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Budget Archives - TurnAround Executive Coaching
Control Hidden Expenses - Leaders should worry when the contract covers the expense but the program doesn't use the equipment or staff
Leaders get lost in a fog of numbers when they only need 7 Key Financials to make decisions.
I hope that you can join me at OpCon, June 13th, where I will be on a panel “What Nonprofits Need to Know About Nonprofit Accounting and Finance”. If you come with a CPA, bring aspirin as they recover from an encounter with a Management Accountant. If you’re a CEO, bring champagne to celebrate as you learn about 7 numbers that actually help you manage your agency.
In my book “Doing Bad at Doing Good”, I discover that the best nonprofits have an Operations Budget model that only requires 7 key financials. I’ll have copies of that available for attendees!
When you’re ready for a coaching investment, let’s talk! https://taconsulting.live/our-nonprofit-promise/
This is the 5th of 10 articles on Sundays that look at the 990s to understand what is happening to nonprofits in general and give you some data for your own nonprofit. Today, the focus is on the ability of companies to make payroll. Is your next paycheck safe?
I advocate for nonprofits to set a 10% surplus target. Greg Crabtree has the same advice for privately owned companies. We are both worried about the bills that accumulate while waiting for cash to settle them.
- For companies that make a product, the operating cycle begins when inventory has to be purchased or built. Bills have to be paid. A sale occurs, but cash still may not appear until merchandise is shipped and the cash is transferred. The entire period has to be financed.
- For nonprofits, late payments by government can create a cash lag of months or years. Meanwhile, payroll has to be paid.
The largest nonprofit in the study so far, Children’s Village, has an Accounts Receivable of 27% of Revenue and only 3 days of its next payroll on hand in unrestricted cash. There are 1,319 people on staff!
In a study of 14 nonprofits of various sizes ($1 million – $85 million revenue), 7 nonprofits showed a decline in the ability to make payroll over 4 years. The worst performer was over 2 months in cash arrears on payroll.
What can nonprofits do?
- They borrow from their restricted funds with the promise to repay
- They borrow from prepaid tuition and fees or prepaid money on government contracts
- They finance up to 75% of the collectible cash from government with a line of credit at a bank
- They blend methods and simply tell staff that payroll will be late.
Any company with less than two payrolls in the bank in cash is putting the wellbeing of families in jeopardy who depend on regular checks. Richard Reeves tells us that jobs that pay less than $120,000 face an increasingly expensive middle class lifestyle with more and more income insecurity.
Nonprofits have missions to do good – and that includes generous treatment of staff.
Calculate your own cash for payrolls from your 990:
- Copy the number from Page 1, line 15 and divide by 26 to find the Cash for One Payroll.
- Copy the numbers from Page 11, lines 1 and 2, to discover total Cash on Hand at End of Year.
- Subtract from the Cash on Hand, restricted assets on page 11, lines 28 and 29 to find Unrestricted Cash.
- Divide Unrestricted Cash by Cash for One Payroll.
If you have 4 payrolls in the bank, you have time to maneuver if bad days arrive. If you have less and less payrolls in the bank, you need to make a plan. Scaling Up business coaching creates a plan in 90 days, a quick win in the 2nd quarter and a 20% growth in revenue in the 2nd year. We’re here for you!
No gossip column on 990s can omit the juicy topic of what we’re all getting paid.
The 990 tracks highest paid compensation in two places – Part VII, Line 1d on the main form and also Schedule J (There are 16 additional schedules that can accompany the main form and sometimes this is where the bodies are buried.)
There are two ways to examine the data.
- What did the highest paid staff member receive?
- What percentage of the total compensation expense (Part I, Line 15) are the Highest Compensated Employees taking?
Let’s start with the highest compensated in $ even though the percentage of total compensation by percentage may not be unusual.
- Leadership of universities/medical facilities and private schools for the wealthy are routinely given higher salary in lieu of stock options. The theory is high leadership skill is required but leaders could also make more in the for-profit corporations with stock options as incentives. The eye popping salaries are a replacement for the stock and other incentives to be made at Apple, GE, and IBM.
- Higher pay can be concealed by Part VII Section A Column F – Other related organizations. While I have an upcoming look at nonprofit captive corporations, some midmarket nonprofits with financial sophistication use this column to add an extra $50,000 to the executive compensation. Wish I worked there 🙂
- Guidestar publishes an annual compensation report. For example, the CEO in Sacramento for a nonprofit should make approximately $54,000 if the total revenue is less than $500,000; $112,000 if the total revenue is less than $1 million. $130,000 if the total revenue is less than $5 million, and $175,000 at greater than $5 million revenue. These numbers strike many Boards as generous, but Guidestar is watching all of these clever add ons and reporting them. Why should you settle for less than fair? (Guidestar, 2017:208)
Let’s continue with the underpaid!
- Leadership compensation by percentage of total compensation is how much the Board thinks that the leadership is worth. An agency of $6+ million should expect that leadership compensation will absorb 3-5% of total compensation.
- Since ill-equipped leadership will never get the nonprofit to $6 million in revenue, small organizations may experience 6-12% of total compensation for leadership costs. Boards have to pay in advance of the larger size that good leadership can provide. It’s necessary pain of investment!
- If you are in a $500,000 revenue organization, be careful not to overvalue the ED job. Let’s use the Sacramento example and your compensation should be $54,000. Because the company is small, your job may also include clerical for 25% of the time and program meetings for 25%. Those two compensations for full-time work are $30,000 and $40,000.
So your total compensation would be
- 50% ED – $27,000 (54,000*.5)
- 25% Clerical – $7,500 (30,000*.25)
- 25% Program – $10,000 (40,000*.25)
- TOTAL $42,500
- I’ve also seen another nonprofit with $18 million in revenue and 1% in Highest Compensated Staff. While I applaud the benefits that staff receive in pension and health, it appears that they are risking a loss of leadership when managers go to a convention and chat about salaries. (People gossip at conventions! ). Poor Board leadership.
Let’s finally think about the overpaid
- I’m looking at a $7 million revenue organization with compensation requiring about 16% of the total compensation budget. That is leadership that has the board in their pocket!
- I’m also looking at a medical nonprofit that has been in the news for fraud charges. There is $2.5 million in compensation from related organizations – for 2 people.
Conclusion
Board of Directors should structure compensation to be generous to leadership and expect high results in return. Small agencies must suffer with tight budgets until total revenue approaches $6+ million. Boards should work with Executive Directors/CEO so that most of their time is spent in leadership. Mixing job descriptions will never produce great results in lives of clients. At the same time, there are ceilings to compensation for highest paid employees. With the 990, we can see where an agency is on the continuum.
The CEO/ED job is challenging. A business coach can help and contact me if you need support to go through this process.
Are Your Assets Resting?
Why would you buy a truck or a bus for your company and fail to use it? Why would you hire a new accountant and fail to use her? We are supposed to buy fixed assets and employ people and get more money back than we spent. Nonprofits will focus on social impact as well as cash. That’s fine but some nonprofits find it easy to spend other people’s money for things of little value.
The 990 tells whether assets are being purchased or employed wisely.
Assets
Each industry has its own range of the dollars returned in profit divided by the Assets. For profit education companies average 5%. The beverage industry is 9%.
The nonprofits studied have a return of assets of about 3%. That means that each $100 of investment in assets returns about $3 in profit. That is a lot lower than the industry ranges mentioned above because the corporate tax rate has been 35%! It’s fair to say that nonprofits actually do divert resources to the social sector that are returned in some other metric.
Two concerns emerge:
- Nonprofits that are less than 10 years old have a return on assets in the 20% range. Since they are probably carrying fixed assets with little accumulated depreciation – why are they so much more effective in acquiring assets that actually return the cost of investment? Are newer nonprofits born in a more competitive time in the nonprofit industry and will be stronger structurally?
- The historic nonprofits over 25 years old show returns as low as 3%. If they own heavily depreciated buildings or other long term assets, their return of 3% may be inflated. It could be closer to 0%.
Human Assets
In a post-industrial age, the real asset of any company is the compensation budget and the human resource that it represents. One way to measure effective hiring is to relate the total revenue to the dollars spent on compensation. If you hire a new staff member for $100,000, it’s clear that you have to raise at least $100,000 more in revenue to support the position. The labor efficiency ratio is usually between 2 and 7, depending on industry.
The formula used in the study is total revenue / total compensation.
Nonprofits are low, regardless of size.
- Some of the lowest include nonprofits in existence for 25+ years that have limited federal funds. For example, one reported an average of 1.26 over four years. This means that only 26 cents were left after payroll for rent, materials, food, office, etc. An overemphasis on payroll indicates poor program quality.
- The lowest reported (1.22) was family operated which probably means that they drain the nonprofit of cash by paying three sisters in management very well. Since it’s a special needs daycare, I pity the recipients of the services.
- Regulated nonprofits (child care) will have lower labor efficiency ratios because of required staffing and credentials. Companies such as McDonald’s have few staff requirements other than the practical matter of getting hot food to customers quickly.
- New nonprofits (under 10 years) tend to produce more money per staff member hired and spend more money on program (labor efficiency ratio of 1.7 – 2). This doesn’t mean that they pay staff poorly – they have enough money to do everything
- Nonprofits with growth rates of 20%+ per year have labor efficiency ratios of 1.5 – 2. This seems reasonable. They are saving money for program and rent. They have budget balance.
A labor efficiency ratio under 1.4 is a danger signal. The income may be critically lacking for required infrastructure. There may be undue influence of board or management to drain resources. Accrediting and regulatory agencies should measure program quality carefully.
Conclusion
The only way for nonprofits to serve and succeed in mission is through wise use of assets. When the financial return on assets is too low, it will reduce cash and destabilize the nonprofit. Older nonprofits generally seem to need more business training to approach 5% or more return on assets.
Labor efficiency is a critical asset because almost all companies spend most of their budget on payroll. When a budget is set up with less than $1.40 coming back in cash for every $1.00 spent on payroll, there is not enough money left to pay rent, insurance, and program supplies.
Younger nonprofits appear to be more nimble. They are less burdened with nonproductive assets and save enough money (aside from payroll) to finance quality program supplies and infrastructure.
Success = monitoring return on assets and labor efficiency.
I’m doing a 990 study. Each Sunday for 10 weeks, I will give out one insight for leaders. Most people ignore the 990 and its 16 additional schedules. Life is too short to do all that reading!
There are three critical areas for every company that plans for stability and growth – a) leadership, b) marketing, and c) infrastructure. It’s not possible to draw conclusions about leadership development and marketing from 990 reports.
Technology
There is an entry on technology expense on page 10 of the 990. This number is from the income statement so we can treat it as a signal of the priority that a company places on infrastructure. It’s only an indicator because infrastructure is more than technology.
I’m assuming that most of the technology expense is cloud based software as a subscription. Nonprofit subscriptions can be expensive. Blackbaud is a common software environment and its most inclusive packages range at least to $50,000 per year.
What did I find?
Old line NPs (more than 25 years old) only devoted .33% of their total revenue to technology. Their other financial indicators are fragile and they are not set up for a great future. The largest agency was an exception with $85 million revenue. Children’s Village reported 1.29% over 4 years.
New agencies (less than 10 years old) 1.07% of total revenue per year over 4 years.
Incubated agencies from think tanks 1.07% of total revenue per year over 4 years.
Single donor funded agencies average 1.07% of total revenue per year over 4 years.
Growth companies averaging 20% overall growth in revenue for 4 years on average also each used 1.07% as their benchmark for technology expense.
What do these numbers mean if you want to learn something for your company?
- Your investment will be greater than 1.07% for growth because these numbers do not include any hardware or software that was capitalized and depreciated. 2% of total revenue cash costs per year is probably a safer technology target for growth. For example – on a $10 million budget, devote $200,000 cash per year to technology
- Increasing Labor costs make technology investments critical. One company that I coach added a tuition collection program from Blackbaud which integrates directly into the general ledger. Suddenly, there are no labor costs for mailing, creating and printing invoices monthly.
- Infrastructure is larger than technology and involves decisions on how fast to add staff in Human resources, administration and accounting.
- These numbers are drawn from companies in the $3-$100 million revenue. If you are a startup under $3 million in revenue, you need to plan for a Valley of Death time where costs for infrastructure are difficult to manage.
The message is simple – companies that are thriving make investments in infrastructure. Set your own goals for infrastructure and sustainability.
Scaling Up business coaching creates a plan in 90 days, a quick win in the 2nd quarter and a 20% growth in revenue in the 2nd year. Until next Sunday, keep your eyes on technology!
If you want One Minute TurnArounds by email, please sign up!
GDPR – Your email is collected by an automated system so that the One Minute Manager posts can be sent. You will be invited twice a year to a two hour Scaling Up workshop for CEOs and EDs. Annually, you will be offered an Ebook and asked whether the resources of TurnAround Business Coaching are helpful.
A maximum of 10 companies per year develop a relationship for Business Coaching to turn around their company or scale up past a growth barrier.
If you’re out of cash, you’re not the first leader to have the experience. In 2010, the New York Metropolitan Opera ran out of cash. They were surprised. They had a balance sheet which was filled with rich things. They had a budget of $291 million.
Here they were, humiliated and humbly asking singers to take a 10% pay cut.
There is no substitute for cash. Your employees can’t be paid in dog food, bedding, free haircuts, or whatever your business produces.
Most leaders who don’t have a financial background love the profit and loss statement. It’s an unfaithful lover. Make a date with your balance sheet.
In the left-hand corner of the balance sheet, the first thing you see is Current Assets. The arrangement is that these highly liquid items are the most important because you can pay bills with them.
- Line One is Cash followed by other lines in order of how quickly they can turn into cash. Cash is good.
- Line Two is Petty Cash. It’s small. It’s hard to make payroll with Petty Cash if you pay minimum wage or more 😊
- Line Three is Temporary Investments. These are great things but risky. I invested my parents’ life savings and it was $54,000 in 2008. I cashed out when it hit $26,000. I can’t even write this without saying a prayer of forgiveness to my parents in heaven. Are you big enough to watch this daily?
- Line Four is usually Accounts Receivable. Is that money from a deadbeat government contract that plans to pay 4 months late? They won’t speed up just because you’re desperate.
- Line Five is inventory. Is this stuff that’s going to sell next week?
The balance sheet holds a truth of your company on line 1. How much cash do you have?
How did the Metropolitan Opera survive? They have some world-famous murals by Chagall and they took out a special mortgage (Chattel mortgage) to get enough money to keep payroll going. Most of us don’t have the Chagalls and Rubens hanging around the factory so don’t get excited.
What about the income statement? The problem of the income statement is that you can’t tell the difference between real cash and other things like Accounts Receivable and Depreciation. Haven’t you had times where you are running a profit and counting the pennies to make payroll? The income statement is important but it’s a dangerous tool in the hands of a non-financial leader.
The Cash tools are part of the 4 key decisions because cash shortage will put you out of business faster than any other decision you make. Cash surplus gives you time to recover from a problem in any other area of business.
Dust off your balance sheet! Then plan to build your cash with TurnAround Business Coaching.
If you want One Minute TurnArounds by email, please sign up!
GDPR – Your email is collected by an automated system so that the One Minute Manager posts can be sent. You will be invited twice a year to a two hour Scaling Up workshop for CEOs and EDs. Annually, you will be offered an Ebook and asked whether the resources of TurnAround Business Coaching are helpful.
A maximum of 10 companies per year develop a relationship for Business Coaching to turn around their company or scale up past a growth barrier.
I live in a mixed income neighborhood. I was delighted when a new restaurant opened with a lounge style, creative tapas, and space for mingling. The staff were well dressed and professional. There was a waiter for every 3 tables! No more Joe the Bartender nights. It was worth twice the price 🙂 What a shock when Volcano suddenly closed its doors. I’m still in mourning,
BUT Business success balances quality against cost.
We all want to hire a lot of Grade A staff. Let’s assume that you own a restaurant. In this example, you hire only specialty chefs – pastry chef, sous chef, saute chef, fish chef, glacier, etc. Add professional waiters with 5 years previous experience. Just to be perfect, add a maître d’ to die for.
Would you get the Zagat Award?
No. In my neighborhood your restaurant will be bankrupt after 3 months. You cannot afford a staff team where everyone is a superstar and there’s too many staff anyway. You need a mix of employees at different levels and just the minimum number of staff.
Success in business requires a few Grade A staff, a few Grade B staff who are teachable, and constant firing of Grade B staff who won’t learn and also quickly fire Grade C staff who actually hurt your business.
A great business uses a Salary Cap. The Salary Cap is simply the total amount of money that you can spend on payroll. You can split the Salary Cap any way that you want. If the Salary Cap is $1 million, you can hire 10 people at $100,000 each or 20 people at $50,000 each.
The Salary Cap is easy to find. Start with your total revenue and subtract Fixed Costs (lease, taxes, mortgage, depreciation, interest, and insurance.) Now subtract all supplies and inventory purchases. If you own the business, subtract your return on investment.
The remainder is your Salary Cap. You can hire as many people as you want as long as the total salary is under the Cap. See how it works in this example.
Example:
Revenue: $5 million
Minus Fixed Costs: $1 million
Minus Inventory and Supplies: $1.5 million
Salary Cap = $2.5 million
Won’t people pay more for quality? Why not hire all the chefs in the first example and simply raise the price of every meal by $10. Your revenue goes up and so does the Salary Cap.
It depends on your market. If your business is in a high poverty area, people may enjoy very competent waiters at the restaurant and great food, but they will still eat at McDonalds. Your recipe for success may be to hire some Grade B- people and hire one good trainer and one good supervisor who can fire people regularly. The combination will give you enough Grade A staff to be a success.
I’ve always hated cooking. It takes so long and not easy either. You have to experiment with the recipe. Of course, people who like to cook get better and better at it. You have the same challenge with your company. The only way to get good at it is to experiment to find the right mix of staff. No one likes to fire people or move them around. It’s hard to find new people and train them. What a headache! Just like using recipes 🙂
Have patience. Keep practicing until you have the perfect recipe. Bon Appetit.
If you want One Minute TurnArounds by email, please sign up!
GDPR – Your email is collected by an automated system so that the One Minute Manager posts can be sent. You will be invited twice a year to a two hour Scaling Up workshop for CEOs and EDs. Annually, you will be offered an Ebook and asked whether the resources of TurnAround Business Coaching are helpful.
A maximum of 10 companies per year develop a relationship for Business Coaching to turn around their company or scale up past a growth barrier.
Summary:
Kindheartedness can kill your business in less than 15 years if you are paying for staff or salaries that you don’t need.
Compensation is your biggest cost
If your company is a nonprofit or service company, the biggest budget line is compensation. You only have one thing to offer the public – the actual service of your staff. For example, the cost of owning a barbershop is not the chair and the razor – it’s the barber.
You create savings or leverage for more results only on your biggest line item in the budget. That line is your biggest expense so that is where the profit or loss really happens. Your line item to watch is compensation. In the case of the barber, saving 30% on the cost of razors is very nice but doesn’t really change the bottom line. The cost of razors is a small cost compared to the cost of barbers.
A common way that labor can be changed is buying technology so that a manual task can be automated. We used to have a time clock and cards which were manually input into payroll with cards and work papers stored. We bought hand scanners which directly enter the online payroll program. We require direct deposit so there are no checks to distribute. We changed the pay date to twice a month instead of biweekly and went from 26 payrolls per year to 24 payrolls. The result is a reduction of 18 hours of labor per month.
Technology is only one way to leverage labor. Use your imagination!
Reasons Not to Change Labor Costs
It would seem logical to reduce positions, hours, or compensation when needed except that:
- You’re a nice person and hate to cut hours even when staff have nothing to do
- The staff member is 55 years old and you’re afraid she can’t get another job
- You’re concerned about age or other discrimination
- The staff member scares you and you’re worried that he will damage the company online after the termination
- You have two sisters working in the same company so you will end up with two headaches while changing one job.
Since these are all real feelings, let’s look at each one –
- Starting with two sisters – never hire related persons in the same department. Move one of them as soon as possible into a different department so that each can be supervised on their own merits. If the company is small, it can be very difficult without losing both of them.
- The staff member scares you – I remember one staff member who scared other staff. When I fired him, I felt like a lion tamer facing an unusually hungry beast. He left the firing room to accuse other staff of hating him and sent notes to customers about my untrustworthy behavior. My only mistake – you need to escort the person off the property as soon as you finish telling them the news. Ignore the threats
- Discrimination – you must follow labor law scrupulously. Consult your attorney. The money you spend on the attorney can be paid with the dollars you save from making the change. Document all your actions and employee responses.
- Age – There are now more and more people working later in life in all companies. That is wonderful as long as they add value. You can protect the company and protect them with an immediate policy that they have to invest in their skills development every year to keep the position. In my first job, the company had a policy of requiring progress towards a Master’s Degree within 3 years of hiring or the 3rd year would be the terminal year. They wanted the freedom to change the work force as needed without damaging employees. What a graceful way to handle staff relations! I’ve always followed it.
- The biggest problem in making change is your own feelings as a manager. It’s an awful feeling and responsibility to disrupt someone else’s life. And it’s part of the responsibility that comes with your compensation.
Conclusion
Our economy is changing rapidly. “The average lifespan of a company listed in the S&P 500 index of leading US companies has decreased by more than 50 years in the last century, from 67 years in the 1920s to just 15 years today, according to Professor Richard Foster from Yale University.” (BBC News). I can’t predict how your agency will manage external threats and opportunities. What I can say is that labor costs in a service organization are your major challenge. If you don’t manage those costs, your chance of survival is bleak. Good luck!
If you want One Minute TurnArounds by email, please sign up!
GDPR – Your email is collected by an automated system so that the One Minute Manager posts can be sent. You will be invited twice a year to a two hour Scaling Up workshop for CEOs and EDs. Annually, you will be offered an Ebook and asked whether the resources of TurnAround Business Coaching are helpful.
A maximum of 10 companies per year develop a relationship for Business Coaching to turn around their company or scale up past a growth barrier.