Avoiding self-made financial disasters

A three-year old human services nonprofit was dealing with serious discord between board members and the executive director. The board felt that overhead costs at 20% of revenue were too high and that the perceived imbalance was taking too much money away from programs. The ED countered that the reduced effectiveness was due to not having enough qualified staff. The board issued an ultimatum. Reduce staff costs by 20%, or the ED would be replaced.

The ED responded by cutting hours, wages and benefits, whereupon 4 of 14 staff members quit. Citing failure to deliver client services, the board fired the ED anyway. The ED then filed a wrongful termination lawsuit, since the board mandate to reduce costs by 20% was achieved due to having fewer employees, and having fewer employees impacted client services. The ED eventually won the case.

On the face of it, this seems like a classic case of a power struggle between the board and the executive director, with the staff and clients caught in the middle.

Upon further examination, the actual cause of the imbalance between overhead and program budgets proves to be more complicated.

The board had previously voted to expand a program by 50%, as outlined in the five-year plan. They mandated that the counseling center be open two more hours daily, and four hours on Saturday. This increased payroll and other overhead costs such as utilities and office supplies by about 12%. In addition, a change in state regulations required that there had to be an upper-level professional physically on duty whenever the client services center was open. Heretofore, the master's level staff only had to be available on call during evening and weekend hours. Shortly after the expanded program started, state and county funding for the program was abruptly scaled back by 15% due to decreased tax revenue.

The immediate problem was that the board failed to re-assess the challenges to the program and when the problems became obvious, they responded by trying to cover funding shortfalls by cost reduction alone. In the long term, their desire to hold administrative and other overhead costs at 10% of revenues was simply unrealistic, given their need for highly qualified professional staff.

The problem seems very simple. In their zeal to help more people, the fundraising part of the equation had been overlooked. Instead of diversifying and expanding sources of non-governmental funding, the nonprofit was relying solely on  government fee-for-service revenue to pay for the expansion.

The real problem was a failure by the board to adequately develop contingency planning and funding. As many organizations often do, they neglected the unpleasant parts of strategic planning. They developed the strengths and opportunities section well, but failed to acknowledge the threats and weaknesses portions, taking the rose-colored glasses approach.

You cannot plan adequately without considering worst-case scenarios. This organization was relying solely on one source of funding and that source had historically been very sensitive to outside influences, in this case a substantial drop in state tax revenues coupled with increased regulatory costs. In addition the board was highly resistant to developing an emergency fund. All revenue had to be spent on the mission annually, and even the idea of having excess funds (called profit outside of the nonprofit sector) at the end of the year was abhorrent to the board.

The board had made half-hearted attempts at fundraising, but felt that it was unnecessary due to their fee-for-service model. Donor development or grant research wasn't even mentioned in their financial plan.

The obvious answer was to postpone the planned expansion and start developing a more diversified funding stream. The NPO's mission was still being fulfilled in regard to their existing client base, and a 15% fee-based income reduction was realistic to try to cover with income from fundraisers and grants.

Instead, this nonprofit came very close to shutting down. Client services had to be curtailed by a full 75%. The staff eventually settled at just four paid professionals. In press releases, the nonprofit blamed the recession and the resulting loss in government funding. In reality, the reason was poor planning.

Bad things do happen to good people and organizations. Some things truly are beyond one's immediate control. Recognizing and planning for that can make the difference between success and failure.