Risky Business For Nonprofits (Commentary by Keith Ekenseair)

Long-gone are the days when organizations were criticized for having excess liquid cash on hand.

We all recall when CFOs were encouraged to maintain zero balances in their checking accounts and invest excess funds utilizing “sweep” accounts that invested in overnight financial instruments. In today’s economic times, many organizations are tossing out the notion of maximizing interest income because they are struggling to have adequate cash to meet current operating needs.

This is certainly true with some nonprofit organizations. Nonprofit organizations are funded primarily through two sources, contributions and investment earnings. Both sources are impacted by today’s economy. In a downturn economy, private contributions decline as donors are less inclined to give; earnings from investments shrink along with their capital market values; and community needs increase – hitting nonprofits with a funding triple whammy.

“This is probably the most challenging environment that most fundraisers have seen in their lifetimes,” said Paulette V. Maehara, president and CEO of the Association of Fundraising Professionals, earlier this year.

Many generous donors have given significant funds to nonprofit organizations in the form of endowments. These funds may be permanently restricted, which means the nonprofit organization cannot utilize the original contributed amount for any purpose for perpetuity. However, these endowments typically allow the organization to utilize the investment earnings and fair-market value appreciation over the original donor contributed amount to meet the organization’s overall or specific program needs.

Endowment funds may also be impacted by law restriction such as the Uniform Prudent Management of Institutions Funds Act of 2006, which is a robust set of guidelines about what constitutes prudent spending and explicitly requires consideration of the duration and preservation of the endowment fund.

Given the current stock market, bond yields and certificate of deposit rates, investment earnings are fundamentally low, which means nonprofit organizations may struggle to have sufficient resources to meet their increasing program needs. Some are cutting back on program services and operating expenses, while others may be using their reserved funds.

The current situation brings to light the fundamental risk that some nonprofits, corporations and individuals have historically taken for granted – investment risk. There are three basic types of risk associated with investments: credit risk, interest rate risk and foreign currency risk.

Credit risk is the risk an entity holding an organization’s funds will not be able to fulfill its obligation.  If applicable, the risk may extend to the insurer or other responsible party. Interest rate risk results when changes in the interest rates adversely affect the fair market value of an investment. A common example of this is with the pricing of bonds, where the fair market value is determined by yield. Bonds held to maturity will not suffer any loss of principal, but not every bond is held to maturity. With our growing global economy, foreign currency risk is becoming more common. Foreign currency risk is impacted by the exchange rate – which can be adversely affected in the same way that interest rates can.

With the recent bank failures, government bailout programs, current economic uncertainty, declining investment earnings and portfolio values as well as new complicated instruments available to investors, there is certainly significant risk involved. All organizations including nonprofits need to dust off their cash and investment policies and update them to adequately address the risks associated with depositing or investing cash.

During this tough economic environment, keep your favorite nonprofits in mind. We all need to continue to support our wonderful philanthropic organizations as they strive to improve our communities and our lives.

(Keith Ekenseair, CPA, is a Frost PLLC partner with nearly 25 years of accounting experience with a wide range of companies in many industries. He can be reached at [email protected].)