ICYMI | Top Challenges Facing Not-For-Profit CFOs Today
In Brief
Chief financial officers of not-for-profit organizations have always faced many challenges, some common to all corporate leaders, some unique to the sector. Today’s postpandemic environment has brought some novel circumstances and transformed ongoing trends. This article focuses on the top four challenges facing NFP CFOs today: inflation, outsourcing to third-party providers, risk, and the expanding role of the CFO.
***
Chief financial officers (CFO) of not-for-profit (NFP) organizations face many challenges today, especially workforce issues. Foremost is the inability to recruit and retain employees because of extraordinarily tight budgets. A large percentage of an organization’s expenses is related to personnel, making it difficult for nonprofits to compete for talent against for-profits. Second is the role of culture within the organization. Staff equity between in-person and remote positions is a concern in the post-pandemic environment: Mission-driven positions that serve the public need to have their functions performed in person, but many of the work functions of administrative staff can be conducted remotely; this can create an unhealthy “us vs. them” work environment. A consequence of this dynamic can really be felt in organizations that haven’t been able to modernize, where paper-driven processes can impact remote work, further frustrating staff. Without investment in automation, recruitment suffers and overwhelms an already stretched workforce.
Other challenges in the hybrid work model that NFP CFOs face include the recent increase in fraud and related concerns that internal controls may no longer be effective. NFPs are also targets for costly cybersecurity attacks because it is difficult to prioritize preventive spending on protection and insurance rather than mission. The long-term limits on resources and lack of expertise often prevent these organizations from taking advantage of emerging technologies. Many other challenges specific to the nonprofit sector are present, but this article focuses on the top four challenges facing NFP CFOs in the coming year: inflation, outsourcing to third-party providers, risk, and the expanding role of the CFO.
Inflation
The definition of inflation is “a rise in prices that results in a decline in purchasing power.” Costs are increasing, but unlike the for-profit sector, NFPs cannot simply increase customer prices in response to the trends. NFPs currently face a broader impact of inflation primarily due to a sustained period when the economy was healthy, followed by a global pandemic that devalued comparable data. The cumulative effect on the workforce and supply chain has created pressure on both the top and bottom lines; to adapt, CFOs are creating multiple scenarios in a budget or proposing deficit budgets. This year’s data will look vastly different in comparison to previous years. NFPs have benefited from a period of steady growth in the stock market, low-interest rates, stable employment, and a reliable supply chain that resulted in predictable forecasting, budgeting, and planning. During the pandemic, the lack of in-person activity reduced several spending categories, including supplies, utilities, and travel expenses; in contrast, others (e.g., information technology, health equipment) increased. Although occupancy-related expenses such as utilities were lower, relief for rent and unutilized space was rare.
Mounting pressure on both revenue and expenses means CFOs must forecast. Traditionally, historical data has been reliable; however, what has happened over the past few years is much less likely to be indicative of the future than ever before. In budgeting and planning, the pertinent considerations must include a return to the office or continued remote work, interest rate assumptions, stock market performance, donor behavior, and uncertainty in government contract renewals. It has also never been more challenging to get like-minded people to agree on a set of assumptions.
In the last three fiscal years, many organizations received stimulus money in some form and saw significant variations in their traditional spending. On the revenue side, donors may be hesitant to give due to business pressures or market conditions, and many are still reluctant to attend special fundraising events. Foundation giving is directly tied to market performance; as a result, NFPs are likely to experience a reduction in such funds in 2023. For those expenses that were reduced during the height of the pandemic, some have returned at significantly higher levels.
Since the 2008/09 financial crisis, endowment returns have been higher than their spending policies for most organizations. With a good spending policy that was adhered to, some organizations will have a cushion to weather a lower return environment, unlike other organizations that spent more than usual, viewing operating reserves as a rainy day fund and the pandemic as a storm. Much like in 2008, CFOs today need to have the discipline to balance program needs with long-term planning stability.
For most nonprofits, personnel expenses usually comprise 50–90% of their annual budget. In the past few years, NFPs have faced unfunded mandates—such as increases in the minimum wage, cost of living, health insurance, equity, and parity—all of which have represented challenges to the bottom line. Meeting these challenges has been further exacerbated by turnover and vacancies, creating pressure on existing personnel to do more with less.
Inflation can impact other areas outside of revenue and expense—for example, collectability of revenue, pension liability, leases—and can have a significant negative impact on operating results. A traditional approach for nonprofits has been to utilize a line of credit for bridge financing; however, the cost of borrowing on these lines of credit has increased dramatically over a relatively short period. Substantial fluctuations in key ratios should be discussed with donors, lenders, and watchdog organizations.
CFOs are making choices today that they have not had to make in the past. Comprehending how long an organization can maintain current operating assumptions while understanding threats to mission delivery and sustainability is critical to that success. Comparable data is not as valuable as it used to be. To manage the volatility caused by inflation, various scenarios need to be created while extending time horizons. CFOs need to decide where to make tough decisions while mitigating the impact on programmatic offerings—while realizing that making no decision is often itself a decision.
Outsourcing
Another way to adapt to rising inflation and expand the effectiveness of senior leadership is to outsource. From a specific task to an entire department, outsourcing can allow the mission to be the NFP’s focus. Areas that are commonly outsourced include payroll, investment advice, tax return preparation, gift and acknowledgement processing, event planning, cloud and disaster recovery services, staff recruitment, employee benefits administration, insurance, whistleblower hotline monitoring, and retail operations. Some NFPs outsource their entire accounting, human resource, and information technology functions due to the recruitment and retention challenges noted above.
There are several advantages to outsourcing. It provides specialized skills at reasonable rates in areas like ERISA attorneys, bond counselors, actuaries, investment advisors, and special event planners. It would be inefficient and cost prohibitive to have these professionals on staff full-time and year-round. For smaller and newer organizations that lack an established infrastructure, outsourcing can provide a wide range of essential areas that require technical expertise, such as workforce compliance, Form 990 and 990-T preparation, 403(b) plan administration, charitable state solicitation registrations, donor acknowledgments, strategic plan development. Outsourcing increases access to technology, skills, and insights that may not be available or affordable. It allows an NFP to navigate through regulatory compliance, such as donor credit card processing or employment law. It may result in cost savings and improved quality. Importantly, outsourcing often gives employees additional time to focus on more mission-based areas.
Outsourcing also presents some potential challenges. Loss of control is a significant barrier, as staff are unwilling to relinquish power because they do not believe an outside organization understands their programs sufficiently to add value. Development staff may be concerned with an outside third-party interfacing with its donor base or resolving a donor-related concern. It is much harder to outsource complex customized systems; for example, because many social service organizations are required to comply with complex government billing rules, they may struggle with outsourcing their billing function. Outsourcing may result in diminished employee morale. Senior leadership needs to realize that there is a change management component to outsourcing, as staff are always mindful of job security. Other challenges include lengthy contract negotiations and a required in-depth evaluation of the third party’s internal controls. It also increases risk, as NFPs can outsource certain tasks but cannot outsource ultimate responsibility.
In any case, it is crucial to evaluate the cost and operating effectiveness of outsourcing a task or function. Due diligence is essential when selecting a third-party provider; this includes determining whether the entity has a good reputation, is financially sound, pays and treats its employees fairly, and operates in the United States or offshore. Another good practice is to develop key performance indicators to measure critical functions that are valued by the NFP. This way, the vendor can be measured effectively. This includes monitoring the vendor for sound financial practices, establishing fail safes, and creating a backup plan in case the relationship fails.
Organizations should have written policies and procedures governing the use of third-party providers, including the circumstances under which tasks and functionality should be outsourced, the selection process for an outsourcing vendor, and an assessment of whether the benefits of outsourcing outweigh the costs. The policy and procedures should also include monitoring standards; contingency plans in the event the vendor does not perform; and key elements to be included in an outsourcing contract, such as the security of information, indemnification, and dispute resolution. NFPs should review the service organization’s System and Organization Controls (SOC) report and implement the “user control” steps identified by the third-party vendor. External auditors will require evidence that the suggested user controls are being followed and request documentation demonstrating the review of the third party’s SOC report.
In the past few years, NFPs have faced unfunded mandates—such as increases in the minimum wage, cost of living, health insurance, equity, and parity—all of which have represented challenges to the bottom line.
As always, CFOs should check with peers in the nonprofit sector for recommendations and referrals of third-party vendors.
Risk
Risk is defined as the “potential for harm or loss.” To create a framework to help CFOs plan and prioritize, risk can be divided into the following categories: strategic, operational, reputational, and compliance.
Strategic risk often requires the CFO to stand alone. For most NFPs, delivering the mission has the most organizational support. Most CEOs are good at being mission driven and maintaining a long-term, big picture view, so the CFO often has support in this area. However, CFOs are also responsible for quickly identifying threats to sustainability, failing aspects of the business model, declines in funding, and macroeconomic forces that might negatively impact the organization.
Operational risk has been changing in recent years. The global COVID-19 pandemic, remote work, and cyber threats have changed workflow and information flows; as such, organizations needed to adjust. Given these economic forces, expectations must be reevaluated; CFOs must determine whether the supply chain can deliver, the workforce can sustain the required effort, and the organization can fulfill its contract performance.
Reputational risk is critical for a nonprofit to consider, because donor perceptions can quickly translate into significant lost revenue. This type of risk is harder to identify and can become theoretical, often entailing an organizations’ reaction to the opinion of a minority, or even just one donor/volunteer. Social media has increased the potential for damage as relatively minor incidents can become public quickly. It is more important than ever for NFPs to monitor organizational brand and “walk the walk.”
Compliance risk requires a great degree of judgment. NFPs must comply with myriad compliance requirements, some of which are onerous. Identifying the line between “best practice” and required compliance often entails important cost-benefit choices. The annual audit, funders, and human resources require a balance of time, effort, costs, and risk. The best CFOs can do is prioritize these items and rely on their networks, peers, vendors, and others to support their role.
There are many ways in which NFP CFOs can successfully manage the position’s continuously growing portfolio and focus on strategy and mission-related activities while fulfilling traditional financial responsibilities.
To focus time and resources on the right things, CFOs should refer to the probabilities and impacts detailed in the Exhibit, which is a tool for how CFOs can think about, manage, and prioritize organizational risk. CFOs can better determine an appropriate course of action by considering a threat or event’s potential impact and likelihood; the key components are anticipating a problem and planning accordingly. CFOs should be careful to save their energy on low-likelihood, low-impact issues so that they can ensure the support and resource allocation for high-impact, high-likelihood risks. The most difficult decisions are often in the middle ground, where time and priorities can easily be wasted.
Exhibit
Prioritizing Risk
A CFO’s network should include insurance agents, attorneys, bankers, auditors, and other professionals. The right experts in these areas can provide tremendous value as the CFO’s role expands. CFOs should also make sure policies and procedures are up to date and cover key risk areas. Many risk areas have more than financial costs; they may cost time and effort, employee turnover, and reputational loss.
Going forward, CFOs should evaluate how and why their time is utilized to address risk. They should make sure that adequate resources are allocated to the most significant issues and ensure that constantly changing assumptions are communicated; often, the role of managing risk results in unrealistic expectations. CFOs must adapt by using their networks, exercising judgment, and building consensus.
Expanding Role of the NFP CFO
Few CFOs focus solely on finance, because their scope has expanded into procurement; digitization; analytics and dashboarding; information technology; diversity, equity, inclusion, and belonging (DEIB) and environmental, social, and governance (ESG) initiatives; board engagement; and regulatory compliance. In addition, CFOs have not relinquished accountability over transactional activities, including maintaining cash flow, financial processes, reporting, collaborating with the auditors, and implementing new accounting pronouncements. CFOs are expected to drive long-term performance, whereas donors, funders, community leaders, and board members seek updates with unprecedented granularity and frequency.
The CFO’s broadened role, while challenging, can be extremely exciting for the right person. There are many ways in which NFP CFOs can successfully manage the position’s continuously growing portfolio and focus on strategy and mission-related activities while fulfilling traditional financial responsibilities. To begin, CFOs should build relationships across the C-suite, as a CFO is in the unique position to advise on all aspects of the organization. When working with the CEO, CFOs should focus on strategy; from there, the Chief Information Officer can enable data modernization, which will help the Chief Fundraising Officer communicate with donors. Focusing on recruitment and retention, the Chief People Officer can better staff the organization; with the right consensus, this collaboration can aid in public relations, effectively marketing the mission’s success.
Ultimately, the finance function needs to change along with the role of the CFO—and the finance department needs to evolve too. Putting the right people in the right jobs is crucial for improved communication, technological familiarity, and finding a balance with accounting skills. While most NFPs cannot afford to hire an entire team of data scientists, CFOs should look for candidates that are curious, embrace analytics, data driven, and are supportive of an organization’s mission.
Another perspective in staff recruitment and retention is to focus on career development and growth opportunities. To start, the CFO has to invest in their own understanding of the latest technologies, pronouncements, and the strategic nature of the organization’s future. This means inserting high-level finance into strategic conversations and moving beyond a sole focus on cost optimization. CFOs should look for ways to drive growth and innovation, they should advocate for better automation to allow the finance staff to grow and interact with other departments. Despite demands to reduce expenses, CFOs should ensure the preservation of the training budget. Exposing staff to experiences beyond their day-to-day responsibilities through job rotation and special projects is an effective way to engage staff. Placing finance people within programmatic departments helps foster staff that understand both program and finance.
Staff should also be trained up, mundane tasks automated, and the reliance on multiple spreadsheets stopped. To the extent possible, systems should be integrated into a single source of truth to prevent errors in data. Work-life balance is a fantastic way to keep staff engaged; this can be accomplished simply by learning where and when people work. It is important to remember that the return on investment in staff is not immediate, but it is ongoing. Key performance indicators are appropriate to determine that the investment in people is moving in the right direction.
It is imperative that CFOs educate staff about the organization’s strategy to carry out its mission so that all functions understand the importance of their role within the organization. This can be accomplished through multiple modes of communication, including staff town halls and presentations. Recent surveys reveal that many CFOs believe that DEIB can provide advantages in developing strong teams with complementary skill sets. CFOs should play a leading role in ensuring that DEIB is an important part of an NFP’s culture.
Going forward, financial models that allow CFOs and their finance team to be proactive rather than reactive will also be essential. Building predictive models and performing scenario analyses is key. It is not all about cutting costs; it is about selective measured spending. Linking finance and strategy in the budget process is important. It is imperative to develop key performance indicators (KPI), including KPIs that measure programmatic and fundraising effectiveness, that define success and identify areas of improvement. These models help organizations better prepare for uncertainty and add a forward-looking dimension to financial reporting. Projections improve anticipation, which increases mission effectiveness.
CFOs should focus on high-impact and high-likelihood risks and engage outside expertise to help mitigate such risks.
In partnership with the CEO, today’s strategic CFO should spend more time working with the board on strategic vision. Board meetings should devote a greater percentage of the time to discussing strategy as opposed to administrative and compliance-related items. The board’s focus should be on long-term strategy, programmatic innovation, and financial health. The CFO should also influence the composition of boards and governance structures by adding diverse board members and members with expertise in emerging areas including information technology, real property, and climate.
An Exciting Challenge
Today’s NFP CFOs face many challenges including inflation, use of third-party providers, risk, and the expanding role of the CFO, as detailed above. Inflation is impacting many aspects of organizational operations; to manage such volatility, CFOs should create multiple scenarios and adjust operating models accordingly. Many NFPs find it cost-effective and efficient to outsource tasks and functionality to third-party providers; before doing so, NFPs should perform adequate due diligence. CFOs should focus on high-impact and high-likelihood risks and engage outside expertise to help mitigate such risks. For NFP CFOs to be successful in their rapidly changing, challenging, yet exciting role, they need to build the right finance team, effectively utilize real-time decision-making data and tools, increase collaboration with their peers, and encourage the board to play a more strategic role. Following basic, yet evolving, principles can enable CFOs to be relevant and influential in maintaining their organizations’ success.
Travis Carey, CPA, is chief executive officer, Carey & Co., New York, N.Y.
Amy West, CPA, CGMA, is executive vice president and chief financial officer of AHRC NYC, New York, N.Y.