It’s a relatively straightforward process to determine how well a for-profit business is performing. But the question of how to assess non-profit financial performance can be a bit more nuanced.
We often think of non-profits in terms of the societal benefit they bring, but what often goes unnoticed are their unique organizational structures, which enhance their ability to pursue their missions. They’re different from businesses because they’re not organized primarily to pursue profits for shareholders; instead, they’re organized principally to advance a mission in the public interest. However, like for-profit businesses, non-profits do need to be financially sustainable to pursue those missions over time.
At Oaklyn Consulting, we help non-profits pursue mergers, acquisitions, alliances and partnerships, including acquisitions of other organizations as they grow and thrive, and sales to other organizations as they run out of options to thrive independently. Here’s a closer look at how to assess non-profit financial performance.
Understanding Non-profit Risks
Non-profits face two primary risks that can hamper their ability to fulfill their missions effectively:
- Too few resources to withstand major change, whether emergencies or smoldering issues.
- Lack of focus on maximizing their value creation, often resulting in inefficient management practices, underpriced products and services, or insufficiently aggressive pursuit of contributed income.
Recognizing that non-profits need to function as well-run businesses to pursue their public interest missions, we at Oaklyn Consulting help non-profit boards and executives negotiate mergers or similar transactions that strengthen the pursuit of their missions while modifying their corporate structures to overcome or take advantage of operational challenges.
How to Assess Non-profit Financial Performance in 3 Steps
For a non-profit to survive and thrive, it needs to generate an economic surplus in the same way a commercial business aims to maximize its net income. While commercial businesses prioritize financial metrics for the benefit of shareholders, non-profits instead must somehow quantify how their financial results benefit their overall mission, which is not explicitly stated in financial statements.
As we examine how to assess non-profit financial performance effectively, we urge boards and executives to consider the following three-part approach:
1. Distinguishing Discretionary and Non-discretionary Spending
Generally speaking, there is no need for a non-profit’s total income statement to show profit (or an increase in net assets) each year.
Non-profits should think of their expenses as being separated into two categories:
- Non-discretionary: Expenses that are absolutely necessary to deliver on the past year’s mission goals and are related to the past year’s revenue (whether earned or contributed). These expenses will, ideally, be a lower amount than revenue, leaving a cushion of funds for reinvestment.
- Discretionary: Funds used to reinvest in the organization’s ability to pursue its mission in the future.
Separating discretionary and nondiscretionary income in management reports is an important way of demonstrating value creation, effective management and financial sustainability.
2. Pro Forma Financial Analysis
Board members and executives should create regular “as if” financial statements, showing how financial results and plans might look if the organization has not made discretionary reinvestments in pursuit of its mission. Ideally, the result would be a profit or financial surplus, and a commensurate, measurable reduction in growth or mission attainment. In the best situations, financial ratio analysis will show that the non-profit business operated as efficiently as commercial counterparts.
3. Descriptive Analysis
While financial results are a math equation, mission attainment can be an essay question.
- Articulate, in an essay form, how nondiscretionary and discretionary resources were each used to advance the mission.
- Assess how resources from donors were utilized to support ongoing operations and reinvestment.
Mergers, Acquisitions, Alliances and Partnerships as Tools for Sustainability
Those wondering how to assess non-profit financial performance should realize that it requires a nuanced understanding of economic surplus, mission impact and strategic decision-making. By effectively managing discretionary and nondiscretionary funds, non-profits can build a foundation for sustainability, allowing them to navigate uncertainties and focus on their core missions.
When the interplay of these three factors is well understood by clear-eyed board and executives, then mergers, acquisitions, alliances and partnerships become powerful tools for expanding mission impact (as with our client Eckerd Connects) or reconfiguring the activities of the charity (as with our client Hospice of Chattanooga).
If you’re a non-profit leader or board member, our advisors at Oaklyn Consulting are glad to discuss how we can help you leverage your sustainability or take proactive steps to ensure it.