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Preface
Overthepastthreedecades,thenonprofitsectorhasgrownatan astonishingpace.Today,therearemorethan1.1millionnonprofit publiccharitiesandabout380,000othertypesofnonprofitentities.The sectorisbeginningtofigureprominentlyinpublicconversationsasan acknowledgedsourceofinnovationandsolutionstovarioussocialissues, especiallyinareaswheregovernmentatalllevelswasformerlymoreactive. Thistrendseemslikelytocontinueandevenaccelerateintheyearstocome.
Withgreaterprominenceandmorewidespreadacceptancecomegreater attentionandmorescrutiny.Nonprofitmanagementisbecomingarecognizedspecialty,andthereisagrowingrecognitionthatnonprofitfinancial managementisnotjustfor-profitfinancialmanagementwithadifferent name.Thenumberofindividualsandentitiesspecializinginnonprofit financialmanagementisgrowingaswell.
Withthisgrowthinnumberscomesacomparablegrowthinthedemand forsophisticatedmanagement.Theproblemisthatfewnonprofitmanagers haveanyformaltraininginfinancialmanagement.Almosteverythingthey knowisfromon-the-jobtraining,withaliberalamountofassumptions andconventionalwisdomthatmayormaynotbehelpful.Insomecases, thesemanagerscanrelyonnativeinstinctandclarityofthought,butmost oftentheysimplywingitandhopeforthebest.
Nonprofitorganizations—andtheusersandfundersoftheirservices— deservebetter,andtheyaregettingit.Itisnotmuchofastretchtosay thattheincreasedemphasisonfinancialmanagementinnonprofitsreflects alaudablestrivingforgreateraccountability.Nolongerisitenoughjust forone’sfinancialrecordstobeinorder;onemustbeabletodemonstrate
goodfinancialsystemsinordertomeetalltheotherrisingdemandson today’snonprofit.
Inmyworkasanonprofitmanagementconsultantandnonprofitboard member,Icontinuetofindawidespreadhungerforpractical,immediately helpfulfinancialinformation.Thatwastheinitialstimulusforthisbook, anditremainssotoday.
Inthisvolume,Itendtosteerawayfromtechnicalcompliance-related matters,fortworeasons.First,otherscancoverfinancialcompliancesubjectsbetterthanI.And,second,myvisionoffinancialmanagementgoes farbeyondsimplecompliancetoastagethatIferventlyhopewillbecharacterizedbythoughtful,creative,andpersistentmanagementactions.
Tosupportthosewhosharemyvision,Ihavetriedtomakethisbook aspracticalaspossible.Forexample,mostofmyfinancialcalculationsand manyexamplesarebasedontheIRSForm990,thenonprofittaxreturn. Byusingtheonlycommonfinancialreportingform,Ihopetobridgethe gapsbetweendifferenttypesofnonprofitorganizationssothatthecontent willworkequallywellforabroadaudience.
Inrecentyears,IhaveseenagrowinginterestintheAmericannonprofit sectorbypeoplefromothercountries.Fromconversationswithmyconsultingandacademiccolleagues,IknowIamnotalone.Foreignstudents andmanagersfacethedoublechallengeoflearningfinancialconceptswhile alsofamiliarizingthemselveswithculturalmattersthatareuniquelyAmerican.ThisiswhyIaddedanappendixagaininthisversionthatisdesigned tobeakindofculturalprimeronpractices,institutions,andpoliciesthat mostAmericanstakeforgrantedbutthatwouldbestumblingblocksto non-Americans’understanding.
Aswiththefirstedition,thisbookisnotintendedtobeprimarilya textbook.Therearehundredsofthousandsofpeopleinvolvedwithnonprofitswhoneedtoknowaboutfinancialmanagementbutwhodon’tneed anothertextbookintheirlives.ItistothemthatIspeakthroughthese pages.Atthesametime,Ihavebeenflatteredthatmanyprofessorsand academicprogramsthroughoutthecountryhaveadoptedthebookforuse intheclassroom,andIthankthem.Icanonlyhopethattheirstudents do,too.
Asarookieexecutivedirectormanyyearsago,IneverdreamedthatI mightonedaywriteabookthatsomanywouldfinduseful.Mainly,Iwas consumedwithtryingtofigureoutwhatseemedlikeagargantuantask
rapidlyenoughtoavoidappearingfoolish.Insomeveryrealways,this bookisarecordofmypersonaljourneythroughasometimesconfusing topic.Theexistenceofthisfourtheditionispleasingvalidationthatmany peoplehavefoundmyapproachtononprofitfinancialmanagementhelpful. Ihopeonlythatthatwillcontinuetobethecase.
—TomMcLaughlin November2015
Acknowledgments
Manypeoplehelpedwithoneormoreeditionsofthisbook.IparticularlywanttothankAllwynBaptist,BeckyJ.Cerio,Robert Cowden,DennisFusco,JimGambon,RobertGardiner,CatherineGill, ElizabethHart,JohnJoyce,LauraKenney,BillLevis,MartyMcLaughlin, JimMecone,ClaraMiller,WayneMoss,JamesNesbitt,DavidOrlinoff,MaryPlant,JoanneSunshower,ShariSankner,andSherrellM. Smith.CatherineGillattheNonprofitFinanceFundsuppliedsomeof thevignettes.MyeditorsatJohnWiley&Sons,MarlaBobowick,Susan McDermott,andMattGilbertprovidedsupport,feedback,andguidance inoneormoreeditions.
NotetoReader
Throughoutthisbook,awebiconindicatesthatyoushouldgoto theaccompanyingwebsiteforcorrespondingtemplatesorexamples. Thewebsiteaddressiswww.wiley.com/go/basics4E.RefertoAppendix C,“UsingtheWebsite,”forthetableofcontentsanddetailedinstructions foruseofthesetemplates.
Streetsmart Financial Basics FOR Nonprofit Managers
PARTONE
Analysis
StructureofNonprofit Organizations
CORPORATIONS
Oneofthedistinguishingfeaturesofourlegalandfinancialsystemsisthat theyhavefoundawaytomakesomethingthatnoonecanseeortouch seemreal—andtherefore,ithasbecome real.Thehighpointofthisaccomplishmentisthatperfectlyintelligent,normalpeoplecanfindthemselves debatingthevirtuesofthebehaviorofthisthingandevenchangingtheir ownbehaviorsandchoicesbecauseofitsexistence.
Wearetalking,ofcourse,aboutthecorporation.Eventheworditself soundssubstantial,andwhenvariousnamesorotheridentifiersgetput infrontofit,weaccepttheresultseasily.Buttheideaofacorporation isnothingmorethanaconstructthatgainssubstanceandcredibilityin financialmatterslargelybecauseweneedittodoso.Ouracceptanceofthe metaphorofacorporate structure istangibleevidencethatwehumanbeings yearnforpredictabilityandconsistencyevenwhentheentityitselfexists onlyinourmindsandinthewaysthatacorporatestructureissaidto behave
Wesayallthisbecausewhatevercorporatestructureslackintangible qualitiestheymorethanmakeupforviatheirwidelyacceptedwaysof indicatingfinancialboundaries.Asyouwillseelaterinthisbook,those boundariescantakeonthenearlyconcretefeelofsomethingthatcanseem tobevirtuallyaphysicalpresence.
Thehighestlevelofnonprofitmanagementisthecorporationthat “owns”orrunstheprograms.Thecorporationisastatutoryentity
establishedbythelegallysanctionedactionsofoneormoreindividuals. Asalegallyapprovedentityseparatefromitsconstituentindividuals,the corporationhasitsowncontinuingexistence.Inlegaltheory,corporations aretreatedasdistinctentitieslikeindividualpeople,andcorporationshave theirowncollectionofresponsibilities,liabilities,andpowers.
Whyacorporation?Theanswerisdisarminglysimple:becauseit’seasier fortherestofus.Corporationscanbementionedinthesamelegalbreath astheindividualswhousetheirservices,workinthem,orsimplyexistin thesamestatewiththem.Allareonthesamelegalfooting,inthatrespect. Thecomplicatedandnarroweranswertothequestionhastodowitha varietyofpracticalconsiderations.Forinstance,revenuesourceregulations andpoliticalrealitiesoftennudgenonprofitsinthedirectionofaspecific typeoforganizationalstructure.Programssuchasbatteredwomen’sshelters almostofnecessitystartoutassingle-servicecorporations,whileolderand moreestablishedgroupsmayhavedevelopedamulticorporatestructure.
Therearealsoliabilitylawstoconsiderwhenoperatingdifferenttypes ofbusinesses.Nonprofitpubliccharitiestraditionallyhavebeengranted generousprotectionfromstateliabilitylaws,althoughthattendencyis beginningtochange.It’satraditiongrowingoutofEnglishcommonlaw thathasbeencodifiedinmanyplacesaroundthecountry.Oftentherewill beeitheranexplicitlimitationonsuitsoraprohibitionaltogetheronthe groundsthatentitiesfundedbythepublicatlargeoughtnottobesiphoningresourcesintoprivatehandsvialawsuits.Liabilityconsiderationsalone arenotnormallystrongenoughtodetermineacorporatestructure,butthe morefavorableliabilityclimateforpubliccharitiesisclear.
Likemostfor-profitbusinesses,nonprofitorganizationsmusthavea legallyacceptablestructurewithinwhichtooperate.Nonprofitpublic charitiesareofficiallyconsidered501(c)(3)corporations.Thereareliterally dozensofotherstructuralchoicesintheIRSlistoftax-exemptentity types,butthisoneiseasilythebestknown.TheofficialIRSlistofthese choicesisreproducedinExhibit1.1fromIRSPublication577.
Thisbloodlesslistofunsentimentalchoicesobscuresacentralpoint. Corporatestructuresinthenonprofitworldarechosenformanyreasons, theprimaryonesbeingriskmanagement,taxtreatment,andthebestavailablecorporatefitforcarryingoutmissions.Thesamekindofreasoning
aboutstructuralchoicetakesplaceinfor-profitentities.Withsuchalarge numberofpotentialstructuraloptions,entrepreneurs—inthenonprofit sectororoutsideofit—woulddowelltomimictheguidingprincipleof goodarchitecture: formfollowsfunction.Putsimply,beasclearasonecan possiblybeindeterminingwhatonewishestoaccomplish andthen give someseriousthoughttothebeststructuralchoiceavailable.
Thisareaofstructuralchoiceforpublic-servingentitieshasseen unprecedentedinnovationrecently.Oneofthemostintriguingdevelopmentsinthenonprofitsectorhasbeentheriseofalternativestructural choices,suchaslow-profitlimitedliabilitycompanies(L3Cs)andbenefit corporations(moreabouttheseandotherchoiceswillfollow).
DROPPINGOUTOFSCHOOL
Thecommunitycenterprideditselfonbeingabletoidentify communityneedsandrespondtothemeffectivelyovertime. Unfortunately,theirgrand,old175,000-square-footbuildinghad alreadychewedupsubstantialfundingjusttokeepitrunning. Theyachievedtheirfirstoperatingsurplusinyears,butitwas atissue-thin$7,900onabudgetof$10million.Projectionsfor nextyearcontemplatedmoreredink.
Themostprominentprogramintheirbuildingwastheir Montessorischool,whichoccupiedonlyabout7percentof theirtotalspacebutrepresentedhalfoftheirtotalemployees. Moreover,itwasrunningaregularsix-figuredeficit.Aspartof astrategicpositioningprocess,thequestionarose:Whyarewe doingthis?
Therewasnotanobviousanswer.Whenafinancialcommitmentofthissizedoesnothaveareadyanswertothissimple question,itisusuallytimeforsomerethinking,whichiswhat thecenterdid.Asaresult,theschoolwasspunoffasitsown nonprofitpubliccharity,withparentsandteacherstakingover themanagement.Thehappyendingisthattheschoolnowrents itsspacefromthecommunitycenterandisasteadysourceof earnedincome.
(continued)
(continued)
Ultimately,corporatestructuresaresimplyawaytoorganize programsandservicesinlogicalwaystoachievemaximum results.WhatthecommunitycenterrealizedwasthataMontessorischool,whileimportanttothecommunity,wastoomuchof amissionstretchforthem.Recastingthelegalstructuresallowed thecentertofocusontheprogramsandservicesitwasgoodat, whileturningamanagementdiversionintoasourceofrevenue.
PROGRAMS
Programsarethemostvisibleandbestunderstoodaspectofthenonprofit formofbusinessorganizationanditschiefmeansofcarryingoutitsmission. Alsocalledservices,projects,clinics,divisions,departments,floors,orany oneofathousandothernames,programsaretheactivitiesofthenonprofit organization.
Comingupwithafairandworkabledefinitionofaprogramisdifficult. Here’sanattempt:Aprogramisacoherentlypackagedgroupofactivities,usuallyassociatedwithoneormorespecificlocations,designedto accomplishastatedresult.
Nonprofitorganizationsrunallkindsofprogramsandoftenmorethan one.Daycarecentersofferinfantcareprograms,environmentalgroups operaterecyclingsystems,museumsrunartappreciationcourses,andso forth.Thetwokeystounderstandingprogramsarethattheygenerallyhave somecoherentinternalstructure,andtheyappearasdistinctchoicesto potentialusers.
Inmostnonprofitorganizations,programsarelikelittlebusinesses,with astructurereinforcedbynonprofitaccountingrulesandwithimmense iflargelyunnoticedconsequencesforeverythingfromcompensationto organizationaleffectiveness.Theyrepresentadelegationofresponsibility fromtheCEO,andsotheyaretheenginesofmission.Itisattheprogram levelthattheorganization’sgoalsareaccomplishedornot;therefore,those inchargeofprogramscarryheavymoralpressuretogetthejobdone.
Noticetheuseoftheword“moral”intheprecedingsentence.Typically, themotivationsofthosewhorunnonprofitorganizationsaredifferent
fromthosewhodothesamethinginthefor-profitworld,andthe motivationsofprogrammanagerseverywhereareoftendifferentstillfrom theirbosses.We’llexploresomeofthosedifferinginterestslater.Forthe moment,we’llusetheprogramasthesmallestmanagementunitofthe nonprofitcorporation.
TheRoleoftheInternalRevenueService
Ifprogramssometimesseemfuzzilydefined,thereisnosuchproblem withcorporatestructure.Unlikeotherformsofbusinessorganization,acorporationdoesnotexistuntilcertaingovernmentalauthorities sayitexists.Fornonprofitcorporations,theleadvoiceinthechorus istheInternalRevenueService(IRS).Inmattershavingtodowith nonprofitcorporations,itistheIRSthatgivethandtheIRSthat takethaway.
Corporationsareorganizedaccordingtothelawsofindividualstates. Ordinarily,startingacorporationisaseasyasfilingtherequiredpaperworkandpayingthenecessaryfees;infact,thatishowallcorporations muststart.Butgovernmentatalllevelsreservestherighttotaxtheprofitsofabusiness.Inordertogetthegovernmenttowaiveitsrightto tax—toallowacorporationtobe taxexempt—awould-benonprofitcorporationmustshowthatithasbeencreatedandwillbeoperatedwithcertain purposesinmind.Itmustdosoaccordingtopre-establishedguidelines spelledoutinthecode.Then,itmustwaitfortheIRS’sdecisiononthe application.
IRSacceptanceofexemptstatusistheturningpoint.Afterthisstep,state governmentoftenmusthaveitssayabouttheorganization’sacceptability asatax-exemptentity.Normally,stategovernmentiswillingtofollowthe IRS’slead,sooncetheIRShasweighedin,it’susuallyproformathereafter.
Ineffect,theIRSconsidersallnonprofitstobetaxableentitiesuntil theyproveotherwise.Themajorthingthatdistinguishesanonprofitfrom afor-profitcorporationisthatmostnonprofits(includingallcharities)are notallowedtohaveshareholderswithwhomtoshareprofits.Notethat thisisnotaprohibitionagainstprofits,justagainsthavingshareholderswith whomtosharethem.Thisisthereasonwhyitisoftensaidthattheprofits ofanonprofitarekeptwithinthecorporation—salaries,benefits,andperks notwithstanding.
Thefirstpermanentfederalincometaxwasenactedin1913 butaffectedlessthanone-halfof1percentofthepopulation. Congressexpandedthetaxbasein1917,whenitalsoinitiateda deductionforcharitablecontributions.
HYBRID CORPORATIONS
Inrecentyears,therehasbeengrowinginterestinwhataresometimes knownas“hybrid”corporations.Theseentitiescombinetheexplicit profitmakingandeaseofcapitalformationcharacteristicoffor-profit corporationswiththesocialresponsibilityofnonprofits.Socialenterprise practitionersareparticularlyinterestedinhybridcorporationsbecause theyoftenmustcreateabasisforsocialresponsibilityinafor-profitor manufacturewaystoraiseprivateequity(notdonations)throughanonprofit.Thecompromisestheymustreachareunsatisfyingorimpractical, andthatiswhatdrivesthesearchforanewform.
Thereissomeprecedentforthesehybridcorporations,suchasin Englandwherethecommunityinterestcompanyformwasapprovedin 2004orintheUnitedStateswherewell-knowngroupssuchasNewman’s OwnorBen&Jerry’sIceCreamwereamongthefirsttomoldtraditional for-profitsintosocialenterprises.Manynonprofitshavebeenexperimentingwithfor-profit-likestructuresandcultures.Thedifficultyisthatthese areone-of-a-kindventures.Creativelegalandfinancialadvisorscanoften findwaystojerry-rigastructurethatmimicsahybridcorporation,but untilsuchoptionsarewelldefined,wellunderstood,andenshrinedinlaw inallstates,hybridcorporationswillneverreallybecomewidelyaccepted. ThisisthesignificanceoftheL3Cformthatfirstgainedlegalacceptance in2008.Thisvariationonthetraditionallimitedliabilitycorporation (LLC)isspecificallyintendedtosupportsocialenterprise,andsoithas becomethefirstgenuineprototypeinhybridstructure.
AnIRSQuestion:PrivateFoundationorNot?
Historically,Congresshasdislikedprivatefoundations,whichareaformof charitableorganization,probablybecauseoftheabusesthatoccurredwhen theywerefirstcreated.In1969,theU.S.Congresslaidthegroundwork
