Can nonprofits invest in the stock market? What about investing in startups?

We have heard more and more questions about how to properly save and invest excess funds. Perhaps this is a result of record levels of giving from foundations and individuals, as documented by Giving USA in the aftermath of both the COVID-19 pandemic and increased awareness of the violent murders of black and brown people across the United States by police. Organizations might have also been the recipient of Paycheck Protection Program funds, which were meant to support payroll and other operating expenses to stay in business during the economic shutdowns. Whatever the case, many organizations have found themselves in the position of having excess cash and are struggling, many for the first time, with how to manage it properly.

Before we go any further down this road, we know that this article will not speak to all organizations. Prior to the pandemic, Guidstar published a report that found that more than 50% of nonprofits had less than 30-days cash on hand. At the height of the pandemic, multiple nonprofit associations reported that many organizations were struggling to make payroll and Candid even estimated that in a “realistic” scenario 11% of nonprofits would fail.

While we haven’t seen any data that would suggest that the nonprofit industry is in a similar position as it was a year ago, nonprofits have historically always been under-resourced. If your organization has less than 30-days cash on hand and struggles to make payroll to this day, you need to be prioritizing strategies to increase revenue, decrease expenses, and build a cash reserve. 

If your organization has seen the benefits of the uptick in giving trends and government assistance to businesses, your attention should start to be on managing the funds you do have. Let’s explore some common questions and key considerations of cash management for nonprofits.

Why should you care about cash management?

It’s a good question. If you have excess money in a checking account that’s covered FDIC insurance, isn’t that good enough? If you need access to it, you can readily utilize it. It’s easy to reconcile (especially if there are no transactions in that account) and easy to understand. There doesn’t seem to be much downside.

I totally get it. The easiest course of action is inaction. Unfortunately there are three things you need to consider:

  1. THE BIG ‘I’ – INFLATION. The negative impact of inflation is real. I’m sure you’ve seen the latest news coverage about inflation in 2021 alone. If not, here’s an article from a few weeks back. The reason this is a big deal is because that money you are keeping in your organization’s checking account is losing value every day and will continue to lose purchasing power as time goes on. For example, if you put $100,000 in a bank account 5 years ago and let it sit there it would only be worth $89,427 today. That’s a 11.5% loss of principal. If you had put that same $100,000 in a bank account 10 years ago and let it sit there, it would only be worth $83,822 in today’s dollars. That’s a 16% loss of principal. Those figures are during a period of record-low inflation. According to the Federal Reserve, inflation is expected to be a staggering 4.8% in the next year alone. This is a big deal and should be mitigated by proper cash management.
  1. FIDUCIARY RESPONSIBILITY. You and your Board of Directors have a fiduciary responsibility to properly manage your organization’s cash. Boards and managers have actually been sued for not upholding their legal duty to be good stewards of organizational finances. While it would admittedly be rare for organizations to be taken to court for not investing funds altogether, cash management is key to upholding the fiduciary duties of care, of loyalty, of obedience, and to act in good faith. Not convinced? Think of it in terms of risk management. Instead of operational or reputational risk, frame it as inflation risk. It’s a Board’s responsibility to help mitigate risk and this is an ever-present risk that needs to be discussed and hedged against.
  1. SUSTAINABILITY. Since inflation eats away at purchasing power, you want to find a way to preserve your cash’s value so that if you need to use your cash to fuel growth or float the organization through a period of economic uncertainty your money will go as far as possible. While this is not necessarily what many organizations think about when the word ‘sustainability’ is mentioned, it’s an important way to think about building financial resilience. Whether you are a believer in the phrase “cash is king” or “cash flow is king,” our argument is that more cash is always going to be better than less.

This is where I’m imagining you at this point in this post:

“Fine, Chad. You’re slowly convincing me. I guess there is an argument for managing our cash. So… are you going to give me some help up in here or are you just going to cause me more anxiety?”

Don’t worry, help is on the way. Fortunately your organization is not the only one in the history of nonprofits that have started to have this conversation. Let’s take a look at some leading practices that organizations have used to manage their cash.

What are some methods we should be using to manage our nonprofit’s cash?

Liquidity Policy

You might hear that some organizations have developed a “liquidity” policy. A few years back, FASB expanded the reporting requirements for nonprofits to disclose available liquidity. Many organizations took this opportunity to develop a liquidity policy. However, in relation to this blog post, liquidity is a more expansive term than just cash, which is why we’re not going to go into too much detail about this. If you are looking at developing a true liquidity policy, we would encourage you to reach out to your auditor or CPA to put something together. Here’s a good article from TDT CPAs and Advisors that goes into details that need to be considered when drafting a liquidity policy.

Operating Reserve Policy

If you have not already developed a cash reserves policy, you should prioritize this. If you do not have a strong financial partner in your organization or on your board, check out this amazing Operating Reserve Policy Toolkit for Nonprofit Organizations. While it was drafted way back in 2010, it is still very useful in today’s environment. As discussed in the toolkit, your operating reserve policy should be developed with the following questions in mind:

  • What does it mean to be financially stable?
  • What are adequate operating reserves?

These two questions can help your organization navigate through the discussion around what financial risks are present, how likely they are to materialize, what the financial impact could potentially be, how financial requirements should be funded, and what the optimal amount of reserves should actually be on hand. These questions should be discussed with board members, finance staff, your auditors, and possibly strategic funders.

This toolkit gives organizations a great outline for what should be included in the policy itself. Among the most important elements are:

  • Funding. Beginning balance of operating reserve, if any, ultimate target amount for the fund and timeline for achieving it, including an annual increase in targets and strategies/ sources for funding.
  • Procedures. Details of how the policy is to be implemented, including the formula for calculating the operating reserve ratio, the amount of the operating reserve balance, whether or not the operating reserve should be formally board‐designated, if it is to be a funded operating reserve and its relationship to the approved investment policy.
  • Uses. Circumstances in which the operating reserves can be used.
  • Governance. Procedures for approving the use of operating reserves, persons authorized to establish policies and oversee the operating reserve ratio and balance; provisions for recalculating the formula of the operating reserve balance and distributing the excess operating reserve balance, or funding operating reserve deficiencies.
  • Authorization of Drawdown from the Operating Reserve Fund. Define terms and conditions for drawdown from the fund for operating purposes in the case of a financial emergency, including procedures for eventual replenishment.

Again, this type of policy should ultimately be developed in consultation with many stakeholders but it really should be approved by the Board of Directors. The toolkit also provides some great examples of an actual operating reserve policy. If you’d like to see another few examples, Propel Nonprofits has some great examples here.

Investment Policy Statement

Last but not least, let’s talk about investments, which is why you’re probably reading this article in the first place. Before I go any further, however, I think it’s important to say that investments should only be considered if you have an adequate amount of operating reserve on hand. If you do not have 1 to 3 months of cash in your bank account, do not pass ‘Go’ and do not collect $200. An investment strategy should only be considered when your foundation is solid.

Now you’re probably thinking:

Fantastic, Chad. We have 3 months of operating reserves and now we’re ready to dump all of it into this amazing startup we saw on Shark Tank. How do we make this happen?

Hold your horses for a second. Unfortunately it’s not that easy. And, let’s be honest, the last thing you want to be an investor in is a pig-shaped wooden box that functions both as a bacon oven and alarm clock.

So what do nonprofits in this situation do with their excess cash and how do they proceed? Most organizations in this position typically start by developing an investment policy statement (IPS) to set the rules as to how an organization’s cash above and beyond operating reserves are invested and managed. How an organization invests, how they will benchmark performance, what type of fees they deem acceptable, returns expected, and how often the policy will be reevaluated are all detailed in an IPS.

Here are a few good examples of investment policy statements for nonprofits:

Once your IPS is developed, it is a good idea to circulate the document to several financial advisors and wealth management firms who have worked with nonprofits to get feedback on asset allocations, expected returns, potential risks, mitigating strategies, performance benchmarking, communication with the organization, etc. They will be able to suggest tweaks, updates, and set expectations with you, your finance committee, and your board.

Our concluding thoughts…

Hopefully this blog post has given you some resources to help your organization better manage cash and shown you that it is both important and possible to invest excess cash. Not only does it mitigate inflation risk, it builds sustainability and preserves value.

ABOUT AZUL ANALYSIS

FINANCIAL DASHBOARD FOR NONPROFITS. AZUL ANALYSIS CREATED THE FIRST TOOL EVER BUILT TO HELP NONPROFITS TELL A MORE COMPREHENSIVE FINANCIAL STORY. FOLLOW US ON FACEBOOK, INSTAGRAM, LINKEDIN, AND TWITTER.

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