Cash management is of vital importance for all organizations, but it’s especially important in the nonprofit sector. To ensure they can continue to fulfill their mission, nonprofits must embrace comprehensive cash management policies.
Many nonprofit organizations have a diverse revenue base, drawing income from donors, patrons, and unrelated business activities. At the same time, nonprofits have significant costs: from meeting payroll obligations to paying a wide variety of vendors, artists, and performers. Correctly accounting for all of these revenues and expenses is important to organizations’ long-term financial stability.
Effective cash management policies and controls are crucial not only in ensuring day-to-day liquidity. They also enable nonprofits to build cash reserves that ensure they can plan for the long term while remaining resilient in the face of unexpected financial challenges.
In this guide, we explore the importance of cash management to nonprofit organizations and outline several best practices that nonprofits can adopt in order to strengthen their cash management policies and improve their financial position.
Effective cash management can be the difference between making payroll and not.
This is especially true for organizations with a significant element of seasonality in their revenue model. Examples of this include independent schools that collect tuition revenues at varying levels from year to year depending on payment plan options exercised by students or a botanical garden that sees increased attendance during the summer but is less well attended in the winter months.
When an organization has uneven monthly cash flows, a cash management plan can help them conserve and appropriately disburse these funds throughout the year. Only with robust budgeting and forecasting can a nonprofit ensure it retains liquidity throughout the fiscal year.
Cash management isn’t just important for day-to-day liquidity. It also ensures an organization has the capacity to make forward-looking investments that advance its mission. Take the example of an art museum: when they host a temporary exhibit, they must pay the artist two or three years in advance. Retaining the ability to make these investments helps organizations invest in the sustainability of their organization, laying the framework for programs that will attract new guests and donors.
Developing sufficient cash management policies requires a more mature financial infrastructure.
Creating the appropriate internal controls and budgetary oversight measures is an important first step, but as we explain below, there are other steps that financial leaders in nonprofit organizations can take to further strengthen their organization’s cash management policies.
Perhaps the most important element of cash management is ensuring that your organization follows a routine monthly accounting cycle. It’s important to actively track accounts receivable and payable and regularly review your organization’s cash position against its monthly forecasts.
Prepare a monthly financial package that tells a true story of what has occurred each month. A Quickbooks report is a good starting point, but it’s important to work with an experienced nonprofit accounting firm to build a more advanced model that projects the future financial trajectory of your organization.
Many nonprofits have a relatively complex accounting environment. They may have large buckets of restricted funds that can only be used for purposes expressly permitted by donors. By leveraging accounting technology, it’s simple for nonprofits to create a clear delineation between these funds and their cash reserves, ensuring leaders never have to dip into restricted funds to meet the organization’s financial obligations.
Automated payables models are also becoming increasingly popular among nonprofit organizations. These software programs help nonprofit leaders understand when to pay vendor invoices for optimal cash flow, ensuring predictable cash flow and healthy vendor relationships.
The pandemic was a major shock for many nonprofit organizations. Those without significant cash reserves found themselves in deep trouble, whereas those with sufficient retained liquidity were in a better position to ride out the mandated closures and subsequent months and years it took to attract visitors, audiences, and donations.
One of the required disclosures of a financial statement audit for nonprofits is the liquidity of the nonprofit. In general, nonprofit organizations should look to hold a liquidity account of six to twelve months of expenses. This can be built up gradually over time, and it is generally considered an indicator of good financial health if a nonprofit can increase its liquidity account over time.
Nonprofit leaders should also work closely with their banking partners to optimize their organization’s financial performance. Many banks have programs that support better cash management in nonprofit organizations.
One example of this is sweep accounts, which are becoming increasingly popular as interest rates have risen. At the end of each business day, the cash held in an organization’s operating account is swept into an interest-bearing account. Overnight, these funds generate interest, and before the beginning of the next business day, they’re returned to the operating account. These types of opportunities bring in a small but welcome amount of additional income for nonprofits.
If an organization has a budget surplus at the end of each financial period, these funds should be invested into an endowment that earns income earmarked for future operations.
As nonprofit organizations continue to recover from the pandemic and replenish their cash reserves, it’s important for organizations to take steps to protect themselves against other unforeseen operational challenges that may occur. Investing any budget surplus helps organizations achieve this goal, essentially building a ‘rainy day fund’ that will be invaluable in times of need.
Building the mature cash management policies required to ensure nonprofits retain sufficient liquidity is an important task that demands experienced leadership. At Smith + Howard, our team of nonprofit accounting professionals has significant experience working with leading nonprofit organizations across the nation.
Our team’s breadth of experience ensures we understand what best practices look like and know the common errors to avoid. We support many nonprofit organizations in building budgeting models, providing an objective view that gives nonprofits clarity over their best path forward.
To learn more about Smith + Howard’s accounting support for nonprofit organizations, contact an advisor today.
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