While standard nonprofit financial reports – the budget, income statement, and balance sheet – provide important management information, these reports alone do not tell whether there is enough cash on hand to pay for an unexpected heating repair, to take on a new program opportunity, or even to cover payroll next month. For this, effective cash flow management is essential.
What is Cash Flow?
Cash flow is simply the mix—and timing—of cash receipts into and cash payments out of an organization’s accounts. It is where the numbers on budget spreadsheets and financial reports translate into the reality of money changing hands. It is a very specific lens on the reality of a business — one that considers not just what an organization’s revenues and expenses look like, but when they come and go.
Managing cash flow, therefore, is primarily a question of when—when we pay our staff, when this bill is due, when the grant payment will come in.
Cash flow is often a problem for both nonprofits and for-profits, but unlike a for-profit, a nonprofit can’t offer discounts to increase sales. For seven consecutive years, Nonprofit Finance Fund’s State of the Sector report revealed that less than 25% percent of those nonprofits responding had more than 6 months of cash in reserve. In fact, most of the nonprofits responding reported that they had less than three months of operating reserves on hand. And close to 10% had less than thirty days of cash on hand.
Common Causes of Cash Flow Problems
Every organization has ups and downs in cash flow because the timing of when money is received often doesn’t match when payments are due. Cash flow shortages can be caused by:
- Timing of donations and grants
- Reimbursement-based contracts
- Timing of disbursement, such as advance payments
- Changes in revenue sources or payment schedules
- Operating with a deficit (expenses exceed revenue)
- Unexpected or unplanned events
The cost of these shortages can be very high, including:
- Late fees, penalties, and finance charges
- Damaged relationships with vendors and contractors
- Lost opportunities for new mission-building activities
- Time spent worrying about and trying to resolve cash flow problems after they occur.
Managing cash flow is not a one-time activity and is essential to:
- Avoid problems and shortages
- Provide stability for an organization
- Take advantage of opportunities to purchase capital assets and build capacity
Projections should be updated and reviewed regularly with the frequency being dependent on how closely the organization’s cash flow needs to be monitored.
How to Manage Cash Flow
The first step in improving your cash flow is to develop and maintain cash flow projections that look forward 12 months. Of course, as with all financial reports, the usefulness of cash flow projections is based on the accuracy of the information used.
When developing projections:
- Start with an accurate cash balance
- Base projections on realistic budget assumptions
- Budget a surplus – budgeting a surplus will protect you from a bad revenue or cost projection
- Reflect the expected timing of receipts and payments, don’t just divide by 12 – look at historical data to see when income has been received in the past and analyze if sources are likely to adhere to the similar schedule in the future
- Take a team approach – while one person or department (finance) will oversee the central cash flow projection tool, effectively planning and managing cash requires input across an organization
- Pay particular attention to when you expect to receive grants and use conservative assumptions for unidentified grant funds
- Be careful about including grants that are restricted for use in a future time period
- Note any lumpsum payments, such as payments for insurance, printing, payroll taxes, etc. Again, look at past years to see if there is a pattern of expenses that is likely to continue and should be used in your projections
Once you have a cash flow projection, you will be able to:
- Plan the use of cash
- Prepare to avoid problems
- Respond to changes and adjust plans and stuff and things
How to Avoid Cash Flow Problems
- Develop realistic, well-considered budgets each year
- Build internal cash reserves over time
- Be aware of cash flow and budget assumptions and react to changes
- Maintain good relationships with vendors, contractors, and bankers
Being informed, strategic, and collaborative in cash flow management can help to ensure that a nonprofit’s long-term strategy isn’t derailed by avoidable — if inevitable — short-term obstacles. If you have any question about optimizing your organization’s cash flow, please reach out to an experienced RINA professional.