Jeanne Tedrow, President and CEO, of North Carolina Center for Nonprofits.
Imagine a customer walking into a pizza shop to order a pizza, then only wanting to pay for the ingredients – flour, sauce, toppings, cheese. (See Pizza and a Laugh ‒ A Reminder about Your Nonprofit Financial Stress Level, Nonprofit Quarterly, December 18, 2018.)
In this scenario, the customer wants to restrict payment to cover the direct cost of ingredients without wanting to cover all the other expenses – the box, the oven, the lights, and the cooks in the kitchen. It is a humorous analogy that represents well the dilemma that happens all too often with nonprofits; funders and donors – understanding the total cost of service delivery – restrict the use of their contributions to direct program costs. This leaves the organization in a quandary and potentially a funding gap.
Restricted funds pay for direct services and programs, while unrestricted funds cover the operations that indirectly support the programs. Nonprofits must secure both restricted and unrestricted funds to effectively deliver programs and maintain efficient operations. However, organizations often seek funds to do their mission work without asking for, or receiving, the necessary unrestricted dollars to support indirect operations.
Sometimes nonprofits won’t tell funders their true costs for fear the funder will not give or continue to provide support. Some funders will only give restricted dollars, leaving the organization to find other fundraising activities to fill the gap. This may be especially true if a nonprofit receives public funds with specific guidelines to determine an acceptable indirect cost rate.
Like any thriving business (or well-managed pizza shop), it’s important to know the true costs of service and product delivery, and to be able to communicate this internally and externally.
A healthy nonprofit has an optimal balance between its restricted and unrestricted funds. Its board of directors will be aware of how much operating support is needed to effectively deliver its programs, how and for what purpose restricted funds are raised and leveraged to support operations, and when there is an imbalance. With these full costs known, the nonprofit can communicate this with confidence to its funders.
As nonprofits strive for best practices in financial management, funders and donors can also play a role to encourage healthy nonprofit management. One way is to allow or designate a portion of its projects’ grant to be used for general operations.
Supporters, board, and staff have a shared goal to support the overall health of the organization and its work in the community. An imbalance between restricted and unrestricted funding creates a false tension that distracts from the mission and weakens both program delivery and the organization itself. When in balance, the organization is better able to effectively manage finances and focus on its mission.
For more resources on financial management, check out Principles & Practices: Best Practices for North Carolina Nonprofits and Information Central.