Risk Management Archives - Page 3 of 3 - TurnAround Social Sector Coaching

Introduction
Unlike banks, large nonprofits are failing. And they seem to do it in a sudden dramatic way. The Community Services Society investigated the collapse (November, 2014) of FEGS (Federated Employment and Guidance Service), a large non profit in New York City with revenues of $250 million. (1)

Their report reminds us that government doesn’t  pay in a timely way and doesn’t pay enough anyway.

The report fails to emphasize that nonprofits can choose a business model that understands government contracts and creates surpluses while accepting them.

 

Betrayed
Important points of the study that blame government and foundations:

  1. Companies above $10 million in revenue are more apt to fail because of unfunded audits and regulations and paying interest on lines of credit while waiting for contract money.
  2. Government contracts are often created without input from actual providers. Some results are comical and tragic.
  3. Underfunding of 80 cents on the dollar is the primary cause of nonprofit failure when funded largely by contracts
  4. Governments and donors resist paying for repairs, technology upgrades, and administration.
  5. A large nonprofit may endure up to 250 government audits per year
  6. Half of all NYC nonprofits are in the red with no reserves
  7. A typical DYCD provider has overhead costs of 18.84% while funded for 10%
  8. NY State Education Department allows 2.6% overhead
  9. Unfunded mandates abound include paying staff during abuse investigations that have a founded complaint ratio of 2.7%

 

Bemused
But it’s important to see what is missed in the report —

  1. The report does not consider fraud. FEGS has unexplained payments to executives which have attracted the federal district attorney. FEGS also (2) (3)
    1. created a captive forprofit,
    2. outsourced functions such as accounting to the forprofit,
    3. allowed a private director to be on the board of the forprofit,
    4. and watched as he sold his own company to the captive forprofit

This all could be explainable, but complex stories with murky motives attract district attorneys. Many larger nonprofits seem to have complex fiscal structures that they may not understand.

  1. The golden age where you only open your doors and provide the program is gone. Contracts are now like fishing licenses. You choose the line, stream, and lure and hope that you’re good enough and strong enough. Non profits are just like forprofits with different purposes. Nonprofits have to compete, plan, prepare for problems. The report includes the example of a city grant that won’t pay for capital repairs because the agency owns their own building. This is clearly a case where a captive forprofit that owned the building and leased it to the nonprofit would be the preferred strategy. Charter schools understand this but most nonprofits do not.
  2. There are 4 sources of funding (contracts, gifts, blended forprofit, and fee for service). Nonprofits are doomed to fail with a contract funded model. It is painfully difficult to master more than one source. Nonprofits without planned financing simply cannot overcome government.
  3. Nonprofits need to be strong in mission and strategic planning. The contract model lulls organizations into completing the requirements of the contract and nothing more.

 

Conclusion

A lot of nonprofit failure lies just ahead. Nonprofits can either be victims or choose to make their own destiny with good strategic plans, willingness to compete, and predictive accounting that understands and outwits their biggest deadbeat customer.

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Notes

  1. http://www.capitalnewyork.com/sites/default/files/Nonprofits%20in%20the%20Aftermath%20of%20FEGS%202016.pdf
  2. http://forward.com/news/322260/fegs-faces-federal-criminal-probe-over-fiscal-collapse/
  3. https://nonprofitquarterly.org/2015/10/02/social-enterprise-swallows-big-agency-whole-more-about-fegs/

I’m worried about Non Profits going out of business – some with a bang, but more with the comforts of hospice.

My agency has a grant that joins us to 6 other agencies plus two others in the neighborhood. In preparation for the meetings, I read the 990’s of all involved. Hold on to your seat.

  • The range of agencies’ revenue was $1 million – $54 million
  • 1/3 actually made a surplus last year, 2/3 had a loss
  • The two largest agencies had more debt than assets. While accounting can lowball the market asset value of a building, this report is still really bad. I wouldn’t work for this company! It turns out that we don’t have to  🙂  They just laid off 80 staff to try to turn things around. Too little, too late.
  • The 2nd largest agency in the study at $31 million has similar troubles except that they are cutting administration instead of program. They’re down to 9% for administration. Good luck with that strategy for 5 years.
  • Two other agencies (revenues of $5 and $7 million) have complicated balance sheets that show complex fiscal structures or — corruption. How can you have a revenue of $7 million, yet invest $9 million in a limited partnership with the founder and ex director still on the board? I was going to copy their fiscal complexity in our agency but, — oh, they are both still in deficit!! So much for financial deals that we mortals can’t understand.
  • 4 agencies have Receivables at the end of the year of 11%, 14%, 17%, and 18%. How can they stay alive with that much government money that hasn’t paid?
  • Of the three agencies that made money, one has the smallest budget and volunteers.

What is going on?

  • It’s a small sample. Maybe I accidentally found all the nonprofit problems?

My guess is that many agencies don’t spend time thinking about where they are going and how they will get there. Long term viability for nonprofits requires a good strategic plan, including a section on what the agency will not do. Too many strategic plans are magical thinking.

Historic, long-lived agencies have a special problem. They need to ruthlessly cut programs that no longer serve the mission well. It means cutting off some well loved staff who have added a lot of value in years past. Most of the agencies in this small study are not new nonprofits.

Also, someone with predictive accounting ability (management accounting) needs to make a financing plan to pay for what has been planned. Cash is gas for the strategic plan. Out of gas – out of plan.

Finally, make sure your fraud policies are in place. As soon as you say $1 million, you’ll attract new friends and they won’t all be donors J

I’d be interested in the experience at your nonprofit (anonymously if necessary).

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Budgets are planning documents. It’s always good to have a plan – but it’s even better to add risk protection in your plan.  If your company has at least a modest surplus, it’s time for risk management.

How to Reduce Risk in Your Budget

  1. Calculate your bad debt from last year. Bad debt is fees not paid for service, pledges that were not paid, government contracts that had a clawback, etc. It’s money that you expected to receive in your budget, but it never arrived.
  2. Add an amount of bad debt as a new expense account in this year’s budget. It will be similar to last year’s total amount of bad debt. Charge the budget entry  each month this year in your general ledger (debit expense and credit a new contra account in the Accounts Receivable). When the Smith family doesn’t pay that $200 bill, you can use the savings from the contra account (debit the contra account and credit income) and your operating budget doesn’t change at all. Mischief managed.
  3. Sudden worker’s compensation insurance bills are very similar if your work force is growing. Add an expense account and a contra account to plan for a sudden bill.
  4. Unexpected maintenance on leased equipment charges such as extra use of copiers, overtime minutes on cell phones, etc.
  5. Unemployment claims if you use the direct reimbursement method offered to non profits in some states.

Only add these budget entries if they are large enough to be material. Adding $100 contra account for extra cell phone use is more effort than it’s worth.

These accounts take the unknowns for this year and give you one more tool to manage risk and sleep at night.

 

Side Note
Monitor the contra accounts yearly and  reduce unreasonable balances. Since they are balance sheet items, they just continue to grow if the risks don’t actually occur. Some clever directors add vacation expenses in that trip to the Caribbean by charging the contra account and hoping the Board doesn’t notice.

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Most Non Profits have little idea about the working capital to keep in the bank at all times. Nonprofit articles often recommend cash equal to 6 months of expenses. Those writers have obviously not actually worked in a smaller nonprofit. Aside from a legacy, there is little chance of putting aside half of the year’s program budget for a rainy day fund.

Many nonprofits take one of two approaches. One approach is to receive a windfall legacy or grant and keep the entire amount in a savings account to be safe. This sadly reduces the investment in mission. Imagine operating a food bank that can open a new location and get reimbursed for food. It will cost $1,000.000 to renovate the space. The Board decides not to proceed because it has $3 million available and fears drawing down its cash.

The other common approach is to put your head down, keep operating and hope that the day never comes when the unavoidable demand for cash clashes with the available bank balance.

Fortunately, there are formulas that help.

Greg Crabtree* advocates for 2 months of operations plus 10% profit of cash in bank. For example, a $12,000,000 revenue company might have $2,000,000 plus $1,200,000 ($3,200,000) in ready cash and securities.

On a daily basis that same company may only need $10,955 in constantly available cash and the rest in a money market (or line of credit).

Get out the calculator! The formula is  (2 * monthly amount needed to pay bills) / (Interest rate on line of credit/ 12).  Got that?  Now take the square root of that number.

Example: Your budget is $12 million** and your business is so regular that you need exactly 1/12 of that every month to pay bills. Line of credit is 5%

(2 * 1,000,000) / (.05 / 12) = 480,000,000.  The square root is $21,909.  The maximum to keep in the bank account is that amount and the average daily balance should only be $10,955. Save on line of credit costs or get more interest from the money market by holding only what the formula requires.

You can feed the hungry while making sure that your agency doesn’t end up needing bread.

*CRABTREE, GREG. SIMPLE NUMBERS, STRAIGHT TALK, BIG PROFITS!: 4 Keys to Unlock Your Business Potential. LIGHTNING SOURCE, 2014.

**My companies always have regular numbers to make clear examples. Don’t be surprised if you need to make some adjustments when you apply the formulas 🙂

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A new book called ‘The Challenger Customer’ points out that government and business are both much larger than in 1990. The result of this huge increase in scale is more stakeholders who review your contract or grant. The judgment of one person is replaced by the varying perspectives of a committee. Committees don’t agree internally so everyone gets more cautious with the contracts.

Each stakeholder adds an extra rule – just so that their unpleasant teammate can’t report them to the boss.  A grant that took one person 3 days to process in 1990 is reviewed now by 5 people on average, based on data in the book. And the new massive rule writing threatens to inflate the cost of ink.

I direct a non profit with 7 contracts. Let’s look at typical changes this year  —

September – new rule that you can’t file a renewal until it expires although expirations freeze contracts. Government returns 42 page application. I respond and complain.
October – Government says “my boss says the renewal is fine, send it back.”  (a week later) “Oh. I’m returning part because the person who signed before is no longer eligible.”
November – new insurance certificate is required November 1 but the insurance company won’t issue for the next policy year until it begins on the 15th. Contracts paused.
December – insurance declarations certificate is no longer acceptable.  New form required. Payments Paused.
January – new language required on the Additional insured in new insurance form and is more characters than the Insurance Company computer allows. Government response =”Not my Problem”. Director starts screaming at broker and insurance company until they shrink the type and provide a magnifying glass for government to read the text.
January again – new insurance policy is accepted, all is fine, but no money. Government replies – “we did not mean that you get the money, we have to send to Comptroller now”

I seriously wondered if there was a political vendetta against us. But no, the local Jewish Community Center has been receiving $15,000 per year. The new rule is that amounts over $5,000 require an audit. The cost of the audit? $15,000

So, apart from more whine, wine and vacation – what can we do?

If you are small or midsized, you need a Strategic Plan for growth, or a partner non profit to outsource administration, or a planned possible closure.

Growth – A study sponsored by Goldman Sachs indicated that non profits in 2005 needed to have an Operations Budget in the $8-$10 million range for long term sustainability. Growth is uncomfortable but you need the scale to afford the labor costs to handle all of the stakeholders.

Outsource – If you are small and specialized – consider an affiliation with a larger general agency who allows you program autonomy as long as you cooperate on financial and legal.

Wind Down – A community group here has stopped applying for government money and realize that they are vulnerable to closure if volunteer vision does not continue. That’s not a bad thing. If we do good in non profit work and then close – it does not ruin all the good that has been already done.

The good news is that your feeling of smothering is not paranoia or inability to handle the top job. You are being smothered!  (in addition to any other problems you have).  More good news is that you have choices. But –  the bad news  – you need to respond before the rest of us finish you off so we can have your contracts and grow 🙂

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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.

A crippling snowstorm has closed my nonprofit today.  I can rest easy. It’s difficult to be a nonprofit fraud victim when you’re closed. But that strategy is impractical for the longer term  🙂

Nonprofits attract fraud like ants to honey. Why?

  1. It happens because you have money. If your total revenue is $100, you are relatively safe from fraud. There is not much theft from lemonade stands. When you receive a grant for $10 million, people notice. Board recruiting suddenly becomes easy. You attract Freddie, whose sister Betty — owns a building perfect for renting as a school. You need a new building. Freddie uses the board position to push the lease to Betty at a high price. The nonprofit gets the school, Betty gets rich, Freddie gets a finder’s fee. It’s corrupt, and often impossible to prove.
  2. Fraud happens because nonprofits don’t pay that well. The typical profile is a female who has worked in your nonprofit for 3 years, has considerable responsibility, and doesn’t make that much (Non Profit Quarterly 12/21/2007)
  3. Fraud happens because nonprofits build a corporate atmosphere of trust. Can you imagine your local bank being as friendly as you are?
  4. Finally, Fraud happens because nonprofits are famously weak on punishment. Sam, the front desk guy that everyone loves, stole $10,000 by tampering with checks received (NPQ, Ibid). It seems a shame to add a criminal charge to such a nice guy.

As much as we trust audits, they rarely reveal fraud. True forensic audits are very expensive. Even the government prosecution of Sheldon Silver (Majority Leader NYS Assembly 1/2016), almost did not succeed with the jury.  The majority of fraud is discovered by accident.

So, how can you stand in the door and keep (some) corrupt money from flowing this week?

  1. Realize that all of us will commit fraud under the right circumstances. If my child needs a medical treatment and I see a way to steal from you, I will do it and worry about the consequences later. You will too. And you have no idea what personal crises are going on in your company personnel.
  2. Once you have announced to your managers that we will all steal under the right circumstances, implement protective policies to reduce and eliminate. As Ronald Reagan said so famously ‘Trust, but verify’
  3. Set a high ethical tone. People watch you turning in lunch receipts that are not believable, attempting every known device to get more expense money. Sheldon Silver chose longer routes in business plane flights to get more points on his personal account. Certainly his office staff and direct reports knew that a flight to Albany does not go through Washington  🙂

You don’t have the time and money to catch fraud this week, but you probably can prevent it.

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If you direct a non-profit, then expecting payments from government is likely to be a dreaded, constant feeling. Payments from government are guaranteed to be slow. Government demands quality services and expects that the non profit will float the costs until the public payment machine wheezes into action. You can’t follow up and call on every late government payment. Save your energy for the payments in danger.

How do you decide which payments are truly at risk? How can you save your time for the payments most likely to disappear?

Determine Average Payment Speed
Each agency has its own payment speed. When you have time on a snowy day, look at the last 10 payments from each agency to your bank and calculate an average payment lag after the request for reimbursement is sent. For example, you send the invoice and notice that the agency typically issues payment 23 days after receiving the invoice.  Now you have a realistic expectation of when money arrives. Ignore any collection attempts before that average payment day. You likely will not get the money, use some of your precious time, and annoy your agency contacts.

FollowUp Late Payments of Contracts in Progress
On the day after your calculated average payment day, decide if any payments for contracts in progress are missing. Also look at payments and make sure that they match the invoices that you sent. Start a planned series of followups for any money missing. If the payment is late because of office vacations or layoffs, call weekly and ask to be at the head of the processing line. Ask about the new expected payment day.  This is likely to be the only collection that is needed for money that normally arrives on time and just had an unexpected late payment.

Followup New Contracts
The greater risk is with new contracts. You may not be familiar with the contract process and mistakes are more likely to happen on all sides. Costs mount quickly as soon as services start. If the paperwork is lost or shuffling between offices, you could give an interest free loan to the government for months to come unless you keep following up. You need a daily campaign to claim what you have already earned in services provided. This is the area to place most of your collection energy.

Start the new campaign a week before services are to start. It’s not ethical for government to expect services and still not have essential legal papers prepared. Write down the names and dates of everyone to whom you speak and the topic of the call.  Keep copies of all paperwork in one place for easy reference. This has to be organized as a campaign. One or two calls are unlikely to solve the blockage.  Build relationships, memorize secretary names. In moments of non cooperation, find the name of the supervisor and look carefully at the agency website. You will be surprised at the effectiveness of persistence.

Conclusion
You have constructed an Accounts Receivable Schedule for Government. You have decided to ignore many late payments. You have set your collection dates as the day after the average payment day for existing contracts and 7 days before a new contract starts to operate. You will increase the speed of payments and use less energy.

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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.