Cash flow isn’t just an issue for small nonprofits that depend on donations to meet payroll each month. A lack of cash on hand impacts nonprofit organizations of all sizes.
Take this example…
A few years ago, we were working with a fully-funded nonprofit.
This organization’s revenue was secured by government contracts and a few key foundations. Their budget projected a surplus, and they were hitting those numbers.
Everything was looking not just good, but great.
So when they came to us, they couldn’t understand why they didn’t have the cash flow to make payroll or pay the heating bill on time.
After all, their financial reports showed they had much more revenue than expenses. They were hitting their budget numbers month after month. And their revenue sources were 100% committed.
On paper, they were a flourishing organization— a model of nonprofit success. But behind the scenes, their management team was losing sleep.
Why did reality not match up with the numbers in their financial statements? We’ll tell you exactly what happened to them here below.
And then, we’ll give you 5 simple indicators that anyone can watch to see if nonprofit cash flow is becoming an issue for your organization.
Why does nonprofit cash flow matter?
Cash is king, as they say. But why, exactly?
In an accrual accounting system, financial reports are complex documents. And not every number on your financial statements reflects cash changing hands.
For instance, you may record donations or grant revenue this year but you will not receive the cash until next year. Or you might bill a funder for services provided but have to wait 2 months to get paid.
In those cases, your revenue numbers look great on the reports, but you haven’t received the cash that those revenue numbers appear to indicate.
And that’s exactly what happened to the nonprofit we talked about above. They delivered the agreed-upon services and were entitled to payment by their funders. But they weren’t doing the necessary legwork to actually get paid.
In fact, their team was billing their funders incorrectly and their payment requests kept getting kicked back for revisions. Nobody was taking charge of the situation to get the much-needed payments approved, so money stopped flowing into their bank account.
By the end, they had blown through nearly half of their operating reserves and were quickly running out of money, despite being quite profitable on paper.
If you want to avoid a similar situation, look out for these 5 signs that you’ve got a nonprofit cash flow problem on the horizon:
1. Accounts Receivable Keeps Climbing
Accounts receivable (AR) is the red flag that should have alerted our client above— if your AR keeps increasing and your cash decreases, you know you’re earning revenue but not collecting it.
You should jump into action to see if one of these issues is causing your incoming cash to dry up:
- Failing to submit invoices to your donors and funders
- Submitting invoices but not doing it accurately or timely
- Key funders and donation sources are behind on payments, and your team isn’t following up (or isn’t letting you know)
It is easy to pinpoint if accounts receivable are becoming an issue. Simply compare your AR balance on your Statement of Financial Position to the balance from previous months. If you see a significant change from month to month, ask your financial team to investigate.
If you do this consistently, you’ll start to understand the seasonal flow of funds in your business. And that will help you identify and resolve nonprofit cash flow hiccups before they turn into major problems.
2. You’re Not Paying Your Bills
If you’re not paying your bills, it may be a sign that you don’t have the money to pay them.
So if you notice your accounts payable balance creeping up—or you’ve heard from vendors that your payment is late— it’s a big red flag you should investigate immediately.
It may be sloppy bookkeeping (which you should also address) causing the late payments. Or it could be that your cash flow balance is low and your team has to choose who to pay and who not to pay.
Regardless of the reasons, we’ve seen many nonprofits in desperate situations after tarnishing relationships with their key vendors. In today’s world of ACH transfers and credit card payments, vendors expect to be paid quickly, and the days of 30-day or 60-day remittance periods are mostly a thing of the past.
PRO TIP: AP is a big challenge for nonprofits running on a reimbursement grant funding cycle. You won’t get paid for 30 to 60 days in some cases, even if you do everything perfectly. But your vendors probably won’t be happy to wait 2 months to get paid. So we’d suggest either building a healthy operating reserve and/or opening a line of credit to help you fill that gap.
3. Operating Reserves are Drying Up
A nonprofit’s operating reserve is kind of like its savings account or rainy-day fund. It’s a reserve of cash (or highly-liquid assets) that you can use to get through periods with less cash coming in than you need to spend.
You build it the same way you create your personal savings account— by putting some money aside when cash flow is strong. If you don’t have a reserve, it tells donors that you haven’t historically been able to bring in more cash than you spend, which is a big red flag for them.
Nonprofit best practices suggest you should have 30 to 90 days worth of operating expenses on hand as a reserve. But not all of that has to be cash in your bank account. Use this formula to calculate your operating reserve, and then try to watch it each month.
The balance may decrease at times— that’s okay, it’s what it’s there for— but you should see it start to build back up once the short-term cash flow issue is resolved.
4. Decreasing Working Capital Ratio
Your Working Capital Ratio is an important indicator of whether your nonprofit has enough working capital to cover obligations. It calculates how long your organization could sustain its current programs without generating new revenue.
You can calculate you working capital ratio like this:
Working Capital Ratio = Working Capital ÷ Average Total Expenses
You primarily want to watch for changes in your working capital ratio from one period to the next. So you need to calculate it consistently (monthly, preferably) and be on the lookout for any significant increases or decreases.
5. Too Many Restricted Funds
In a nonprofit, not all “cash” is created equal.
Unrestricted cash that you can use for anything your organization needs is the most sought-after (and hardest to secure) type of funding.
Unfortunately, many nonprofits struggle to build large reserves of unrestricted funds. So it’s essential to know how much of your cash has restrictions at all times.
We’ve seen too many instances of nonprofits “robbing Peter to pay Paul” by using restricted funds to cover operations, intending to pay it back later.
And while this isn’t necessarily illegal, it is not a recommended financial practice. Because these same organizations inevitably find themselves in trouble when they fail to pay back the funds as intended.
So keep an eye on your restricted vs unrestricted assets each month to be sure that you can actually use the money you have for the things you need.
On-Time Accounting is the Key to Avoiding a Nonprofit Cash Flow Crisis
What do all five of these warning signs have in common?
You’ll never see ANY of them coming if you don’t have updated accounting information on a timely basis.
And THAT is where 9 out of 10 of nonprofits really drop the ball.
At The Charity CFO, we help 150+ nonprofits execute accurate bookkeeping and create timely financial reports while actively looking out for issues that may be looming on the horizon.
So if you want a financial partner that can give you accurate numbers and help you understand them too, look no further…
We can’t raise money for you, but we can help you see what’s happening in your business so that you can make critical informed decisions that move your organization forward.