Assessing Your Economic Logic
Handout 2
A comprehensive financial assessment should look at the following1:
1. Surpluses
2. Reliability of Revenue
3. Costs and Cost Allocation
4. Structure of Assets
5. Liabilities
6. Liquidity and Reserves
For each, identify areas where the organization has performed well and areas where it has
struggled or might be at some financial risk. Think about how each of the strengths and challenges
you identify will impact how you go about launching your new venture or how each might impact
your chances for success. What could you do going forward to lessen your financial risk?
Specific questions to ask:
Where are we strong?
Where are we struggling? Where might we be at risk?
How will we acknowledge, leverage, and/or address these strengths
and risk factors in the business planning process?
1
Detailed descriptions may be found on the following page.
Using a Business Model as a Framework:
ORHP’s 2013 Network Development Program Meeting
Handout 2: Assessing Your Economic Logic
La Piana Consulting © 2013
Assessing Your Economic Logic
Handout 2
Areas of Potential Financial Risk
1. Surpluses
Generating consistent year-over-year operating surpluses is a key indicator of financial strength.
Since nonprofits do not have shareholders to whom “profits” are distributed, any surplus that is
generated will need to be reinvested in the organization to support its mission or held to promote
sustainability by strengthening its cash position. Whether surpluses are used (e.g., for program
expansion) or set aside (e.g., for a building reserve, opportunity fund, rainy-day fund, etc.) is a
strategic decision that the organization’s leadership must clearly understand. Consistent deficits
are often an indicator of structural deficiencies (deficiencies that will continue to exist even when
things are otherwise going well) with the current business model.
2. Reliability of Revenue
Reliability of significant revenue sources is critical and correlates with the sustainability of the
economic model. It is important in any financial assessment to arrive at a shared understanding of
which sources are reliable and which are uncertain in the short and long term.
3. Costs and Cost Allocation
Identifying direct program costs and using a well-defined and consistent methodology to allocate
shared costs ensures that the fully loaded costs of programs are identified and funded. If this isn’t
something your organization has done to date, now would be a good time to start. Failure to fully
understand, appropriately apportion, and secure funds to cover shared costs is a major reason for
nonprofit financial failure.
4. Structure of Assets
Organizations can be categorized into those that are facility intensive—requiring specialized and
therefore expensive space in which to deliver their services (theaters, hospitals, schools, and the
like)—and those that are not. For the former, there are often significant costs associated with
facility management (e.g., fixed-asset replacement, upgrades, debt service, facility reserves) to
consider when assessing financial risk. Facility-intensive organizations are also at risk of seeing
the value of their properties drop due to factors outside of their control, such as a downturn in the
real estate market. Organizations that are not facility intensive need to carefully examine the
assets they do have (e.g., receivables, cash reserves, an endowment) and consider how future
plans and goals may change or put stress on the current structure of the balance sheet. It is also
important to assess whether your assets are structured to support your organization over time. For
example, is your building a revenue-generating asset, and/or is it central to service delivery?
Using a Business Model as a Framework:
ORHP’s 2013 Network Development Program Meeting
Handout 2: Assessing Your Economic Logic
La Piana Consulting © 2013
Assessing Your Economic Logic
Handout 2
5. Liabilities
Debt is not necessarily a four-letter word. A line of credit, for example, is an appropriate tool for
managing cash flow challenges. A mortgage makes sense if a building is core to the business
model or if ownership costs are less than the cost of a lease. It is essential to assess whether an
organization’s debt has been used for the right reasons (e.g., for the acquisition of an asset such
as a building or for short-term cash flow management) vs. the wrong reasons (e.g., to plug
recurring operating deficits) and is manageable from a budgetary standpoint. It is also important to
examine the rates and terms of any debt, especially in the new environment of more-stringent bank
covenants, and carefully consider the downside or risk of over-leveraging. A nonprofit that has
increasing payables and/or debt as a result of repeated deficits should flag this as a risk. High
payroll tax liabilities caused by delay in payment of these taxes should be considered a risk
because it may indicate the organization has used the taxes withheld from employees for
operations. (Don’t underestimate the seriousness of this particular red flag. The IRS doesn’t take
this lightly and will collect—if not from your organization, then directly from board members,
insurance notwithstanding.)
6. Liquidity and Reserves
It is critical to have sufficient cash on hand to manage cash flow. It is also important to hold
reserves sufficient to address fixed-asset upgrades or replacements and manage other external
risk factors, including the risks associated with a new venture or a financial downturn. In fact, one
specific measure of liquidity, unrestricted liquid net assets, is sometimes referred to as an
organization’s risk reserve. Auditors’ reports often call this out. It can also be computed using data
from your balance sheet: take your unrestricted net assets and subtract out buildings, land, and
other property, net of accumulated depreciation, and any related debt.
Using a Business Model as a Framework:
ORHP’s 2013 Network Development Program Meeting
Handout 2: Assessing Your Economic Logic
La Piana Consulting © 2013