Budgeting and financial management for nonprofit organizations using money to drive mission success

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PART V: NEW DIRECTIONS 15. Adapting to Turbulent Times: Conventional and Entrepreneurial Financial Strategies Appendixes Glossary Index

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Contents Tables, Figures, and Worksheets About the Authors Preface PART I: INTRODUCTION 1. An Introduction to Nonprofits: Mission and Money Definition of a Nonprofit Nonprofit Origins and Growth The Modern Nonprofit Structure The Identification of Nonprofits as the Third Sector Size and Scope of the Nonprofit World Nonprofit Structure Differences between the Business and Nonprofit Worlds Setting Financial Policies The Link between Mission and Money The Push for Accountability: Watchdog Organizations and Their Standards Conclusion Discussion Questions Assignments Assignment 1.1. Linking Mission to Money Assignment 1.2. Proposing Improvements to a Nonprofit’s Accountability Standards Key Terms Suggested Readings PART II: PLANNING AND BUDGETING 2. Budgeting as Part of the Planning Process Budget Vocabulary The Links between Mission and Budgeting Roles of the Board, Executive Director, and Staff The Tools of Budgeting Budgeting as a Planning Tool Budgeting as a Management Tool 9

Budgeting as a Communications Tool Different Types of Budgets: Operating and Capital Two Sides of a Coin: Revenue and Expenses The Link between Operating and Capital Budgets Formatting Budgets: Line-Item Budgets, Program Budgets, and Performance Budgets Line-Item Budgets Program Budgets Performance Budgeting or Results-Based Budgeting Cutbacks and Performance-Based Budgets The Budget Process as a Cycle The Preparation Stage The Approval Stage The Execution Stage Ending the Fiscal Year: The Auditing and Reporting Stage Periodic Budget Reviews and Revisions Applying Indirect Costs for a New Program Cutback Budgeting Conclusion Case Study: Examining the Hypothetical Budget of the Sojourner Truth Settlement House Discussion Questions Class Exercise Class Exercise 2.1. Creating a Projected Budget for a New Program Assignments Assignment 2.1. Creating a Nonprofit Budget Assignment 2.2. Serving Seniors Key Terms Suggested Readings 3. Liquidity and Managing Cash Flow Liquidity Timing of Cash Flows and Undercapitalization Restricted Monies Liquidity Targets Cash and Cash-Flow Management Cash Budget Examples of Cash-Flow Management and Cash-Flow Budget Working through a Cash-Flow Analysis Cash-Flow Budgeting in Practice Cash-Flow and Liquidity Management Issues: Updating the Cash Budget with Actuals Cash-Flow Strategies What Do We Do When We Run Out of Cash?

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What Do We Do When We Have Too Much Short-Term Cash?

Conclusion Case Study: Hope for All (HFA) Borrows Money Discussion Questions Assignments Assignment 3.1. Identifying Working Capital and Liquidity Assignment 3.2. Developing a Cash Budget Assignment 3.3. Managing Cash Flow Key Terms Suggested Readings 4. Costs and Cost Analysis Opportunity Costs and Accounting Costs Opportunity Costs Accounting Costs A Short Study in Determining Program Costs Direct Costs and Indirect Costs Estimating Direct and Indirect Costs Costing Services and Allocating Costs Step-Down Method to Allocate Costs Working through the Step-Down Method Fixed, Variable, and Step Costs Average Costs and Marginal Costs Examples of Average and Marginal Costs Relevant Costs in Financial Decision Making Extension of Existing Services: Marginal Analysis Potential New Programs or Services: Break-Even Analysis Conclusion Case Study: New Program at City University to Help the Unemployed Discussion Questions Class Exercises Class Exercise 4.1. Assessing Fixed and Variable Costs Class Exercise 4.2. Considering Program Expansion with Marginal Analysis Class Exercise 4.3. Conducting Break-Even Analysis Assignments Assignment 4.1. Applying Opportunity Costs to a Grant Application Assignment 4.2. Determining the Break Even Point for a New Program Assignment 4.3. Identifying Types of Costs Key Terms Suggested Readings PART III: FINANCIAL ANALYSIS IN NONPROFIT ORGANIZATIONS 11

5. Basic Principles of Accounting and Reporting Requirements Accounting Standards Structure Users of Accounting Principles of Accounting The Four Key Assumptions The Four Basic Principles The Four Basic Constraints Basis of Accounting Cash Accounting Accrual Accounting Advantages of the Accrual Accounting Method Fund Accounting Unrestricted Net Assets Temporarily Restricted Net Assets Permanently Restricted Net Assets Introduction to Financial Statements Balance Sheet or Statement of Financial Position Income Statement or Statement of Activities Statement of Cash Flow Statement of Functional Expenses The Accounting Cycle Reporting Requirements National-Level Requirements State-Level Requirements The Task of Financial Responsibility Conclusion Case Study: Fraud and the Importance of Accounting Principles Discussion Questions Class Exercise Class Exercise 5.1. Identifying Financial Terms Assignments Assignment 5.1. The Assumptions, Principles, and Constraints of Accounting Assignment 5.2. Identifying Cash and Accrual Accounting Assignment 5.3. Creating Balance Sheets Assignment 5.4. Reconciling Surplus and Deficit in Wisconsin’s Budget Key Terms Suggested Readings 6. Understanding Financial Statements The Statement of Financial Position (Balance Sheet) Assets 12

Current Assets Long-Term Assets Liabilities Current Liabilities Long-Term Liabilities Net Assets (Fund Balance) Unrestricted Net Assets Temporarily Restricted Funds Permanently Restricted Net Assets Nonprofit Financial Statements: The Statement of Activities (Income Statement) Revenues Expenses Relationship between the Statement of Financial Position and the Statement of Activities Cash-Flow Statement Statement of Functional Expenses Conclusion Discussion Questions Class Exercise Class Exercise 6.1. Recording and Categorizing Transactions Assignments Assignment 6.1. Recording Transactions Assignment 6.2. Determining Marketable Securities Key Terms Suggested Readings 7. Financial Analysis Financial Resources Liquidity Long-Term Solvency Efficiency Profitability Matching Revenue Diversification Conducting Ratio Analysis Ratios and Liquidity Ratios and Long-Term Solvency Ratios and Efficiency Ratios and Profitability Matching Diversification Red Flags Financial Health of the ABC Nonprofit Corporation 13

Ratios and Rating Agencies Conclusion Case Study: Financial Analysis of the Montana Mentoring Nonprofit Discussion Questions Assignments Assignment 7.1. Using Ratios to Assess Current and Long-Term Liabilities Assignment 7.2. A Second Year’s Worth of Data Assignment 7.3. The MLK Settlement House and Its Profits Key Terms Suggested Readings 8. Financial Tools for Informed Decision Making Reporting Problems in Financial Statements Separating the Net Asset Classes Fiscal Year Comparisons within the Statement of Activities Transferring Funds Confusion with the Budget Campaign Funds Financial Tools to Drive Management Decisions Breaking Down the Data for Effective Comparison Determining Financial Issues Understanding Budgets as an Aid to Mission Success The Importance of Cash Management The Benefits of a Quarterly Financial Reporting System Financial Plans Offer Strategy for the Future Conclusion Case Study: Creating a Balanced Budget for Management Decision Making Assignments Assignment 8.1. Creating a Statement of Financial Position Assignment 8.2. Creating a Statement of Activities Assignment 8.3. Describing the Financial Situation Key Terms Suggested Readings PART IV: FINANCIAL MANAGEMENT 9. Understanding Revenues Theoretical Development on Nonprofits’ Finance: The Benefit Theory Types of Benefits Matching Benefits and Revenues Existing Sources of Revenue Donations 14

Government Grants and Fees for Services and Goods from Government Earned Revenues Nonprofit Revenue Strategies Funding Models of Large Nonprofits: The Benefit Theory in Practice Diversification: Revenue Strategies and Risk Management Advantages and Disadvantages of Different Funding Sources Conclusion Case Study: An Environmental Nonprofit Considers Extending Its Cleanup Program Discussion Questions Assignments Assignment 9.1. Identifying Main Sources of Revenue Assignment 9.2. Using the Benefit Theory in Revenue Strategy Assignment 9.3. Considering a Deal for Corporate Support Assignment 9.4. Assessing a Nonrelated Business Key Terms Suggested Readings 10. Performance Measurement in Financial Management Performance Measurement’s Role in Mission Success Linking to Budgets Educating Stakeholders Managing Resources The Ingredients to Measuring Program Performance Inputs, Process, Outputs, and Outcomes The Challenges of Measuring Effectiveness Efficiency or Unit Cost Ratio as Compared to Effectiveness The Development of Performance Management Systems The Urban Institute’s Steps to Develop a Performance Management System The Balanced Scorecard System The Challenges of Selecting Performance Indicators Outcomes as Compared to Outputs Relationship between Program Evaluation and Performance Measurement Performance Measures and Management Information Systems The Role of the Federal Government The Role of Foundations and Policy Centers Conclusion Case Study: Mentoring Program to Reintegrate Ex-Prisoners into the Community Discussion Questions Class Exercise Class Exercise 10.1. Indicators of Program Performance Assignments Assignment 10.1. Identifying Program Performance Indicators 15

Assignment 10.2. Working within the Balanced Scorecard Framework Assignment 10.3. Developing a Performance Management System Key Terms Suggested Readings 11. Time Value of Money and Cost-Benefit Analysis The Time Value of Money Calculating Future Value Calculating Present Value Net Present Value: A Decision Criterion Introduction to Cost-Benefit Analysis Conceptual Framework of CBA Steps in Conducting CBA Conclusion Case Study: Cost-Benefit Analysis for a Nonprofit Hospital Considering Adopting New Technology Discussion Questions Assignments Assignment 11.1. Calculating Future Value Assignment 11.2. Budgeting for Debt Service Payment Assignment 11.3. Evaluating Property Purchase Key Terms Suggested Readings 12. Capital Budgeting and Financing Capital Budgeting and Capital Assets The Relationship between Capital Budgets and Operating Budgets Accepting or Not Accepting a Donated Capital Asset: An Example Capital Budgeting Process Life-Cycle Costing Capital Financing: Pay-as-You-Go and Debt Financing Debt Financing: Bank Loans and Bond Issuance Securing a Bank Loan Issuing Bonds Payment Schedules Level Debt Service Payments Level Principal Payments Capital Budgeting Policy and Debt Policy Conclusion Case Study: The Drug-Free Center Considers Which Repayment Schedule to Select in Bond Financing Its Facility Expansion Discussion Questions 16

Assignments Assignment 12.1. Conducting Life-Cycle Costing Assignment 12.2. Preparing a Level Debt Service Bond Payment Schedule Assignment 12.3. Understanding Capital Budgeting Key Terms Suggested Readings 13. Investment Strategies Investment Policies and Guidelines Roles and Responsibilities of the Board Investment Policy Statement Short-Term Investment Strategy Issues in Short-Term Investment Investment Objectives: Safety, Liquidity, and Yield Default and Market Risks Key Short-Term Investment Vehicles Long-Term Investment Strategy Key Issues in Endowment Investment: Spending Policy Key Issues in Endowment Investment: Investment Policy Other Key Investment Practices and Considerations Key Long-Term Investment Vehicles and Instruments Conclusion Case Study: The Financial Manager Takes Steps to Manage a New Endowment Discussion Questions Assignments Assignment 13.1. Formulating an Investment Policy Assignment 13.2. Where to Invest Short-Term Assignment 13.3. Managing Endowment Funds Key Terms Suggested Readings 14. Internal Controls Defining Internal Controls The Internal Control System Safeguarding Assets Controlling Personnel and Nonpersonnel Services Setting Audit Standards The Independent Sector and Accountability The Sarbanes-Oxley Act Examples of Fraud Controlling Cash and Its Equivalents and Reconciliation of Bank Accounts Accessing Cash: Forging Signatures and Controlling Payroll 17

Nonprofits as Victims Conclusion Discussion Questions Assignments Assignment 14.1. Crafting Internal Control Policies to Prevent Conflict of Interest Assignment 14.2. Applying Internal Control Policies to Guard against Theft Assignment 14.3. Using Internal Control Policies to Discourage Fraud Key Terms Suggested Readings PART V: NEW DIRECTIONS 15. Adapting to Turbulent Times: Conventional and Entrepreneurial Financial Strategies The Effects of the Economic Crisis Assessing Financial Risks Mitigating Risk: Increasing Revenues Mitigating Risk: Cutting Costs Mitigating Risk: Collaborations Changing the Structure The Growth of Nonprofit Capital Intermediaries Venture Philanthropy Nonprofit Loan Funds The Role of Government in Promoting Innovation The Federal Level State Government Models Local Government Models University Models The Role of Foundations in Promoting Social Enterprise The Fourth Sector of Social Enterprise The Yunus Centre Program-Related Investments and the New L3Cs The Rise of the B Corporation Conclusion Discussion Questions Assignment Assignment 15.1. Exploring Social Entrepreneurship Key Terms Suggested Readings Appendixes Appendix A: Form 990 18

Appendix B: Debits and Credits Appendix C: Sample Investment Policy Statement for Nonprofit Education Foundations Glossary Index

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Tables, Figures, and Worksheets

TABLES 1.1

Numbers and Types of Public Charities Filing in the United States, 2010

1.2

Differences between Businesses and Nonprofits

2.1

FY 2010 Adopted Revenue Budget, Sojourner Truth Settlement House

2.2

FY 2010 Line-Item Operating Budget, Sojourner Truth Settlement House

2.3

FY 2010 Program Budget, Sojourner Truth Settlement House

2.4

Program Performance Budget, Sunnyvale, California, Program 230—Housing and Human Services

2.5

College Preparation Program, Operating Budget FY 2010, Sojourner Truth Settlement House

2.6

FY 2010 Variance Report, Sojourner Truth Settlement House (as of end of February 2010)

2.7

Performance Report: FY 2010, Sojourner Truth Settlement House

2.8

FY 2010 Adopted Budget by Program, Sojourner Truth Settlement House

2.9

FY 2009 Adopted Budget by Program, Sojourner Truth Settlement House

2.10

FY 2010 Adopted Revenues, Sojourner Truth Settlement House

2.11

FY 2009 Adopted Revenues, Sojourner Truth Settlement House

3.1

Cash-Flow Projection for a Nonprofit That Cannot Make Payroll

3.2

HFA Cash Receipts Projection

3.3

HFA Program Cash Disbursement

3.4

HFA Program Cash-Flow Budget

3.5

Projected FY 2010 Cash-Flow Management Report, Sojourner Truth Settlement House

4.1

Direct Costs and Allocation Base by Department

4.2

Full Costs by Department

4.3

Total Costs by Department

4.4

HFA’s Total Costs Using the Step-Down Method of Allocation

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4.5

Activity Level as It Relates to Fixed, Variable, Step, and Total Costs

5.1

Example of a Balance Sheet as of December 31, 2009

5.2

Example of an Income Statement and Changes in Net Assets in FY 2010

5.3

Example of a Statement of Cash Flow in FY 2010

5.4

Example of a Balance Sheet in FY 2010

6.1

Access to Learning, Statements of Financial Position (Balance Sheets)

6.2

Access to Learning, Statements of Activity (Income Statement)

6.3

Typical Chart of Accounts

6.4

January Transactions, Access to Learning, January 2010

6.5

FY 2010 Statement of Cash Flow, Access to Learning

7.1

Statements of Financial Position, ABC Nonprofit Corporation

7.2

Statements of Activities, ABC Nonprofit Corporation, during FY 2010 and FY 2009

7.3

Examining Revenues, ABC Nonprofit Corporation, during FY 2010 and FY 2009

7.4

Statements of Financial Position, Montana Mentoring Nonprofit, FY 2010 and FY 2009

7.5

Statements of Activities, Montana Mentoring Nonprofit, FY 2010

8.1

Statements of Financial Position

8.2

Statements of Activities and Changes in Net Assets

8.3

Statement of Financial Position (Balance Sheet)

8.4

Statement of Activities (Unrestricted ONLY)

8.5

Trial Balance (Accounting System), December 31, 2009

8.6

Summary Financial Information

8.7

Major Financial Issues

8.8

Budget Model, 2010 Budget

8.9

Cash-Flows Management Report, 2010

8.10a Quarterly Financial Reporting System, Presentation to the Finance Committee of the Board of Directors 8.10b Quarterly Financial Reporting System, Presentation to the Finance Committee of the Board of Directors 8.10c Quarterly Financial Reporting System, Presentation to the Finance Committee of the Board of Directors 8.10d Quarterly Financial Reporting System, Presentation to the Finance Committee of 21

the Board of Directors 8.11a Two-Year Financial Plan 8.11b Budget Model, 2011 Plan 8.12

Youth Movement Statement of Financial Position and Statement of Activities, June 30, 2011

8.13

Youth Movement Statement of Activities, FY2009/10

8.14

Trial Balance, from Accounting Software

8.15

Temporarily Restricted Net Assets

8.16

FY 2010/11 Claim Information for Claims Filed with Funding Sources

8.17

A Nonprofit’s Accounting Transactions

9.1

Correspondence between Benefit Theory and Financing Practices

9.2

Advantages and Disadvantages of Different Funding Sources

10.1

A Few of the Urban Institute’s Performance Outcome Indicators for Employment and Training Programs

10.2

Example of a Balanced Scorecard, United Way of Southeastern New England

11.1

Purchasing and Operating Costs of Alternative Refrigerators

11.2

Future Cash Flows for Research Center Project

11.3

Discounted Cash Flows and NPV for Research Project

12.1

Simplified Capital Budget Form for Housing/Building Project

12.2

Level Debt Payment

12.3

Level Principal Payment

13.1

Average Returns by Asset Class, Fiscal Year 2010

13.2

Asset Allocations by Fiscal Year and Asset Class, 2008–2010

13.3

Benchmark for Endowment Performance Evaluation, University of California

13.4

Asset Allocation of Yale University Endowment Funds, Relative to Educational Institution Mean, as of June 30, 2010

B.1

Trial Balance for January, Access to Learning Nonprofit Corporation

FIGURES 1.1

2005 Nonprofit Revenues of $1.2 Trillion

2.1

Cycle of Budgeting as a Management Tool 22

2.2

Web of Relationships

2.3

The Budget Process

4.1

Fixed Costs

4.2

Variable Costs

4.3

Step Costs

4.4

Average Cost versus Activity Volume

9.1

Revenues by Source for Reporting Charities, 2009

9.2

Giving by Contribution Sources. 2010

9.3

Distribution of Contribution by Type of Nonprofit, 2009

10.1

Understanding Performance Measurement

15.1

Spectrum of Social and Financial Returns

B.1

Debits and Credits

WORKSHEETS 8.1

Reformatted Statements of Financial Position

8.2

Reformatted Statement of Activities

8.3

Statement of Financial Position and Statement of Activities

8.4

Program Budget Model, FY 2010/11

8.5

Program Budget Model, FY 2011/12

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About the Authors

Lynne A. Weikart is retired as an associate professor at Baruch College School of Public Affairs. She has a PhD in political science from Columbia University, and she is currently a practitioner in residence at James Madison University, where she teaches budgeting and financial management. She has had extensive financial management experience in the governmental and nonprofit sectors. Before her academic career, she held several high-level government positions, including budget director of the Division of Special Education in New York City (NYC) public schools and executive deputy commissioner of the New York State Division of Human Rights. For several years, she also served as the executive director of a nonprofit, City Project, which was a progressive fiscal think tank that focused on reforming NYC’s resource allocation patterns. Professor Weikart’s current research focuses on resource allocation in urban areas as well as on urban finance, and she has published many articles on these subjects. In addition, she has published two books: she is coauthor of Budget Tools: Financial Methods in the Public Sector (CQ Press, 2009) and author of Follow the Money: Who Controls New York City Mayors? (State University of New York Press, 2009). She won the Luther Gulick Award for Outstanding Academic from the New York Metropolitan Chapter of the American Society for Public Administration in 2001.

Greg G. Chen, associate professor at Baruch College School of Public Affairs, has a PhD in public administration from the University of Victoria in British Columbia, Canada. He also has a master's degree in educational administration from the University of Victoria and a master's degree in metallurgical engineering from the University of Science and Technology in Beijing, China. He was the manager of the budgeting and financial reporting department in the Ministry of Finance, and budget manager and senior policy adviser for the Premier’s Office of British Columbia, Canada, before taking his professorship in the United States. He had previously been an associate dean in the College of WISCO in China. Professor Chen conducts research and publishes papers in the areas of budgeting and financial management for nonprofit organizations and governments; program evaluation and cost-benefit analysis of diverse public programs; and comparisons of the health care systems and finance in Canada, the United States, and China. His most recent research led to the article “Do Meeting Standards Affect Charitable Giving?” that appeared in Nonprofit Management and Leadership (vol. 19, no. 3, 2009). He is coauthor of Budget Tools: Financial Methods in the Public Sector (CQ Press, 2009).

Ed Sermier holds an MBA from Columbia University and a bachelor’s degree in mathematics from Manhattan College. He serves as an adjunct professor at the Graduate 24

School of Public Affairs, Baruch College, City University of New York. He teaches courses in nonprofit finance, management, leadership, and strategy. He also serves as an adjunct professor at the Wagner Graduate School of Public Service, New York University, where he teaches a course in nonprofit finance, and as director of national customized services for the Nonprofit Finance Fund. Over the course of his career, Professor Sermier has held positions at many nonprofit organizations, including as vice president, chief administrative officer, and director of program evaluation at Carnegie Corporation of New York, chief financial officer of the New York Philharmonic Orchestra, and director of special education as well as budget director for the New York City Board of Education. He provides volunteer financial consulting services to a wide range of nonprofit organizations in the five boroughs of New York City. He developed the Financial Toolkit for Nonprofit Executives and Board Members, which provides a means to make financial data understandable to an organization’s decision makers.

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Preface

When we got together with the idea to write Budgeting and Financial Management for Nonprofits, we considered our past experiences and current thinking and models. We have taught budgeting and financial management for decades and are highly experienced in the range of nonprofit management, among us having worked as a nonprofit’s executive director, a vice president of finance for a major, national nonprofit, and a nonprofit consultant. The real-life struggles and successes of nonprofit management that we have experienced, along with the long-range perspective we have gained from the study of nonprofits’ history and our engagement in the most recent developments in nonprofit strategy and structure, led us to conclude that there was only one theme possible for this book: the link between nonprofit mission and money.

We have seen over the course of our careers that how effectively a nonprofit achieves its mission is intrinsically tied to its finances. Money drives mission. Donations fund programs that provide public services, aiding mission success. Well-managed budgets and investments can spur long-term growth and achievement. Alternatively, financial mismanagement can damage and even destroy nonprofit organizations. A board of directors making decisions based on data the members do not fully understand can create a host of debilitating problems. We feel that it is vitally important that students understand how to use the tools of budgeting and financial management to fulfill the missions of their nonprofits and how these tools can be used to drive decision making. The best way to do this is to present the tools to students in as practical and realistic a way as possible.

This volume is designed to prepare the next generation of nonprofit managers. It is intended to provide the financial grounding that a student will need to become a successful nonprofit manager. The organizational mission cannot be achieved unless the resources are available to fund the mission and the manager understands how to apply those resources.

Our goal is to enable nonprofit managers to understand and use the financial tools available to create stable financial foundations for their nonprofits and to develop financial strategies that will allow them to weather economic storms and ultimately thrive in both expanding and contracting economies. In this book we provide the fundamentals of financial tools for nonprofit managers and describe the future of nonprofit strategies, encouraging managers to be flexible, creative, and innovative, inspired by the current and coming models of nonprofit organization and funding.

No company, profit or nonprofit, can thrive without sound financial strategy. Nonprofit managers come from a variety of backgrounds, and some tend to avoid the important issues of accounting and financial management out of fear. This book presents financial concepts in a straightforward, comprehensible format, grounded in real examples, readily accessible 26

to students from any background.

STRUCTURE AND ORGANIZATION OF THE BOOK The book is divided into five parts: a short introduction followed by sections on planning and budgeting, financial analysis, financial management, and new directions. The introduction links the mission of the nonprofit to its resources and provides the framework for the skill building that follows. It traces the growth of nonprofits and describes the current fiscal and governance structures. It explains the three sectors: government, business, and nonprofit. The difference between business and nonprofits is analyzed in terms of governing authority, funding, and structure.

The section on planning and budgeting begins with discussion of the foundations of budgeting and then addresses the importance of liquidity, managing cash flow, and analyzing costs. The chapters in this section are comprehensive and practical, explaining by example as well as by theory. Chapter 3, on liquidity and cash flow, is extremely important for nonprofit managers. The cost allocation discussed in Chapter 4, on analyzing costs, is key to developing sound budgets.

The third section, which addresses financial analysis in nonprofit organizations, provides a useful guide to nonprofit accounting that allows students to understand financial analysis.

It ends with a practical explanation of financial tools every nonprofit manager needs to understand and use. The chapters in this section explain the unique accounting structure used by nonprofits and teach students how to apply ratio analysis to further their understanding of nonprofits. This section culminates with Chapter 8, on financial tools, which explains how to use accounting data in ways that nonaccountants can understand and follow. It is critical for nonfinancial managers to be able to use the power of accounting data to understand how a nonprofit’s resources are being used. With this understanding, these decision makers will have powerful financial information to support the organization’s mission. The financial tools discussed in Chapter 8 provide a guide to that understanding.

The fourth section, on financial management, tackles the major topics of managing nonprofits through revenue diversification, cost-benefit analysis, capital budgeting, investment strategies, and internal controls. This section offers strategies for dealing with a constricting economic environment and reduced donor revenues. Each chapter tackles a pressing issue in nonprofit financial management. Chapter 13, on investment strategies, provides an important introduction to this topic, which may seem like a distant fantasy for the start-up nonprofit manager. An understanding of investment strategies should be part of the tool bag and vocabulary of the manager of every nonprofit with long-term mission goals and the intent to establish long-term fiscal stability to achieve those goals.

The final section describes the most current developments in nonprofit organization and strategy, focusing on the growth in entrepreneurial financial strategies that are propelling nonprofits into the “fourth sector.” The fourth sector is a merging of the best of the business world with the nonprofit mission through the use of entrepreneurial skills. This 27

merging allows nonprofits to keep their missions in the forefront while raising revenues in entrepreneurial organizational structures.

Each chapter begins with a list of learning objectives and an introduction that lay out the chapter’s goals. Abundant tables and figures throughout the chapters ensure that students gain familiarity with accounting data and financial statements. Examples are integrated where they are most illustrative of the discussion and most effective for students to learn important points in budgeting and financial management.

Case studies, discussion questions, class exercises, and assignments at the ends of the chapters allow students to test their knowledge of what they have read and to build their skills. The case studies provide detailed information on real or theoretical situations and ask students to participate—for instance, by examining a nonprofit’s budget to determine revenues and program costs to make fiscal year comparisons, by generating appropriate data to aid decision makers in determining whether to launch a new program, by following the steps toward creating a balanced budget, or by completing a cost-benefit analysis. Class exercises and assignments include activities such as developing a cash budget, applying the direct allocation method, recording transactions, and creating a statement of financial position.

Key terms appear in boldface type and are listed at the ends of the chapters, and lists of suggested readings refer students to sources for more information. Three appendixes provide complementary information, such as a sample Form 990, and the glossary defines all of the key terms.

COMPANION WEB SITE: STUDENT AND INSTRUCTOR RESOURCES The companion Web site to this book, http://college.cqpress.com/Sites/nonprofitbudgeting/, offers students online access to the tables, figures, and worksheets replicated in the book’s case studies. Instructors can access PowerPoint presentations for all of the chapters; copies of all of the book’s tables and figures; and solutions to all of the end-ofchapter discussion questions, exercises, assignments, and case studies. at http://college.cqpress.com/instructors-resources/budget toolsir/.

ACKNOWLEDGMENTS We have so many to acknowledge and appreciate. We would like to thank a host of people who have lent us their expertise and read drafts of parts of this book: Richard Buery, president and chief executive officer of the Children’s Aid Society; Dall Forsythe, vice president of finance for Atlantic Philanthropies; Professor Jack Krauskopf of Baruch College School of Public Affairs; Professor Fred Lane, recently retired from Baruch College School of Public Affairs; Stan Schneider, president of Metis Associates; Lawrence Schweinhart, president of the High-Scope Foundation; and Donna Tapper, managing 28

senior associate, research and evaluation, with Metis Associates. We also wish to thank reviewers Gary Rassel, University of North Carolina–Charlotte, and Jay Eungha Ryu, Ohio University–Main Campus, for their thoughtful and valuable feedback on the manuscript.

Jay Eungha Ryu served as the technical editor and did wonderful work. We have been made wiser in prose and writing style with the help of our editor, Lori Richardson. We are indebted to Liz Gewirtzman for the many conversations we have had about ideas in this book. We can never thank Charisse Kiino, CQ Press publisher and chief college acquisitions editor, enough for all of her advice. We are in awe of the skillful editing of CQ Press development editor Nancy Matuszak. We are in debt to Judy Selhorst for her copyediting. We are indebted to our students who suffered through drafts of this book and helped enrich and shape the book through their suggestions and criticisms. Lastly, we are indebted to Laura Gentile, Esq., for the many times she has provided direction and counsel.

29

30

AN INTRODUCTION TO NONPROFITS MISSION AND MONEY Sustaining the mission of an organization is the primary task of nonprofit leadership.

—Allen J. Proctor1

CHAPTER 1 LEARNING OBJECTIVES Defining nonprofits Understanding the origins of nonprofits Learning about the size and scope of the nonprofit sector Distinguishing between for-profits and nonprofits Understanding the necessity for financial policies Recognizing the link between mission and money Understanding the role of watchdog organizations

THE FINANCIAL WORLD of nonprofits—the structure, process, policies, and practices of budgeting, financial analysis, and financial management—is intrinsically tied to the missions of those organizations. Decision makers in nonprofits must understand the finances of their organizations and how their resources can be used to fulfill the organizations’ missions. This book is designed to help you, the student of the nonprofit sector who wishes to work in that sector, to develop the confidence to question and critique the work of a nonprofit’s financial office; it will also serve as a resource when you are stymied about next steps for your nonprofit. Should you expand? Cut back? Reduce every department by 10 percent, or eliminate a program? This volume will enable you to develop the tools to answer those questions.

The twenty-first century has begun with great political and economic turmoil, and nonprofit organizations, as always, must navigate this turmoil and the resultant roadblocks on their paths to mission success. In many ways much of the twentieth century was an easier time for nonprofits, a time when they demonstrated enormous growth and enjoyed generous government resources for many social service programs. Now, they face a challenging and changing future. It is essential that the current and future nonprofit 31

leadership gain the fundamental and advanced skills necessary to navigate the challenges and changes ahead.

DEFINITION OF A NONPROFIT A nonprofit is a corporation that is a legal entity separate from its owners. Like all corporations in the United States, a nonprofit registers in the state in which it does business. Although corporations, including nonprofit corporations, are creatures of state law, only the Internal Revenue Service (IRS) can confer the tax benefits of the federal tax code. Thus it is to the IRS that we refer when distinguishing which corporations are nonprofits. The IRS distinguishes a nonprofit corporation from a for-profit corporation by the fact that a nonprofit may not distribute its income to those who control it. The income is to be used solely for the mission of the nonprofit. The IRS recognizes many kinds of nonprofits, and these organizations need not pay federal income tax. The IRS identifies taxexempt nonprofit organizations as 501(c)s, of which there are twenty-seven different categories. Of these twenty-seven, only organizations in one of them—the 501(c)(3)s—are the traditional nonprofits most of us think of, organizations that include public charities and private foundations. Donors receive federal tax deductions for contributions to only one particular type of 501(c)—that is, a 501(c)(3). The IRS also requires that nonprofits not confer improper benefits on anyone and that they refrain from campaigning for or against political candidates. A small amount of lobbying is permitted. A good source for information on the IRS rules concerning nonprofits, in addition to the IRS Web site, is the Web site of the Council on Foundations,2 a nonprofit association of grant-making foundations and corporations. States may tax nonprofits, but most choose not to.

Nonprofits can be divided into three groups, two of which—public charities and private foundations—are 501(c)(3)s. The third group is made up of other nonprofit organizations that are not called 501(c)3s but 501(c)1s through 501(c)27s. The 501(c)(3) public charities are the bulk of the 1.6 million nonprofits operating in the United States and include charities related to the arts, education, health care, and other human services. A private foundation is different from a public charity. It is an individual, family, or corporation that is endowed (funded) as a nonprofit to provide support to public charities.

Private foundations are subject to federal taxes. In addition, the IRS has created the “other” category, which includes thousands of social and recreational clubs, trade associations, labor unions, veterans’ associations, and advocacy organizations. These other 501(c)s are taxexempt, but donors do not receive tax deductions for any contributions made to them.

These are labeled 501(c)1 through 501(c)27 (except for 3) and represent organizations such as civic organizations and business leagues. Religious organizations are not required to register with the IRS, although many do.

The Council on Foundations provides clarification of the difference in tax treatment between public charities and other nonprofits. The National Football League (NFL) and a soup kitchen, for example, are both nonprofits and are exempted from the federal income 32

tax, but of the two, only the soup kitchen is a charity that can receive tax-deductible charitable contributions and also is exempt from property tax and sales tax. Trade associations, such as the NFL, and other noncharitable nonprofits are unlikely to be exempt from either the property tax or the sales tax, and financial contributions to the NFL are not tax deductible.3

NONPROFIT ORIGINS AND GROWTH The kinds of nonprofits that exist in the United States today have a history more than four hundred years old. England’s 1602 Statute of Charitable Uses serves as the forerunner of today’s U.S. nonprofit institutions. Under this statute, for the first time in England, property could be set aside for charitable purposes. When English settlers came to America, they brought English law with them and along came the charities. As in England, most early American towns had systems to aid the destitute, usually involving a combination of taxes and private charity. Also as in England, organizations rose up to help the poor, funded by public taxes and private contributions. For example, in the early 1800s, the New York State Legislature awarded $750 to the Society for the Relief of Poor Widows with Small Children.4

The Modern Nonprofit Structure In the early nineteenth century, the U.S. Supreme Court established the right of private nonprofit organizations to be free of unreasonable influence from the political sector. In 1816, attorney Daniel Webster and Chief Justice John Marshall helped develop the modern nonprofit structure. Webster, relying on Article I, Section 10, of the U.S. Constitution (which prohibits states from interfering with the obligation of contracts), defended New Hampshire’s Dartmouth College Board of Trustees’ right to independence from the New Hampshire governor and state legislature, which had sought to replace the trustees with their own choices. Chief Justice Marshall agreed with Webster, explaining, “If charitable gifts and charitable institutions were subject to the perpetual threat of legislative interference, no sensible person would be willing to make donations for charitable, educational, or religious purposes.”5 Although Marshall declared that states could not interfere with citizens forming voluntary associations, states retained the right to regulate nonprofits. In addition, the federal government maintained a powerful gatekeeping role in determining, through the IRS, which organizations could become charitable organizations. The IRS further required nonprofits to file annual financial statements. Often, federal statutes, such as antidiscrimination laws, applied to nonprofits as well.

Important to the growth of the modern nonprofit was the protection of trustees created by the “prudent man rule.” In 1830, Massachusetts Supreme Court Justice Samuel Putnam, in Harvard College v. Amory, rejected an attempt to hold trustees personally 33

responsible for the loss of investment capital in a stock (in the absence of mismanagement):6 Trustees are justly and uniformly considered favorably, and it is of great importance to bereaved families and orphans, that they should not be held to make good, losses in the depreciation of stocks or the failure of the capital itself, which they held in trust, provided they conduct themselves honestly and discreetly and carefully, according to the existing circumstances, in the discharge of their trusts. If this were held otherwise, no prudent man would run the hazard of losses which might happen without any neglect or breach of good faith.7 Trustees had to exercise discretion, but they could not be held personally responsible for losses caused by fluctuations of the market. This so-called prudent man rule became the basis of the Uniform Prudent Investor Act (UPIA) created by the American Law Institute.

Under the UPIA, endorsed by the National Conference of Commissioners on Uniform State Laws in 1995 and supported by forty-four states, personal immunity for the loss of investment capital was broadened to include the entire portfolio of stocks and not simply one or two stocks. This became known as the prudent investor rule.

The Identification of Nonprofits as the Third Sector Nonprofits grew enormously in the twentieth century. The income tax imposed in the early part of the century created incentives for charitable donations that came with the benefit of income tax deductions. The Great Depression, which began in 1929, proved too much for the world of private charities and local government. The federal government stepped in, and many people believed that the government’s involvement in providing aid to the poor would end nonprofit work. As Friedman and McGarvie note, “Philanthropists and their organizations, especially the new foundations, resisted the expansion of federal authority.”8 But they need not have worried. Nonprofits grew in size and scope during the twentieth century and worked closely with federal and state governments.

In the 1950s and 1960s, the U.S. Congress sought more power over the growing nonprofit sector. In 1950, it imposed a tax on the unrelated business income of many charities (the Revenue Act of 1950). Congress passed the Tax Reform Act in 1969, which divided all nonprofit organizations categorized as 501(c)(3)s into public charities and private foundations, and then proceeded to impose a special tax on private foundations. In general, the Tax Reform Act of 1969 imposed more regulation on the nonprofit sector.

According to Salamon and Flaherty: “Because of a variety of perceived abuses among private foundations, however, for tax purposes the U.S. Congress established a separate definition of foundations and subjected them to payout and excise tax requirements as well as additional regulations and reporting requirements in order to ensure that their funds were indeed devoted to public, rather than private, purposes.”9 The 1970s were a momentous time for the nonprofit sector. In 1973, John D. 34

Rockefeller III initiated and funded the Commission on Private Philanthropy and Public Needs (1973–77), known as the Filer Commission for its chair, prominent businessman John H. Filer. The Filer Commission established “a new conceptual framework of American society, a framework that added a ‘third sector’ of voluntary giving and voluntary service alongside the first sector of government and the second sector of the private economic marketplace.”10 The commission produced five volumes of specialized studies by scholars and led to the creation of the first of many university centers devoted to the study of the nonprofit sector. The Filer Commission named the nonprofit world the third sector, and through its recommendations came greater interest in this new sector as research about it began in earnest. This was a major turning point for nonprofits. Now we face another turning point as the 2008 economic crisis and subsequent governmental cutbacks have placed nonprofits in a perilous financial position.

SIZE AND SCOPE OF THE NONPROFIT WORLD The National Center for Charitable Statistics reports that 1,617,301 tax-exempt organizations were registered with the IRS in 2010. Of these, 1.1 million are public charities, almost 116,000 are private foundations, and 455,000 are other types of nonprofits such as civic leagues and chambers of commerce. In addition, there are almost 279,000 churches, which do not have to file with the Internal Revenue Service, although some do.

Although 1.1 million nonprofits are public charities, not all of them file the yearly tax form called the Form 990 with the IRS. Until 2010, nonprofits were not required to file annually with the IRS unless they had $25,000 in gross receipts, although most did file.

The nonprofits that filed a Form 990 accounted for 9 percent of all wages and salaries paid in the United States, with revenues totaling $1.4 trillion and total assets worth $2.5 trillion.

Health and education dominate the nonprofit sector. Health-related charities are the largest nonprofit subsector, at 10.7 percent of all public charities. They produce 57.6 percent of the revenue. Education is the second-largest subsector, comprising 18.8 percent of the total number of public charities and 18.0 percent of the total revenue.11 (See Table 1.1.)

Although the public is most familiar with relatively large nonprofits, such as the YMCA or the American Red Cross, only 4 percent of all charitable organizations have annual budgets of more than $10 million. Most nonprofits are small, with nearly three-fourths having operating budgets of less than $500,000.12 Many nonprofits are even smaller. Of the number reporting in 2005, almost 45 percent had operating budgets of less than $100,000.

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DANCE ON STILTS AT THE GIRLS’ UNYAGO, NIUCHI

Newala, too, suffers from the distance of its water-supply—at least the Newala of to-day does; there was once another Newala in a lovely valley at the foot of the plateau. I visited it and found scarcely a trace of houses, only a Christian cemetery, with the graves of several missionaries and their converts, remaining as a monument of its former glories. But the surroundings are wonderfully beautiful. A thick grove of splendid mango-trees closes in the weather-worn crosses and headstones; behind them, combining the useful and the agreeable, is a whole plantation of lemon-trees covered with ripe fruit; not the small African kind, but a much larger and also juicier imported variety, which drops into the hands of the passing traveller, without calling for any exertion on his part. Old Newala is now under the jurisdiction of the native pastor, Daudi, at Chingulungulu, who, as I am on very friendly terms with him, allows me, as a matter of course, the use of this lemon-grove during my stay at Newala.

FEET MUTILATED BY THE RAVAGES OF THE “JIGGER” (Sarcopsylla penetrans)

The water-supply of New Newala is in the bottom of the valley, some 1,600 feet lower down. The way is not only long and fatiguing, but the water, when we get it, is thoroughly bad. We are suffering not only from this, but from the fact that the arrangements at Newala are nothing short of luxurious. We have a separate kitchen—a hut built against the boma palisade on the right of the baraza, the interior of which is not visible from our usual position. Our two cooks were not long in finding this out, and they consequently do—or rather neglect to do—what they please. In any case they do not seem to be very particular about the boiling of our drinking-water—at least I can attribute to no other cause certain attacks of a dysenteric nature, from which both Knudsen and I have suffered for some time. If a man like Omari has to be left unwatched for a moment, he is capable of anything. Besides this complaint, we are inconvenienced by the state of our nails, which have become as hard as glass, and crack on the slightest provocation, and I have the additional infliction of pimples all over me. As if all this were not enough, we have also, for the last week been waging war against the jigger, who has found his Eldorado in the hot sand of the Makonde plateau. Our men are seen all day long—whenever their chronic colds and the dysentery likewise raging among them permit—occupied in removing this scourge of Africa from their feet and trying to prevent the disastrous consequences of its presence. It is quite common to see natives of this place with one or two toes missing; many have lost all their toes,

or even the whole front part of the foot, so that a well-formed leg ends in a shapeless stump. These ravages are caused by the female of Sarcopsylla penetrans, which bores its way under the skin and there develops an egg-sac the size of a pea. In all books on the subject, it is stated that one’s attention is called to the presence of this parasite by an intolerable itching. This agrees very well with my experience, so far as the softer parts of the sole, the spaces between and under the toes, and the side of the foot are concerned, but if the creature penetrates through the harder parts of the heel or ball of the foot, it may escape even the most careful search till it has reached maturity.

Then there is no time to be lost, if the horrible ulceration, of which we see cases by the dozen every day, is to be prevented. It is much easier, by the way, to discover the insect on the white skin of a European than on that of a native, on which the dark speck scarcely shows. The four or five jiggers which, in spite of the fact that I constantly wore high laced boots, chose my feet to settle in, were taken out for me by the all-accomplished Knudsen, after which I thought it advisable to wash out the cavities with corrosive sublimate. The natives have a different sort of disinfectant—they fill the hole with scraped roots. In a tiny Makua village on the slope of the plateau south of Newala, we saw an old woman who had filled all the spaces under her toe-nails with powdered roots by way of prophylactic treatment. What will be the result, if any, who can say?

The rest of the many trifling ills which trouble our existence are really more comic than serious. In the absence of anything else to smoke, Knudsen and I at last opened a box of cigars procured from the Indian store-keeper at Lindi, and tried them, with the most distressing results. Whether they contain opium or some other narcotic, neither of us can say, but after the tenth puff we were both “off,” three-quarters stupefied and unspeakably wretched. Slowly we recovered—and what happened next? Half-an-hour later we were once more smoking these poisonous concoctions—so insatiable is the craving for tobacco in the tropics.

Even my present attacks of fever scarcely deserve to be taken seriously. I have had no less than three here at Newala, all of which have run their course in an incredibly short time. In the early afternoon, I am busy with my old natives, asking questions and making notes. The strong midday coffee has stimulated my spirits to

an extraordinary degree, the brain is active and vigorous, and work progresses rapidly, while a pleasant warmth pervades the whole body. Suddenly this gives place to a violent chill, forcing me to put on my overcoat, though it is only half-past three and the afternoon sun is at its hottest. Now the brain no longer works with such acuteness and logical precision; more especially does it fail me in trying to establish the syntax of the difficult Makua language on which I have ventured, as if I had not enough to do without it. Under the circumstances it seems advisable to take my temperature, and I do so, to save trouble, without leaving my seat, and while going on with my work. On examination, I find it to be 101·48°. My tutors are abruptly dismissed and my bed set up in the baraza; a few minutes later I am in it and treating myself internally with hot water and lemon-juice.

Three hours later, the thermometer marks nearly 104°, and I make them carry me back into the tent, bed and all, as I am now perspiring heavily, and exposure to the cold wind just beginning to blow might mean a fatal chill. I lie still for a little while, and then find, to my great relief, that the temperature is not rising, but rather falling. This is about 7.30 p.m. At 8 p.m. I find, to my unbounded astonishment, that it has fallen below 98·6°, and I feel perfectly well. I read for an hour or two, and could very well enjoy a smoke, if I had the wherewithal—Indian cigars being out of the question.

Having no medical training, I am at a loss to account for this state of things. It is impossible that these transitory attacks of high fever should be malarial; it seems more probable that they are due to a kind of sunstroke. On consulting my note-book, I become more and more inclined to think this is the case, for these attacks regularly follow extreme fatigue and long exposure to strong sunshine. They at least have the advantage of being only short interruptions to my work, as on the following morning I am always quite fresh and fit.

My treasure of a cook is suffering from an enormous hydrocele which makes it difficult for him to get up, and Moritz is obliged to keep in the dark on account of his inflamed eyes. Knudsen’s cook, a raw boy from somewhere in the bush, knows still less of cooking than Omari; consequently Nils Knudsen himself has been promoted to the vacant post. Finding that we had come to the end of our supplies, he began by sending to Chingulungulu for the four sucking-pigs which we had

bought from Matola and temporarily left in his charge; and when they came up, neatly packed in a large crate, he callously slaughtered the biggest of them. The first joint we were thoughtless enough to entrust for roasting to Knudsen’s mshenzi cook, and it was consequently uneatable; but we made the rest of the animal into a jelly which we ate with great relish after weeks of underfeeding, consuming incredible helpings of it at both midday and evening meals. The only drawback is a certain want of variety in the tinned vegetables. Dr. Jäger, to whom the Geographical Commission entrusted the provisioning of the expeditions—mine as well as his own—because he had more time on his hands than the rest of us, seems to have laid in a huge stock of Teltow turnips,[46] an article of food which is all very well for occasional use, but which quickly palls when set before one every day; and we seem to have no other tins left. There is no help for it—we must put up with the turnips; but I am certain that, once I am home again, I shall not touch them for ten years to come.

Amid all these minor evils, which, after all, go to make up the genuine flavour of Africa, there is at least one cheering touch: Knudsen has, with the dexterity of a skilled mechanic, repaired my 9 × 12 cm. camera, at least so far that I can use it with a little care.

How, in the absence of finger-nails, he was able to accomplish such a ticklish piece of work, having no tool but a clumsy screw-driver for taking to pieces and putting together again the complicated mechanism of the instantaneous shutter, is still a mystery to me; but he did it successfully. The loss of his finger-nails shows him in a light contrasting curiously enough with the intelligence evinced by the above operation; though, after all, it is scarcely surprising after his ten years’ residence in the bush. One day, at Lindi, he had occasion to wash a dog, which must have been in need of very thorough cleansing, for the bottle handed to our friend for the purpose had an extremely strong smell. Having performed his task in the most conscientious manner, he perceived with some surprise that the dog did not appear much the better for it, and was further surprised by finding his own nails ulcerating away in the course of the next few days. “How was I to know that carbolic acid has to be diluted?” he mutters indignantly, from time to time, with a troubled gaze at his mutilated finger-tips.

Since we came to Newala we have been making excursions in all directions through the surrounding country, in accordance with old habit, and also because the akida Sefu did not get together the tribal elders from whom I wanted information so speedily as he had promised. There is, however, no harm done, as, even if seen only from the outside, the country and people are interesting enough.

The Makonde plateau is like a large rectangular table rounded off at the corners. Measured from the Indian Ocean to Newala, it is about seventy-five miles long, and between the Rovuma and the Lukuledi it averages fifty miles in breadth, so that its superficial area is about two-thirds of that of the kingdom of Saxony. The surface, however, is not level, but uniformly inclined from its south-western edge to the ocean. From the upper edge, on which Newala lies, the eye ranges for many miles east and north-east, without encountering any obstacle, over the Makonde bush. It is a green sea, from which here and there thick clouds of smoke rise, to show that it, too, is inhabited by men who carry on their tillage like so many other primitive peoples, by cutting down and burning the bush, and manuring with the ashes. Even in the radiant light of a tropical day such a fire is a grand sight.

Much less effective is the impression produced just now by the great western plain as seen from the edge of the plateau. As often as time permits, I stroll along this edge, sometimes in one direction, sometimes in another, in the hope of finding the air clear enough to let me enjoy the view; but I have always been disappointed.

Wherever one looks, clouds of smoke rise from the burning bush, and the air is full of smoke and vapour. It is a pity, for under more favourable circumstances the panorama of the whole country up to the distant Majeje hills must be truly magnificent. It is of little use taking photographs now, and an outline sketch gives a very poor idea of the scenery. In one of these excursions I went out of my way to make a personal attempt on the Makonde bush. The present edge of the plateau is the result of a far-reaching process of destruction through erosion and denudation. The Makonde strata are everywhere cut into by ravines, which, though short, are hundreds of yards in depth. In consequence of the loose stratification of these beds, not only are the walls of these ravines nearly vertical, but their upper end is closed by an equally steep escarpment, so that the

western edge of the Makonde plateau is hemmed in by a series of deep, basin-like valleys. In order to get from one side of such a ravine to the other, I cut my way through the bush with a dozen of my men.

It was a very open part, with more grass than scrub, but even so the short stretch of less than two hundred yards was very hard work; at the end of it the men’s calicoes were in rags and they themselves bleeding from hundreds of scratches, while even our strong khaki suits had not escaped scatheless.

NATIVE PATH THROUGH THE MAKONDE BUSH, NEAR MAHUTA

I see increasing reason to believe that the view formed some time back as to the origin of the Makonde bush is the correct one. I have no doubt that it is not a natural product, but the result of human occupation. Those parts of the high country where man—as a very slight amount of practice enables the eye to perceive at once—has not yet penetrated with axe and hoe, are still occupied by a splendid timber forest quite able to sustain a comparison with our mixed forests in Germany. But wherever man has once built his hut or tilled his field, this horrible bush springs up. Every phase of this process

may be seen in the course of a couple of hours’ walk along the main road. From the bush to right or left, one hears the sound of the axe— not from one spot only, but from several directions at once. A few steps further on, we can see what is taking place. The brush has been cut down and piled up in heaps to the height of a yard or more, between which the trunks of the large trees stand up like the last pillars of a magnificent ruined building. These, too, present a melancholy spectacle: the destructive Makonde have ringed them— cut a broad strip of bark all round to ensure their dying off—and also piled up pyramids of brush round them. Father and son, mother and son-in-law, are chopping away perseveringly in the background—too busy, almost, to look round at the white stranger, who usually excites so much interest. If you pass by the same place a week later, the piles of brushwood have disappeared and a thick layer of ashes has taken the place of the green forest. The large trees stretch their smouldering trunks and branches in dumb accusation to heaven—if they have not already fallen and been more or less reduced to ashes, perhaps only showing as a white stripe on the dark ground.

This work of destruction is carried out by the Makonde alike on the virgin forest and on the bush which has sprung up on sites already cultivated and deserted. In the second case they are saved the trouble of burning the large trees, these being entirely absent in the secondary bush.

After burning this piece of forest ground and loosening it with the hoe, the native sows his corn and plants his vegetables. All over the country, he goes in for bed-culture, which requires, and, in fact, receives, the most careful attention. Weeds are nowhere tolerated in the south of German East Africa. The crops may fail on the plains, where droughts are frequent, but never on the plateau with its abundant rains and heavy dews. Its fortunate inhabitants even have the satisfaction of seeing the proud Wayao and Wamakua working for them as labourers, driven by hunger to serve where they were accustomed to rule.

But the light, sandy soil is soon exhausted, and would yield no harvest the second year if cultivated twice running. This fact has been familiar to the native for ages; consequently he provides in time, and, while his crop is growing, prepares the next plot with axe and firebrand. Next year he plants this with his various crops and

lets the first piece lie fallow. For a short time it remains waste and desolate; then nature steps in to repair the destruction wrought by man; a thousand new growths spring out of the exhausted soil, and even the old stumps put forth fresh shoots. Next year the new growth is up to one’s knees, and in a few years more it is that terrible, impenetrable bush, which maintains its position till the black occupier of the land has made the round of all the available sites and come back to his starting point.

The Makonde are, body and soul, so to speak, one with this bush.

According to my Yao informants, indeed, their name means nothing else but “bush people.” Their own tradition says that they have been settled up here for a very long time, but to my surprise they laid great stress on an original immigration. Their old homes were in the south-east, near Mikindani and the mouth of the Rovuma, whence their peaceful forefathers were driven by the continual raids of the Sakalavas from Madagascar and the warlike Shirazis[47] of the coast, to take refuge on the almost inaccessible plateau. I have studied African ethnology for twenty years, but the fact that changes of population in this apparently quiet and peaceable corner of the earth could have been occasioned by outside enterprises taking place on the high seas, was completely new to me. It is, no doubt, however, correct.

The charming tribal legend of the Makonde—besides informing us of other interesting matters—explains why they have to live in the thickest of the bush and a long way from the edge of the plateau, instead of making their permanent homes beside the purling brooks and springs of the low country.

“The place where the tribe originated is Mahuta, on the southern side of the plateau towards the Rovuma, where of old time there was nothing but thick bush. Out of this bush came a man who never washed himself or shaved his head, and who ate and drank but little.

He went out and made a human figure from the wood of a tree growing in the open country, which he took home to his abode in the bush and there set it upright. In the night this image came to life and was a woman. The man and woman went down together to the Rovuma to wash themselves. Here the woman gave birth to a stillborn child. They left that place and passed over the high land into the valley of the Mbemkuru, where the woman had another child, which

was also born dead. Then they returned to the high bush country of Mahuta, where the third child was born, which lived and grew up. In course of time, the couple had many more children, and called themselves Wamatanda. These were the ancestral stock of the Makonde, also called Wamakonde,[48] i.e., aborigines. Their forefather, the man from the bush, gave his children the command to bury their dead upright, in memory of the mother of their race who was cut out of wood and awoke to life when standing upright. He also warned them against settling in the valleys and near large streams, for sickness and death dwelt there. They were to make it a rule to have their huts at least an hour’s walk from the nearest wateringplace; then their children would thrive and escape illness.”

The explanation of the name Makonde given by my informants is somewhat different from that contained in the above legend, which I extract from a little book (small, but packed with information), by Pater Adams, entitled Lindi und sein Hinterland. Otherwise, my results agree exactly with the statements of the legend. Washing?

Hapana—there is no such thing. Why should they do so? As it is, the supply of water scarcely suffices for cooking and drinking; other people do not wash, so why should the Makonde distinguish himself by such needless eccentricity? As for shaving the head, the short, woolly crop scarcely needs it,[49] so the second ancestral precept is likewise easy enough to follow. Beyond this, however, there is nothing ridiculous in the ancestor’s advice. I have obtained from various local artists a fairly large number of figures carved in wood, ranging from fifteen to twenty-three inches in height, and representing women belonging to the great group of the Mavia, Makonde, and Matambwe tribes. The carving is remarkably well done and renders the female type with great accuracy, especially the keloid ornamentation, to be described later on. As to the object and meaning of their works the sculptors either could or (more probably) would tell me nothing, and I was forced to content myself with the scanty information vouchsafed by one man, who said that the figures were merely intended to represent the nembo—the artificial deformations of pelele, ear-discs, and keloids. The legend recorded

by Pater Adams places these figures in a new light. They must surely be more than mere dolls; and we may even venture to assume that they are—though the majority of present-day Makonde are probably unaware of the fact—representations of the tribal ancestress.

The references in the legend to the descent from Mahuta to the Rovuma, and to a journey across the highlands into the Mbekuru valley, undoubtedly indicate the previous history of the tribe, the travels of the ancestral pair typifying the migrations of their descendants. The descent to the neighbouring Rovuma valley, with its extraordinary fertility and great abundance of game, is intelligible at a glance—but the crossing of the Lukuledi depression, the ascent to the Rondo Plateau and the descent to the Mbemkuru, also lie within the bounds of probability, for all these districts have exactly the same character as the extreme south. Now, however, comes a point of especial interest for our bacteriological age. The primitive Makonde did not enjoy their lives in the marshy river-valleys.

Disease raged among them, and many died. It was only after they had returned to their original home near Mahuta, that the health conditions of these people improved. We are very apt to think of the African as a stupid person whose ignorance of nature is only equalled by his fear of it, and who looks on all mishaps as caused by evil spirits and malignant natural powers. It is much more correct to assume in this case that the people very early learnt to distinguish districts infested with malaria from those where it is absent.

This knowledge is crystallized in the ancestral warning against settling in the valleys and near the great waters, the dwelling-places of disease and death. At the same time, for security against the hostile Mavia south of the Rovuma, it was enacted that every settlement must be not less than a certain distance from the southern edge of the plateau. Such in fact is their mode of life at the present day. It is not such a bad one, and certainly they are both safer and more comfortable than the Makua, the recent intruders from the south, who have made USUAL METHOD OF good their footing on the western edge of the CLOSING HUT-DOOR plateau, extending over a fairly wide belt of country. Neither Makua nor Makonde show in their dwellings anything of the size and comeliness of the Yao houses in the plain, especially at Masasi, Chingulungulu and Zuza’s. Jumbe Chauro, a Makonde hamlet not far from Newala, on the road to Mahuta, is the

most important settlement of the tribe I have yet seen, and has fairly spacious huts. But how slovenly is their construction compared with the palatial residences of the elephant-hunters living in the plain.

The roofs are still more untidy than in the general run of huts during the dry season, the walls show here and there the scanty beginnings or the lamentable remains of the mud plastering, and the interior is a veritable dog-kennel; dirt, dust and disorder everywhere. A few huts only show any attempt at division into rooms, and this consists merely of very roughly-made bamboo partitions. In one point alone have I noticed any indication of progress—in the method of fastening the door. Houses all over the south are secured in a simple but ingenious manner. The door consists of a set of stout pieces of wood or bamboo, tied with bark-string to two cross-pieces, and moving in two grooves round one of the door-posts, so as to open inwards. If the owner wishes to leave home, he takes two logs as thick as a man’s upper arm and about a yard long. One of these is placed obliquely against the middle of the door from the inside, so as to form an angle of from 60° to 75° with the ground. He then places the second piece horizontally across the first, pressing it downward with all his might.

It is kept in place by two strong posts planted in the ground a few inches inside the door. This fastening is absolutely safe, but of course cannot be applied to both doors at once, otherwise how could the owner leave or enter his house? I have not yet succeeded in finding out how the back door is fastened.

MAKONDE LOCK AND KEY AT JUMBE CHAURO

This is the general way of closing a house. The Makonde at Jumbe Chauro, however, have a much more complicated, solid and original one. Here, too, the door is as already described, except that there is only one post on the inside, standing by itself about six inches from one side of the doorway. Opposite this post is a hole in the wall just large enough to admit a man’s arm. The door is closed inside by a large wooden bolt passing through a hole in this post and pressing with its free end against the door. The other end has three holes into which fit three pegs running in vertical grooves inside the post. The door is opened with a wooden key about a foot long, somewhat curved and sloped off at the butt; the other end has three pegs corresponding to the holes, in the bolt, so that, when it is thrust through the hole in the wall and inserted into the rectangular opening in the post, the pegs can be lifted and the bolt drawn out.[50]

MODE OF INSERTING THE KEY

With no small pride first one householder and then a second showed me on the spot the action of this greatest invention of the Makonde Highlands. To both with an admiring exclamation of “Vizuri sana!” (“Very fine!”). I expressed the wish to take back these marvels with me to Ulaya, to show the Wazungu what clever fellows the Makonde are. Scarcely five minutes after my return to camp at Newala, the two men came up sweating under the weight of two heavy logs which they laid down at my feet, handing over at the same time the keys of the fallen fortress. Arguing, logically enough, that if the key was wanted, the lock would be wanted with it, they had taken their axes and chopped down the posts—as it never occurred to them to dig them out of the ground and so bring them intact. Thus I have