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Wednesday, May 6, 2009

CONTINGENCY PLANNING FOR NONPROFITS:
THE POWER OF "WHAT IF . . ." THINKING

Much has already been written in the national and local media about the impact of the recession on nonprofit organizations' financial health and bears no repeating here. What this brief article does present is a quick guide for implementing contingency planning in your nonprofit organization as a high-impact response to these difficult economic times.

First of all, what are we talking about when we say "contingency planning"? Contingency planning is a planning strategy that deals with uncertainty by identifying specific responses to possible future conditions in advance of those conditions taking place. Sometimes referred to as "back-up" or "what if" plans, contingency plans are pre-planned tactical responses ready to address short-term issues.¹ Applied to financial management, contingency plans are essentially back-up budgets to employ once financial conditions indicate that the current budget is no longer realistic.

Contingency planning simply takes the organization's normal budgeting process several steps further. In the traditional budget management process, quite adequate for "normal" economic times, nonprofits create and approve a budgeted spending plan, monitor the budget throughout the year and make incremental adjustments to keep spending and revenues within the plan. In the normal operating environment, nonprofit managers face less drastic funding shortfalls and can make incremental decisions quickly and responsibly as issues emerge to bring the budget back into line.

However, the current economic reality with its greater uncertainty and potentially devastating funding shortfalls, presents a much greater challenge for nonprofit managers and boards. Rather than make decisions “on the fly” that could damage the long-term viability of the organization, contingency planning allows nonprofit leaders to anticipate financial trouble and thoughtfully plan ahead of a critical point.

Contingency planning, therefore, gives management and board members more time to anticipate shortfalls and make rational, strategic decisions about what budget cuts need to be made in which circumstances to stay true to the organization's mission. Simply put, contingency planning allows the leaders to envision what the organization would look like smaller, now. Contingency planning is valuable strategically by forcing the nonprofit's leaders to identify the core programs that are essential to achieving the mission. The process also presents an opportunity to reinvent how the organization goes about meeting its mission, whether through adding or cutting programs or services, pursuing mergers and/or alliances or changes to the underlying funding model.

The following step-by-step guide will enable your nonprofit organization to design and implement contingency planning.

• Management Kicks Off the Process. First, the Executive Director should get approval from the Board of Directors on pursuing a contingency planning process and the approval of a contingency project plan, including a timeline, resources and responsibilities. At this stage, the Executive Director should also form a management team comprised of the Chief Financial Officer, one or more members of the Board's Finance committee and other representatives of key functions of the organization, such as Development and one or more Program Managers.

 

• Gauge the Size of the Potential Financial Hole. The second step is to create alternate financial scenarios for the upcoming year. While organizations could create multiple alternate scenarios such as "best case", "middle of the road" and "worst case," for our purposes, we'll simplify the process to create only one alternate scenario. The organization's approved (or draft) operating budget should be used as the baseline for the organization's financial reality over the course of the next fiscal period. For each financial scenario, start by reviewing revenue sources and attach a probability of success to each. Then multiply the amount of the revenue source by the probability of receiving that amount of revenue to arrive at an adjusted revenue figure. For instance, there may be a grant application for $100,000 pending with a foundation with a 50% estimated likelihood of success. The budget figure to use for this scenario would therefore be $50,000. Continue this process through the remaining revenue sources, such as individual and corporate contributions, government grants and contracts, membership or earned revenues and foundation support. Total the adjusted revenue figures to create the revenue side of the financial scenario. The estimated likelihood of success should come from the Chief Financial Officer, development staff, Executive Director, Board members and other management staff based on internal knowledge of the organization's history and past success as well as larger economic trends. If you have an endowment, discuss its prospects with your financial advisor to help inform your estimate of future funding availability. Contact your foundation and/or governmental contacts and discuss the future outlook of your funding; also discuss how they would react to some of your cost-saving ideas; this will help to determine which steps to consider and which to disregard. This is an appropriate time to enter into discussions with your Board to address the organization's philosophy on spending reserves and/or increasing the spending level from the endowment. The organization should also have a clear budgetary goal in mind, whether that is operating at a breakeven point, at a surplus, or at a pre-determined deficit level in the short term, funded by reserves.

 

• How Can We Fill the Hole? In this step, the organization answers the question, "What are our options and how much financial benefit would each action yield?" Each action needs to be financially quantified (i.e. a cut to pensions will yield $15,000 benefit to the organization, etc.). Options should also be considered in terms of when savings will take place. Some actions create immediate financial benefit, while others may take longer to implement, such as shutting down a program, and create delayed financial benefit. While ideas for new revenue sources to address funding shortfalls can be useful, and should be pursued, this step is really about considering what you would do if none of those plans materialize and cuts need to be made. Don't allow unrealistic revenue-generating ideas divert focus from making a plan that can accommodate the worst-case scenario. Also, be aware of restricted funds when identifying savings options; many activities in the budget may be funded through designated or restricted funding and a cut to those activities would involve a cut to revenue as well. The sum of the cuts identified in this step should equal or exceed the sum of the revenue from the alternative budget scenario above.

 

• What Are the Implications of those Decisions? This step involves careful consideration of the implications of the options identified above, beyond the financial. Specifically, you should evaluate your options based on their impact to personnel, management structure, programs and most importantly, your clients. At this stage, actions should be prioritized so that they can be quickly and coherently implemented if and when circumstances dictate. To prioritize, answer the question, "Which are the first cuts the organization will make if it becomes clear that changes are necessary?" This is also the appropriate time to convene discussions to gain clarity on the Board of Directors' philosophy on making cuts to number of personnel, salaries, pensions and health care benefits, among others. In considering the implications of various cost saving options, pay close attention to the number of people served by each program and the unit cost of people served, if possible. To evaluate entire programs and determine which to keep or drop, the MacMillan Matrix is an excellent resource. The Institute for Conservation Leadership has made the tool available on its website here: http://www.icl.org/sites/default/files/MacMillan%20Matrix.pdf.

 

• When Do We Take Action? The fifth step is to determine the "trigger points" that will spur the organization into making the cuts, in order of priority, identified above. The organization should create a month–by–month calendar which includes the details and dates of the highly uncertain revenue streams, such as pending grants or major fundraising events or campaigns. Based upon that calendar, the organization should set specific trigger points where action must be taken if revenues are below a certain projected level. For instance, an organization with $250,000 in grant applications pending decisions in September may set a trigger that if at least $175,000 has not materialized through those grants, cuts of $75,000 need to be made immediately. In our example, the organization may want to set a board meeting for early October, once the grant decisions have been made, to review financial performance to date.

 

• Approve the Plan. The alternative (or contingency) budget, along with the trigger points, should be presented to and approved by the Board of Directors.

Dewey & Kaye can help your organization through this process. Give me a call if you would like to discuss. I can be reached at 412-434-1335 or ssheridan@deweykaye.com.

Shawn Sheridan specializes in nonprofit budget analysis and strategic business planning.

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¹ Decision Making in Economic Uncertainty: Contingency Planning for Nonprofits. Presentation by Executive Service Corps of New England. January 2009.