution and monitoring is as important as the actual plan. Development of a strategic plan is time-consuming one of the main sources of failure is the collective sigh of relief that sometimes occurs after the initial plan is developed. Too often the plan is completed, put on a shelf and not revisited for the duration of its time horizon. Periodic monitoring of the environment and your plan helps to determine when changes to strategic priorities and goals are necessary. In light of the current dynamic environment, this monitoring is critical, as significant changes in the level or use of resources or changes in strategic or programmatic direction may be needed in the strategic plan. Consider forming a strategy analysis response team to monitor strategy and lead the charge for identifying when modifications need to be made.

Strategic planning has always been a vital component to the long-term success. Given the broader context of change in the competitive landscape, a realistic, flexibly designed and closely monitored strategic plan is fundamental to ensuring financial sustainability and success.


Tom Brean, Partner, Audit Services, Not-for-Profit and Higher Education Practices; Leader, Museums and Cultural Institutions Sector

Big data. Its still new, and its everywhere. The term was added to the Oxford English Dictionary in 2013 and Merriam-Websters Collegiate Dictionary in 2014. But what does it actually mean, and how can it be of use to museums and cultural institutions?

Big data commonly refers to very large, very diverse data sets. It also describes the technologies that allow effective mining of data for analytical insight and informed decision-making. Advances in tracking technologies and social media growth are a couple of the trends that have made it possible for a wide variety of entities to make sense of volumes of information drawn from corporate databases, smartphones, Web activity and other sources. Mining, analyzing and comparing data can draw a detailed, and sometimes unnervingly extensive, picture of individuals and their behaviors.

Cultural institutions, including museums and performing arts organizations, are or should be increasingly using big data tools in their programming, marketing and fundraising.

Track visitor engagement to inform improvementsIn the museum environment, where visitors are continually moving throughout a building and viewing exhibits, how do you collect data related to their engagement and interaction? The answer, increasingly, is digital beacons. The majority of museum visitors now carry a smartphone. Digital beacons are devices that transmit a signal, allowing a smartphone to register its position, collecting a considerable amount of data, including how visitors move through exhibits and how long they linger in front of a particular display.

Additionally, by offering a customized smartphone app, museums can not only obtain details about visitors locations, but can also send additional contextual messages about exhibits to visitors smartphones, helping to educate and enhance their experience. In addition, museums may send a visitor viewing a particular exhibit an alert about related exhibits and presentations or products in the gift shop.

Another method for gathering useful data is offering a frequent-visitor program. By checking in at a performance center or sites around the building with their smartphones or at kiosks, members can earn points toward rewards, such as tickets for special exhibits or performances, free food and parking, souvenirs, or admission to private events. You can then dissect the data to better understand visitor behavior how often they visit, which exhibits appeal to them and which dont, etc. This analysis can help an institution understand if an exhibit is popular on its own or only because of its location, allowing for improved exhibit placement and museum layouts to enhance the overall visitor experience. Likewise, performance centers can analyze ticket sales data as well as statistics on sales methods and referring websites to build smarter schedules, boost turnout for poorly attended events, make better decisions about how and where to market your programs, and incorporate dynamic pricing based on current market demand algorithms.

Track and analyze how visitors use your space, including observations such as the days and times visitors are present or absent, areas they tend to populate or avoid, and length of stay. Also, note how they use auxiliary operations, including ticketing services and your website. These data can provide input to improve efficiencies of staffing and services.

Where institutions historically gathered data on visitors through a ticket-taker and a clicker, big data is a revolution. In appeals to potential sponsors, institutions can now present more than just attendee counts. They can come armed with detailed statistics indicating who attends, what draws them in and why.

In focus: Museums and cultural institutionsWelcoming big data to your institution

Mine data for revenue opportunitiesUse your data to boost outreach and funding. Dig into the details of your supporters and draw on what you uncover. Your institution can learn more about who its patrons are, where they come from, who else is like them, and other marketing opportunities. These data can be used to personalize direct mail and to be more efficient in marketing subscriptions, memberships, special events and fundraising appeals to single-visit attendees.

With information from your ticket and donor databases, your development department can customize fundraising appeals. For instance, you can filter for a list of people who have been longtime ticket buyers or visitors but not significant donors. You can approach that group, explaining how even modest donations to your annual fund can help strengthen their connection with your institution, thereby turning this untapped population into donors. Corporations and other sponsors often look at the number of donors as much as or even more than the total contribution amount.

Prepare to answer privacy and other concernsThe biggest obstacle to gathering big data may not be technology, but instead public apprehension. The methods used to collect this level of detail may result in a backlash about personal privacy. Your visitors may not want documentation of when they visit, how long they stay and how they move around the building.

As cultural institutions collect more personal information, they open themselves up to the same kinds of security breaches we have all read about. To protect your institution and your visitors, require that data be accumulated only about those who have opted in to the program. Encrypt all data and engage cybersecurity expertise. Determine what data require individual identification and where aggregated or anonymized data will suffice, thereby limiting the information you need to protect.

With data-mining tools calculating your most popular offerings, be aware that curators and program developers could make choices that are the most crowd-pleasing instead of the most artistically significant or mission-related. This can lead to bypassing innovation or controversy, and resorting to mediocrity and the expected.

As institutions continue developing technologically taking advantage of the considerable diversity of data available and addressing privacy and integrity concerns it is clear that while the public is experiencing tremendous artistic offerings, institutions will be taking note.


Larry Ladd, Director, National Industry Specialist, Not-for-Profit and Higher Education Practices

Budgeting for not-for-profit organizations is getting more challenging as mission-driven needs exceed available resources. Many have improved their budgeting practices, but more must step up to not just survive but become more successful.

While there are many permutations, just about every not-for-profit organization uses incremental budgeting. Even for those organizations that take a performance or activity-based budgeting approach, incrementalism is at the core of their process. Incremental budgeting involves assessing relatively modest increases or decreases in revenue and expense lines to produce a balanced budget. Performance budgeting uses metrics to make increases or decreases, but its still incremental. Activity-based budgeting involves relegating many budgetary decisions to lower levels in the organizational hierarchy, but even those decentralized decision-makers are using incrementalism. Some organizations claim to use zero-based budgeting, but in reality they cant afford the time and effort it would take to effectively judge each program annually.

Why is incremental budgeting the common practice? It is safe and requires less effort. It creates very little change and causes minimal disruption. It is highly conservative, and it will not rile most stakeholders. The budget simply enshrines the current state of affairs, with modest changes in response to the latest perceived internal needs and constituency pressures. Strategy plays no part, nor does long-term planning based on real-life market positioning.

Taking budgeting to the next level: Integrating the strategic plan

Budgeting approaches entirely combinableThe overarching principle of budget planning is to start with the strategic plan not the existing budget.

Incremental: Changes are made at the margins as pluses to or minuses from the existing budget. What is being done now tends to take precedence over what might be done in the future. This is the most popular approach because it is the easiest and most conservative.

Performance: Performance assessment metrics are usually at the core of this approach. Areas that demonstrate improvement are rewarded with new funding. Areas with poor or deteriorating metrics incur funding reductions. This is nice in theory but hard to practice in reality.

Budgeting by substitution: Revenue and key new expense items are identified based on the strategic plan. Inevitably, the projected budget will be in the red at that point. To balance it, items of low priority (usually those not included in the strategic plan) are deleted until the budget is balanced. This is the optimal approach basing decisions on the strategic plan but it doesnt preclude incorporating the best of the zero-based and performance approaches.

Zero-based: Putting all existing programs on the table to determine if they should continue to be funded is great in theory, but impossible in reality. A more workable approach is a rolling zero-based process that puts some portion of the budget under the microscope each year.

Move from the old to the new and betterThere is a better way. Consider adopting these key elements to create new processes or refine existing ones:

First and foremost, budgeting must be the short-term quantitative embodiment of an organizations strategic plan. In the past, strategic plans were a set of lofty goals indicating how new resources (e.g., service fee increases, debt and fundraising) would be used. They rarely challenged the existing expense base in a material way. Those days are over. Now, strategic plans are expected to represent notable departures from the status quo to define ventures not previously conceived or develop significant redeployments of physical, financial and human resources. Effective strategic plans incorporate meaningful change in response to critical environmental changes. They require trade-offs and, potentially, risks. To make that kind of change, you cant begin with the existing budget. Instead, you must base your budget planning on your strategic plan. The first rough sketch of the budget should be a mirror of that plan.

Second, you must budget by substitution; every new program or initiative must be funded by reducing or eliminating existing programs, rather than finding new funding. Incremental budgeting shaves a little from some existing programs, adds a little to other existing programs, and funds new programs with new revenue. Budgeting by substitution funds new programs by deleting old programs and taking a much harder look at existing programs. There are fewer small reductions in existing programs, which often compromise quality. Further, a powerful incentive is introduced to force the examination of existing programs and make hard decisions about priorities.

Lastly, use zero-based budgeting as a phased discipline. Every year, select a set of programs to intensively evaluate and consider. Concentrate efforts on how consistent those programs are with the strategic plan and the organizations mission, compared with other programs. This form of zero-based budgeting provides funding for new initiatives likely to be essential to organizational viability and success.

Ideally, an organization should use multiyear budgeting to plan several years ahead, but that rarely happens. Next years budget is frequently perceived by participants as the real one, and thats what they focus on. The second and third years are usually an afterthought prepared by staff at the last minute after the real one is put to bed with the elegance of compound interest (e.g., revenue grows by 3%, expenses by 2.8%) as the fallback.

A good way to create realistic multiyear budgets is to start with the third year and work backward. Create a budget that represents an ideal but incorporates clear trade-offs the budget must be balanced. Then move backward through the second and first years. Strategy and planning should take the forefront, with the top question being this: How do we get to ideal? This is a diversion from the way budgets are generally approached. It creates an incentive for decision-makers to remember that their ideal takes priority over their current state. It makes budgeting by substitution emotionally easier.

Follow overall best practices

Maintain a strong commitment from the top for the integration of planning and budgeting. You will be tempted to compromise to satisfy constituencies that dont want change.

Rank the priorities as high or low, rather than the typical list of unranked issues that inhibits decision-making. Make priorities clear and actionable. Have a few at the top of the list, and make sure the budget reflects those priorities.

Be resolute in setting clear priorities. Leadership requires courage in the face of opposition.

Identify all the resources required to achieve and implement the strategic plan (i.e., money, people, facilities, IT, etc.) so they can be translated into the final budget. Any plan must include all of the components needed for success. For instance, you cant create a financial budget for a new program without identifying the required space and IT resources.

Use a budget projection as a component of the strategic plan; it can serve as the basis for the actual budget.

Ensure a continuous conversation between the CEO and his/her leadership team about plans and future budgets so managers know what is likely to be approved or cut. This will speed the budget process.

Keep it simple complex processes are a distraction from the actual work.


Frank Giardini, Principal, Tax Services, Not-for-Profit and Higher Education Practices; Leader, Foundations SectorAlycia Mecchella, Manager, Tax Services, Not-for-Profit and Higher Education Practices

Seeking greater investment yields and rates of return than currently offered by conventional Wall Street equities and bonds, many private foundations and other tax-exempt organizations with significant endowments are frequently choosing alternative investments for their typically higher performance. Some of these investments originate from outside the United States. Although the net investment results of foreign investments, or domestic investments with foreign operations, can appear promising, they may come with onerous and complex U.S. tax reporting responsibilities. An investors failure to be aware of and comply with these rules could lead to costly IRS fines.

Rules for foreign investment have tightened Alternative investments both domestic and foreign generally are complex, limited in regulation and relatively illiquid; they include hedge funds, managed futures, real estate, commodities and derivatives contracts. To complicate things further, many investors use a pass-through type of entity, such as a limited partnership (LP) or an alternative investment LP, to hold the investment, which allows for income, loss, credits or other tax obligations to pass through to the investor. The current demand for alternative investments is prompting investment managers to seek opportunities offshore. It is common to use a foreign equivalent of a pass-through entity as the principal investment vehicle for these offshore opportunities.

With the two stated purposes of combating tax evasion through investments outside the country and assisting in tracking the flow of funds for suspected terrorist activities, Congress enacted legislation and Treasury regulations to deal with these issues. To avoid noncompliance with these new rules and significant penalties, private foundations must become savvier about specific tax regulations, including U.S. Foreign Investment Disclosure Rules (USFID) and the U.S. Foreign Account Tax Compliance Act (FATCA).

Penalties for noncompliance with these filing requirements far exceed those for not filing your organizations Form 990-PF or Form 990-T.

Ignorance will be no excuseAs in all tax obligations, lack of knowing about the rules does not excuse noncompliance. Many private foundations are unaware of these new reporting responsibilities; the tax buyer beware sign was lost in the fine print of the investment prospectus. Investors must gain an education about USFID and FATCA rules. The following can serve as a primer.

USFID: These rules generally require the reporting of property transferred as an investment of $100,000 or more, in one year, to a foreign corporation, partnership or trust. Accordingly, if a tax-exempt organization makes an investment of $100,000 or more within a one-year period, either directly or through a domestic or foreign investment LP, the organization is required to report the asset transfer on IRS-designated forms. The penalty for not reporting this transaction is typically 10% of the investments fair market value at the time of the transfer, with a penalty limit of $100,000, unless there was evidence of intentional disregard for the rules. In that case, the penalty is possible criminal charges.

In focus: FoundationsAcquiring foreign alternative investments: Taxpayer beware

USFID rules also require an additional U.S. disclosure form if the investor owns 10% or more of a foreign corporation. This is a common occurrence for foreign captive insurance companies, as tax-exempt organizations often have a 10% or more ownership interest. Further, USFID rules require special reporting if a tax-exempt organization has operations in countries designated by the U.S. government as boycotting countries. In both instances, failure to file disclosure of these types of activities will lead to severe monetary penalties, as well as possible criminal charges.

FATCA: These rules apply to foreign entities and institutions that hold the investments of U.S. investors, including tax-exempt organizations, such as an exempt organizations ownership of a foreign bank or brokerage account. FATCA rules require that foreign financial institutions (FFIs) register with the IRS and agree to report specific information about their U.S. accounts, including those of certain foreign entities with substantial U.S. ownership. This concerns tax-exempt organizations with significant investments; an FFIs noncompliance can subject payments made by the FFI to its U.S. investors to a 30% withholding tax which is likely to have a negative effect on the expected investment results. Compliance with FATCA rules is in addition to compliance with USFID rules.

Take corrective and preventive steps If you think there is an error in your organizations reporting, look into the IRS voluntary compliance program, which can help your organization eliminate the prior-year penalty exposure to USFID rules. The program could be terminated by the IRS in the future, so if you have previously unreported transactions or investments, you would be wise to not delay.

Take these steps in assuring compliance with USFID and FATCA reporting: Gain a solid understanding of your organizations investments and

corresponding strategy for your alternative investments, especially those held offshore.

Create a team of representatives from your organizations investment function, finance/tax function, external investment advisers, and external tax advisers; together they should address current tax issues and cure existing (prior-year) issues, and establish guidelines to ensure compliance with USFID and FATCA rules going forward.


Utilizing data analytics to improve performance

Matt Unterman, Principal, Advisory Services, Not-for-Profit and Higher Education Practices Mary Foster, Managing Director, National Industry Specialist, Not-for-Profit and Higher Education PracticesAnthony Pember, Senior Manager, Advisory Services, Not-for-Profit and Higher Education Practices

Despite the nonprofit sectors current focus on operational performance, efficiency and effectiveness, many organizations continue to rely on techniques that provide little to no quantifiable insights into performance improvement. To generate measureable results that also support mission achievement, organizations are turning to data analytics.

Data analytics yields meaningful patterns in data financial and nonfinancial that can describe performance, and predict and guide improvements. Analytics is a multidisciplinary approach that simultaneously applies statistics, computer programming and operations research to quantify performance and provide a clearer picture of what is working and where improvement is needed. Analytics can help you validate trends, pinpoint root causes of existing issues and take a comprehensive analytical overview of organizational performance as a whole within programs and their underlying business operations. More importantly, analytics can be predictive as well as real time, illustrating future possibilities to enable decisions about transforming performance.

Data analytics is a continuous, iterative exploration and an investigation of past business performance to gain insight and drive business planning for the future. The results of data analytics can be used to streamline operations, increase cost efficiency, determine and optimize financial margin by program, model and forecast performance (e.g., membership trends, donor trends, resource needs and revenue expectations), improve the budgeting process, and enhance overall mission effectiveness. With a true understanding of business performance based on data, statistical methods and predictive modeling, data analytics allows management to concentrate on the fundamental objectives of the organization and find ways to enhance mission achievement.

Results can be financial, programmatic, constituent building and sustainable As an example of how data analytics can be used to strengthen an organizations membership recruitment and fulfillment operations, consider how membership targeting and member maintenance has traditionally been done buying lists of names in the target market and sending communications deep into that list, as well as the existing membership base. Contrast this with an enhanced approach that effectively leverages metrics in a cross-functional analysis. Instead of hoping for a yield from a static list that offers few additional insights, with the use of data analytics, various factors, activities and characteristics are analyzed in concert to determine how they relate to and affect each other. This enhanced approach enables organizations to generate an optimal number of engaged members in a fiscally prudent manner. Using data analytics, planning exercises can take into account a more complete set of factors e.g., membership outreach yield, cost per outreach, market penetration,

demographic factors and changes, membership engagement, and membership product cross-selling. These factors are brought together in a solution to improve targeting, new member sign-ups and member renewals, as well as to identify future member needs and services all while keeping the cost and return on investment in mind.

Donor building and constituent outreach are fundamental building blocks of revenue for many nonprofits. Similar to enhanced practices in membership development as cited above, organizations are tapping into data analytics to improve donor yield and engagement. Conventional approaches for improving the success of these operations are giving way to donor analytics that extrapolate donor demographics (e.g., financial, geographic, political and gender). The analytics compare the demographics to various donor offerings (e.g., one-time gift, recurring, corporate or product-based purchasing) to determine the right fit for each individual.

Generating donations no longer involves going as deep into your snail mail/digital mailing list as you can afford; it now involves determining the right product for the individual, and the organizations desired yield and margin for each product and donor target. Further, when that outreach occurs, what is the optimal format for doing so? Monitoring open rates and click-throughs is one thing; doing so while comparing graphical layouts, subject lines and timing becomes an altogether different analytical exercise in order to optimize yield and engagement. Similar analysis can be applied to other forms of outreach (e.g., in-person events) to determine what truly generates a return and which activities should be continued. For many years, the label of friendraising was adequate cover for events that did not generate a net positive return; now it is necessary to assess an events indirect and direct impact to determine how and if the activity should continue.

Outcomes can be demonstrated for both planning and competitive advantageBeyond reducing the cost of operations and programs, performance improvement can be measured by mission-related factors and increased constituent outcomes by program. Another factor driving use of data analytics is heightened interest in program outcomes. Constituents and funders are demanding proof that programs are successful and improving the lives of constituents. In response, nonprofits are utilizing data analytics techniques and models to assess service outcomes and report mission-related achievement. Organizations that can exhibit a clear return on investment are at a significant competitive advantage when it comes to obtaining external funding.

While data analytics can assist organizations that are struggling with their bottom-line financial performance, analytics can also benefit financially stable entities by illuminating budget-neutral changes that can deliver better programmatic outcomes. The traditional approach of measuring financial performance solely by financial metrics such as operating margins, and growth rates in revenues, expenses, and specific categories of expense and revenue is limited in that it does not link financial performance to operational performance. Data analytics helps organizations enhance operational as well as financial performance by identifying and integrating financial metrics and business activities that have a significant impact on programmatic outcomes. Improving financial results while expanding program offerings and improving the success rates or outcomes of programs is true performance improvement, which can be achieved when financial and nonfinancial data are analyzed using statistical and predictive modeling techniques.

Analytics can help you validate trends, pinpoint root causes of existing issues and take a comprehensive analytical overview of organizational performance as a whole.


Assessing and measuring budget trade-offs related to investments in program sprawl (i.e., when an organization currently has too many programs, many of which may be underutilized or stray from the organizations mission) is where data analytics also shines. Data is aggregated, analyzed and explored across many dimensions for example: at-risk populations, programmatic factors (such as funding restrictions, per-capita rates versus service efforts, and volunteer service providers) and program type (such as housing, health services and workforce training). To help the organization rationalize program offerings, predictive analytical models can use past financial and outcome performance of programs to analyze, on a program-by-program basis, the impact from changes to specific funding criteria, socioeconomic and demographic changes, program visibility, shifts in government program priorities, interagency collaborations and program delivery models. With so many factors to assimilate, data analytics holistic and objective fact-based approach can help navigate difficult often political waters and enhance performance in a financially sustainable manner.

Satisfying social advocates, donors, funders, dedicated volunteers and committed board members while balancing program costs and outcomes requires a data-driven focus. Therefore, organizations are prompted to make decisions that are solidly based in fact versus emotions as they scrutinize program performance and investments in new programs amid the challenges of a competitive marketplace. To do so effectively, organizations must strive to understand their current program model by looking beyond the traditional metrics of program deficits, staff efforts and numbers of people served. To deliver truly improved performance and the best data for deciding on program investments and divestment, they must expand the data to include program efficacy, quality of program outcomes versus program efforts, salary-cost-to-revenue ratios by program, number of service efforts (hours and staff) provided by other area agencies in the same programmatic fields, relative cost of programs by agency, and program outcomes by other agencies in the same programmatic field.

Steps to instituting data analyticsPrepare your organization for optimal results: Invest in technology (e.g., data warehouse and analytical tools) to

capture desired data and create correlations. Establish performance metrics beyond financial measures and

agree on mission-driven indicators. Acknowledge the human element and the importance of effective

change management. Build collaboration into the process in order to view the

organization as a whole rather than as a collection of departments and interests.

Develop or acquire personnel to bring data analytics and business intelligence skills into your organization.

Commit to act on the trends and insights discovered through data analytics.

Create a cross-functional steering committee that can set aside other biases in order to act on the analysis.

Dedicate organization-wide focus to an ongoing data analytics program, as opposed to conducting a one-time exercise.

In analytics, human factors are as integral as dataIn the end, data analytics comes down to the human element. The organizations leadership needs to champion the desire for a better, more integrated decision-making process based on an understanding of the relationships between business drivers, programmatic outputs and predicted financial performance, and how each sustains the organizations mission.

To perform meaningful analytics, databases and technology tools are critical. However, this is not simply an IT exercise at its core, data analytics involves people and their commitment to the mission. It is essential to involve a variety of perspectives to ensure fair representation of stakeholders. The traditional analysis functions of the finance, budget, program, membership and fundraising departments need to be reassessed, and new skills introduced for analyzing different types of data. Collaboration is needed among various stakeholders to determine what data

Nonprofit operating model

General ledger GL structure and expenditure GL activity assignments

Payroll/HR Payroll structure Personnel

Donor and member records Demographics Point of contact Program affiliation Funding level Giving performance Fulfillment products Advocacy affiliation Crossover data Board member contact

Timetable information Demographic data Program services received Duration of program services Projected service outcomes Crossover to multiple services Crossover to other agencies

Asset/space data Entity Buildings Service areas Service area room types Off-site locations Technology, online services Mobile units Case management office space Administrative space Data and physical warehouses

Fundraising and donor

development

Program activities

HR resources

GL resources

Assets

Membership

Data sources Data sources

should be gathered and analyzed, and how analytics will be interpreted and converted to performance insights. Leadership is needed from the executive team to determine, in collaboration with the board, how decisions derived from business insights will be applied throughout the stakeholder groups, and how opinions about facts and data will be synthesized into action. This approach requires an organizational commitment to change.

The highly competitive nature of the nonprofit sector, increased scrutiny by stakeholders and changing demographics of our nation create an environment in which improving financial and nonfinancial outcomes cannot be achieved based solely on the conventions of past practices. The true power of data analytics lies in establishing a dedicated, ongoing program that enables nonprofit organizations to gain insights into their operations and improve performance going forward.


Randy Shrum, Managing Director, Audit Services, Not-for-Profit and Higher Education Practices; Leader, Social Services Sector Chris Kerzel, Manager, Audit Services, Not-for-Profit and Higher Education Practices

With economic recovery still far from complete, growing community needs are outpacing the ability of social services organizations to address those needs. To meet both current and future demands, organizations must first understand the current environment, then move to recognize the value of automation, strengthen their relationships and take advantage of available relief.

Understand the current environment Keep track of whats changing and how it affects your constituents in order to adjust program services to meet their needs. Too often, not-for-profit organizations come up short financially because they fail to pay attention to the radical differences between what has been and what will be. At the same time, organizations must beware of mission creep when focus on the core mission becomes blurred while trying to keep up with even higher demands.

While some agencies are wisely expanding their fundraising efforts and investigating innovative ways to increase revenues and make the best use of contributions, others are scrambling to make up for funding shortfalls. This practice often forces nonprofits to dip into reserve funds or borrow externally and use lines of credit.

A notable example of how reliance on a no-longer-viable source can lead to disaster is Lutheran Social Services of Illinois (LSSI). On Jan. 22, 2016, LSSI, the states largest provider of social services, announced program closures and staff cuts due to the states inability to pass a budget to fund the programs.1 The deadlock has severely challenged LSSIs ability to provide services to those in need, said Mark Stutrud, LSSI president and CEO. Over the past months, LSSI has relied on a bank line of credit and available resources from our foundation to compensate for the states inability to pay its bills. Currently, we are owed more than $6 million by the state for services delivered. After seven months, we can no longer provide services for which we arent being paid, Stutrud explained. More than 30 programs are closing, eliminating over 750 positions 43% of LSSIs employees. Approximately 4,700 people will no longer receive services from the organization.

Recognize the value of automationPut technology to work by automating time-intensive manual or outdated processes. Transition costs to improve systems can be significant, but there is a payoff in the long run as leadership is freed to add value by focusing on mission-critical activities a shift from mechanics to analytics. New technology can help management see the big picture and use financial information to make rapid and strategic decisions.

In focus: Social services organizations Responding to increased strain on existing programs

1 Kapos, Shia. Big Lutheran social agency cuts 750 jobs amid budget impasse, Crains Chicago Business, Jan. 22, 2016.

http://www.chicagobusiness.com/article/20160122/NEWS07/160129931/big-lutheran-social-agency-cuts-750-jobs-amid-budget-impassehttp://www.chicagobusiness.com/article/20160122/NEWS07/160129931/big-lutheran-social-agency-cuts-750-jobs-amid-budget-impasse

Strengthen relationships Better decisions, increased funding and greater service opportunities are the result of stronger relationships with your board, donors, constituents and partner organizations. In order to build stronger relationships and manage uncertainty, social services organizations should make collaboration a top priority: Fortify management and board relationships with major donors and

partners, and solicit their advice (e.g., invite stakeholders to tour your facilities and host a meal during which all parties can discuss their interests and concerns).

Communicate frequently with your board, and be transparent about the financial strains impeding your work. Take advantage of members years of experience and expertise, and obtain their guidance regarding pressing issues.

Step up marketing activities to increase community awareness of both accomplishments and needs (e.g., utilize social media to report outcomes and to highlight individuals who can tell the story of how your organization directly benefitted them). Report on your results as proof of your organizations effective use of contributions.

Before accepting new sources of revenue, connect with funders early in the giving process to ensure that their contributions align with your organizations mission (e.g., provide a document with your mission statement and supporting activities current and proposed so donors understand how their gift would fit your organizational purpose). Critically examine grants for the true financial cost of compliance: A significant grant might not be the boon it initially appears to be if the restrictions, reporting requirements or associated administrative costs are too onerous. Educate your contributors, donors and grant-makers about the costs of delivering on your mission so they understand what it takes to provide valuable services.

Develop connections with organizations whose core competencies complement yours. If individuals are seeking your services, but their needs better match the mission of another organization, a referral to the other group would avoid mission creep. Reciprocity from others will also benefit your organization. Alternatively, when appropriate, seek affiliations and consider mergers.

2 Office of Management and Budget. Federal Awarding Agency Regulatory Implementation of Office of Management and Budget's Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards, Federal Register, Dec. 19, 2014.

Not all bad newsSince a large portion of the revenue that supports charitable nonprofits comes from government entities, the rules that came out at the end of 2014 were received with relief by not-for-profit leadership. Under the new agreements, organizations should be able to recover more of the full costs of delivering services that are paid in whole or part by federal funds. The Office of Management and Budget (OMB), which oversees the use of federal funds, issued the rules as OMB Uniform Guidance.2 Governments at all levels local, state and federal that hire nonprofits to deliver services are now required to reimburse those organizations for reasonable indirect costs (sometimes called overhead or administrative costs). The OMB Uniform Guidance also raises the thresholds for requiring audits of federally funded programs and simplifies some compliance requirements, potentially reducing compliance costs for not-for-profits. In taking these actions to understand and meet the increasing needs of their constituents, social services organizations will be better-positioned for continued viability and long-term success.

https://www.federalregister.gov/articles/2014/12/19/2014-28697/federal-awarding-agency-regulatory-implementation-of-office-of-management-and-budgets-uniform


Dennis Morrone, National Partner-in-Charge, Audit Services, Not-for-Profit and Higher Education Practices Kira Hilden-Minton, Senior Manager, Audit Services, Not-for-Profit and Higher Education Practices

Financial failure is an increasing risk for all organizations often due to a confluence of contributing factors. Any one or even several of these factors may not have a significant effect, but when they work in concert, it is very difficult to regain financial stability and keep from failing. Leaders finding themselves in this precarious position have been known to compromise strategic goals, reduce critical investments in infrastructure, cut the extent and quality of services, and make other spending and revenue choices that begin to significantly challenge their organizations ability to achieve its mission.

In this post-recession period, philanthropy has still not rebounded to historic highs, and not-for-profit organizations have been called on like never before to provide services and meet the increasing demands of their constituents, many of whom are also suffering post-recession strains.

Monitor and respond to these 10 financial warning signals This list is not all inclusive; instead, it highlights indicators that, if ignored, could lead to financial difficulties in the not-so-distant future. These signals are not new to not-for-profit organizations, but their impact and velocity have increased of late. In large part, the acceleration of these factors is due to the current economic climate, coupled with the inability of most organizations to differentiate themselves from their peers and adopt an operating model that is both financially sustainable and responsive to the evolving needs of their communities and constituents.

For the sake of those you serve and your organization, determine which of the following are signals of concern, and consider the solutions recommended:

Challenges in hiring and retaining qualified leadership: While the perception may be that not-for-profits typically have long-tenured employees, the reality is that not-for-profits in recent times are experiencing increased turnover.1 Nonprofits have many challenges in hiring and retaining qualified leadership, including little to no recruiting budgets and compensation structures that are often not as attractive as those offered by for-profit enterprises. The loss of talented personnel can be extraordinarily disruptive, with a significant cost to hire, train and acclimate credentialed replacements. Often, the principal cause for losing personnel is their frustration stemming from new hires being brought in to fill leadership positions, rather than promoting from within.2 Another factor is a sentiment among employees that the extent of personal and professional enrichment and advancement may not be as significant as in for-profit enterprises. Moreover, while many choose to work for

These signals are not new to not-for-profit organizations, but their impact and velocity have increased of late.

Recognizing, averting risk of financial failure

1 Nonprofit HR. 2015 Nonprofit Employment Practices Survey Results, March 4, 2015.

2 Landles-Cobb, Libbie; Kramer, Kirk; and Milway, Katie Smith. The Nonprofit Leadership Development Deficit, Stanford Social Innovation Review, Oct. 22, 2015.

1

nonprofits because they believe in the mission or are passionate about the cause, individuals may opt to leave if they no longer feel connected with the mission because it has either drifted or their daily job responsibilities do not align with or further the programmatic goals of the organization. In addition, when organizational financial strains become obvious, staff often explore new opportunities with more stable organizations.

To attract talent and thwart unwanted personnel turnover, ensure your mission and its actionable items cascade through all levels within the organization. As for compensation challenges, you might not have the resources to match for-profit compensation levels, but offering a salary near market coupled with stronger benefits can help in recruitment and retention. Also, identify ways to recognize performance and contributions through the use of nonfinancial recognition while this is particularly important to millennial workers, nonfinancial recognition can go a long way with personnel of all generations. Consider creating or promoting personal development opportunities for your staff, including membership in key professional organizations, attendance at national conferences and funding for education germane to their job responsibilities. This will not only improve organization-wide capabilities, but will also lead to enhanced individual employee skills that will create promotion opportunities. While a strong sentiment and tendency exists for not-for-profits to devote a substantial portion of their resources to support programmatic operations, consideration needs to be given to ensuring that a properly credentialed staffing complement is maintained so that policies and procedures are well-defined and instituted, and resources are safeguarded. Without this consideration, challenges in hiring and retaining strongly credentialed staff could result in weakened internal controls or unqualified personnel tasked with essential operational and financial responsibilities, exposing the organization to risk. With periods of financial strain inevitable for most organizations, reassure your staff by conveying your plan to return to stability. Reach out to your employees with the same communications that you extend externally. See in this report Enhancing stakeholder communications, transparency, by Katrina Gomez, Joseph Mulligan and Mark Oster.

Absence of relevant KPIs and metrics: It is broadly accepted that entities manage what they measure, but what if an organization is measuring the wrong indicators? Monitoring relevant key performance indicators (KPIs) has become paramount for all entities, not-for-profit and for-profit alike. For larger organizations, the challenge is to distill the broad spectrum of KPIs to only the most meaningful ones, so that an organization focuses on the most relevant information to help make impactful decisions. The challenge for smaller nonprofits is ensuring that information systems have the functionality to supply operational and financial data critical to developing KPIs and, ultimately, evaluating them.

The production of accurate and relevant KPIs is predicated on the availability of data both qualitative and quantitative. For example, a KPI for a social service organization could be the cost of providing a counseling session to one individual; that cost would then be trended over a defined period of time and regularly analyzed to understand cost fluctuations compared to individuals counseled.

Select and develop KPIs that align with your strategic goals and support your operating model. When selecting KPIs, be collaborative, and create a cross-functional team spanning the board, senior management and programmatic personnel. This multidisciplined approach ensures that indicators of significance will be identified and perspectives at all levels within the organization considered. Do not focus solely on financial metrics; operational metrics are of equal importance. Financial KPIs may track and report on accounts receivable and accounts payable turnover, approval rate of purchase orders, debt to equity, expendable net assets, etc. Operational or programmatic KPIs may include, for example, the number of new or strengthened pollution laws, progress toward the eradication of a disease, or the proportion of repeat offenders. For further direction, see in this report Utilizing data analytics to improve performance, by Mary Foster, Anthony Pember and Matt Unterman.

Select and develop KPIs that align with your strategic goals and support your operating model.

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Lack of clarity in strategic goals: Critical to every strategy is having a well-defined business plan that outlines actionable items to achieve those strategies; without such a plan, the organization will not know how to reach its goals.3 Business plans should give focus and direction to organizational efforts, and be adaptive to changes in the organizations economic and social environment.4 If all levels of your organization do not understand the actions to take to support the business plan, and if the plan is not regularly reviewed and updated, strategic goals cannot be achieved. Further, many strategic plans contemplate lofty and aspirational goals that cannot be fulfilled with existing resources.

Collaboration across all levels within an organization and analysis are required to define and estimate the cost of meeting your strategic goals, and the extent of execution risk. Through this process, you can gain a realistic grasp of the financial and personnel resources necessary to execute your business plan, comparing resources required to resources available. Not-for-profit organizations sometimes become distracted and drift from their principal mission due to ancillary projects embraced by board members or members of senior management that are not integral to their strategy. These peripheral projects, in certain instances, have served to weaken the strategic focus of organizations, dilute the strength of their brand, and divert precious resources both financial and personnel in ways inconsistent with overall mission.

Services not differentiated from peers: Organizations may not have a clear and complete understanding of how they are viewed vis--vis other similarly focused organizations. If organizations have on competitive blinders,5 they may not appreciate that other entities are more effective in providing services or attracting the attention of donors or constituents. The competitive nature of the marketplace suggests that it is counterproductive to espouse a mission statement that is unduly broad and intended to serve a wide array of constituent needs. Specialization and providing focused services continues to be an effective way to reach and serve a desired constituency, and to build brand. Over the past decade, a trend has been afoot wherein many not-for-profits have become introspective and have refined their mission to focus more narrowly on their strengths (i.e., to exploit their greatest programmatic offering). Unless a nonprofit has truly positioned itself as the premier provider of a particular service, growth opportunities are generally limited. Competition among nonprofits centers on revenue and service, with funders (e.g., federal/state/local agencies, corporations, foundations and individual donors) focusing their giving on organizations demonstrating sustained success and programmatic offerings tuned to respond to the evolving landscape.

Begin to focus resources on a refined and narrowly defined set of programmatic imperatives. Modify your strategic plan as necessary to accomplish this sharpened objective. In parallel, research the marketplace to find out what your brand represents to the public, and to determine how your services suit current needs so that you can hone them accordingly. Study the competition, and position your organization as best-in-class provider of your chosen service(s). Herald your differences via marketing channels to communicate benefits and outcomes.

Challenges in hiring and retaining qualified leadership

10 warning signs of financial failure

1 Absence of relevant KPIs and metrics

2 Lack of clarity in strategic goals

33 Nonprofit HR. 2015 Nonprofit Employment Practices Survey Results, March 4, 2015.

4 Landles-Cobb, Libbie; Kramer, Kirk; and Milway, Katie Smith. The Nonprofit Leadership Development Deficit, Stanford Social Innovation Review, Oct. 22, 2015.

5 Jewell, Jim. 7 Reasons Nonprofits Flounder or Fail, The Valcort Group, April 3, 2013.

3 4

http://ssir.org/articles/entry/the_strategic_plan_is_dead._long_live_strategyhttp://valcort.com/7-reasons-nonprofits-flounder-or-fail/

Ineffective connection with donor base: Competition for donors remains pronounced. Accordingly, increased effort and investment in development activities are crucial. Research shows that the old methods of communicating and connecting with donors through mailed brochures and letters are no longer the most effective approaches. Over the past decade, donors have become far more knowledgeable in and focused on assessing a not-for-profits effectiveness and achievement of mission. Information about a charitys financial position and performance, and the extent of its service offerings and progress toward achievement of mission is now more readily available and more easily accessed. The IRS Form 990, coupled with other public disclosures, provides a fairly granular level of transparency into an entitys governance and operating characteristics. When organizations cannot attract and retain donors, they risk losing their ability to fulfill their mission.

First, no matter how well you think you know your donors and potential donors, find out who they really are. Study and analyze the market to understand demographics, and at the same time, to gauge the strength of your brand with your target audience. Reach your audience via social media and events; share testimonials and communicate your outcomes. With household balance sheets the strongest in decades, now is the time for organizations to double-down on their donor acquisition and cultivation activities. See in this report Telling your story transparently: Putting disclosures to work, by Kimberly Schrant and Dan Romano.

Concentration of revenues and receivables: Organizations that are principally dependent on one source of revenue place their organizations at significant risk. A singular revenue source that has long been dependable may gradually or suddenly vanish. This type of financial vulnerability is a pressing concern to organizational management and board members, leading them to reduce further programmatic investments or enhancements, or curtail or limit existing services.

Moreover, for those whose principal revenue stems from federal, state or local funding agencies, the resultant margin available to support infrastructure is typically inconsequential. Government grants provide little to no margin because they are generally paid out after expenses have been incurred, or provide reimbursement based on a fee for the delivery of a service at defined rates. Government grants can be important, but federal/state budget shortfalls are leading to overall grant reductions. A factor in the demise of the historic Hull House was reliance on government contracts for over 85% of its funding.6 Grants can help an organization fulfill its mission, but usually do not provide seed money to develop new programs to respond to a changing economic and social landscape.

Services not differentiated from peers

4

Ineffective connection with donor base

5

Concentration of revenues and receivables

6

6 Cohen, Rick. Death of the Hull House: A Nonprofit Coroners Inquest, Nonprofit Quarterly, Aug. 2, 2012.

5 6

https://nonprofitquarterly.org/2012/08/02/death-of-the-hull-house-a-nonprofit-coroners-inquest/


When an organization has a singular concentration of revenue, regardless of source, a reasonable risk exists that an aging of the receivables associated with such revenue can have daunting negative implications. Specifically, readers of the financial statements can lose confidence in the long-term viability of the entity. Additionally, when receivables become severely aged, they can significantly strain cash flow, which in the extreme, can lead to insolvency and financial failure.

Diversifying revenue sources will help your organization become more financially stable. However, be mindful that the development of new revenue sources takes time and may also have inherent costs and risks, requiring additional programmatic and personnel investments.

Shrinking investment portfolios: Endowments have been weakened over the past several years due to poor market performance, resulting in losses or lower-than-anticipated returns. Of greater concern is strong evidence that the financial woes being experienced worldwide will likely persist. This financial downdraft, combined with an increasing demand imposed on not-for-profits to do more for the benefit of their constituents, have, in certain instances, yielded perilous consequences. With an inability to expand and/or grow current revenue streams (and cash flows), investment portfolios have been called upon like never before to assist in propelling missions and satiating demands, but also to provide for operations and strategic investments. With declining margins caused by decreasing contributions and increasing operating costs, many

organizations have supplemented their board-approved spending policies with additional board appropriations to fund unbudgeted operating costs, underwrite capital campaigns, pay for voluntary retirement plans to aid in aligning personnel costs with refined strategies, or service debt obligations. For some not-for-profits, there may be no alternative to increasing the spending draw from their endowments. However, they must do so with an acknowledgment that additional endowment appropriations, beyond the normalized annual spending policy, can lead to a reduction in the purchasing power of the endowment and an erosion of principal. Combined with lackluster market performance, the endowment could be significantly diminished.

Rather than reacting immediately to the current need, analyze the long-term implications of supplementing board-approved endowment spending policies with additional appropriations. Determine if a better decision would be to suspend endowment appropriations until the investment markets rebound. This may be a sensible solution to preserve the value of your organizations endowment if you have cash reserves or an ability to generate strong cash flows from operations. For those that have neither, an analysis of all noncore operating costs must be performed with a view toward cutting or significantly reducing them to weather the financial strains. Analysts believe that the market will continue to yield lower interest rates and returns, and experience continued volatility. Organizations should remain introspective in evaluating and tuning the mix of their portfolios to achieve the optimal configuration to navigate these turbulent times.

Increasing cost of compliance

Inability to fulfill financial covenants8

9

Shrinking investment portfolios

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Increasing cost of compliance: As scrutiny from watchdog agencies and regulators has heightened, compliance requirements have been ratcheted up. Laws are changing quickly, and the development of responsive and compliant policies has been costly. Nonprofits rarely have the budgetary capacity to accommodate the compensation costs associated with installing or expanding the complement of compliance officers, ombudsmen and legal staff, exposing them to potential noncompliance, reputational loss and financial penalties. Organizations are sometimes surprised by the cost of compliance and need to dramatically update or develop responsive policies; for example, the extent to which the Affordable Care Act has caused organizations to change their policies and reporting processes, and the effort and cost required to become compliant have been significantly more than some expected.

There is no alternative to regularly monitoring the legislative and compliance landscape to ensure your policies remain current with evolving business and regulatory practices. Consider ways to re-engineer your practices and policies to quickly adapt to a dynamic regulatory and competitive environment. Is your enterprise risk management program sufficiently designed to assess and anticipate the impact that legislative changes will have on your organization? Who within your organization is tasked with routinely monitoring the regulatory environment in which you operate?

Inability to fulfill financial covenants: Temporary downturns in philanthropy, combined with stagnant or declining revenues from core operating activities, may cause organizations to experience difficulties in meeting loan covenants. Even with little or no debt, organizations that are contemplating accessing the debt markets may be dismayed to learn that debt financing is not available to them until the state of their financial affairs improves. Failing creditor-imposed financial covenants tied to debt obligations can have costly implications, including substantial fees charged by financial institutions to provide covenant waivers.

When your organization enters into a financing arrangement with a financial institution, it is critical that you first model and stress-test all significant financial covenants; nonadherence can lead to default, an increase in interest and fees, or an acceleration of principal and interest payments. Partner closely with your financial advisor and accountants to understand the mechanics of all financial and nonfinancial covenants to ensure they are tenable on an ongoing basis.

Monetizing assets to provide liquidity or strategic pivot: When organizations owning properties or other valuable assets find themselves in the throes of financial strains, an approach to consider is monetizing nonessential properties that dont align with your strategy. However, this is a gambit not often carefully thought through. The sale of intrinsically valuable assets will likely result in an infusion of cash or a reduction of debt, but if the core operating and business challenges are not understood and remedied, the proceeds of asset sales will be depleted quickly, as the underlying problems continue to drain organizational resources.

Align these asset sales with a refined strategy or mission pivot with the goal of improving financial performance and stability. A word of caution property sales need to be evaluated in the context of your new/refined strategy, with due consideration for the effect on personnel, including associated relocation and severance costs and, perhaps most importantly, the impact on your mission-related service offerings.

Monetizing assets to provide liquidity or

strategic pivot

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Scott Steffens, Partner, Audit Services, Not-for-Profit and Higher Education Practices; Leader, Religious Organizations SectorMatt Unterman, Principal, Advisory Services, Not-for-Profit and Higher Education Practices; Chair, Religious Organizations Sector

Like other not-for-profits, faith-based and religious organizations are heavily reliant on technology in order to operate efficiently and support their mission. However, due to conservative spending over the past several years and an overall focus on mission-related investments, IT systems at religious organizations have become dated and in need of at least a refresh, if not a complete replacement.

Until recently, investments in technology took a back seat to other cash-intensive areas of religious organizations legal issues, declining enrollment at schools, and an ever-increasing capital infrastructure with great maintenance needs. The perpetual deferral of IT investments has now caught up with this group; technology is beginning to crumble, not unlike an old roof of a church. As a result, there is emerging among religious organizations a renewed focus on IT that we have not seen for quite some time.

The number of organizations that are now making major investments in technology is significant, and in many cases, they are doing wholesale overhauls of their core financial and operational systems and are doing it right. As with aging houses of worship, maintenance of IT assets can be deferred only so long; forward-thinking organizations are utilizing several key technology best practices:

1. Thinking beyond IT: Selecting and implementing a new system should not be seen as a technology exercise. It is a way to serve the entire organization and support its mission. The overall system selection initiative, particularly the defining of requirements, should be approached accordingly. Personnel and programmatic activities at religious organizations are often distributed geographically, and as a result, they can become disconnected from one another; transforming organizational systems can be a way to bring everyone together in how they support the mission. Take the opportunity to assess how your technology systems are supporting your strategy, and implement shared systems/services to create financial, operational and programmatic platforms that can integrate the organizations.

2. Soliciting constituent perspectives: Gather a variety of insights and perspectives not just ITs in order to select an optimal system. This will help not only in identifying a system that meets your organization's needs in total, but also with change management efforts, since stakeholders will have been involved from the beginning. Ask your program staff how well they are served by your core financial system, and ask your religious and lay leadership how the administrative offices can better support them in providing critical reports.

3. Engaging a steering committee: Because of the variety of perspectives that will be solicited during system selection, the effort must have appropriate vehicles for governance, such as a steering committee composed of religious, lay, programmatic and IT leaders. Everyone should be at the table.

In focus: Religious organizationsSelecting an IT solution for practicality, effectiveness

4. Determining the total cost: When calculating the system projects budget, do so from a total cost of ownership perspective. To give you a full picture of your expected total organizational spending, this should include all investment areas e.g., configuration/customization, data load, hardware, professional services, and ongoing licensing and maintenance. Its critical to avoid surprises when implementing a new system; capturing all the hidden costs that vendors might not always highlight enables you to understand the true spend and budget accordingly.

5. Honoring budgetary constraints: When identifying your short list of vendors for a solution, dont be tempted to overshoot your project budget. While a more expensive system might provide aspirational functionality, it can introduce unnecessary complexity, limiting its ultimate effectiveness. While board members may be familiar with large corporate IT systems, smaller faith-based and religious organizations would benefit from smaller-scale technology.

6. Reconsidering business processes: When implementing a new system, take the opportunity to revamp your existing b

Government & Nonprofit

2016 State of the nonprofit sector |Grant Thornton