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Impacts of financial decisions
How Strategic Capital Planning Can Enrich Your Nonprofit
Capitalization and financial sustainability are vital for nonprofits. The key question is how to achieve the capitalization necessary to deliver services, grow, and ensure financial endurance.
There are two main reasons capitalization efforts may fall short: underfunding of infrastructure and growth, and unintended penalties for the accumulation of flexible cash. But most nonprofit leaders know that capitalization and sustainability can be achieved in part by:
- Building a stronger balance sheet
- Encouraging liquidity
- Paying attention to depreciation and debt
- Increasing financial literacy — particularly with boards
However, these financial basics rely on past practice. Considering the current economy and future forecasts, you can’t move forward by watching the rear view mirror, particularly if past efforts have fallen short of sustainability goals. The basics alone aren’t likely to lead to sustainability.
So what can you do to strengthen your financial footing? One answer is to more strongly link your strategic thinking to your organization’s capital needs.
Is it an art or a science?
Strategic capital planning is the art and science of managing your capital. Capital is essentially the funds you have available (a combination of your fund balance and your debts). To paraphrase the Kresge Foundation definition, capital planning is the accumulation and application of those resources to support achievement of an organization’s mission over time.
Capital capacity is integral to your financial health. Strategic capital planning is the ongoing process of tying capital investment to strategic and operational plans. It requires your organization’s board and staff to do the following:
- Define financial objectives
- Understand the market and operating initiatives required to meet financial objectives
- Relate these initiatives to a capital investment strategy
- Translate the above considerations into organizational change
What are the key steps?
A strategic capital planning process involves four key steps:
Step 1: Establish expectations
First, you need to develop consensus about overall financial expectations. Ask the following questions:
- How large should the operating margins and cash reserves be?
- What debt coverage ratio is appropriate?
Develop the answers to these questions at the outset. Be sure to involve the board in the process.
The purpose of this step is to provide a baseline understanding of the organization’s current debt and capital capacity. This will serve as a basis for evaluating strategies during the planning process. When setting financial performance targets, keep the following in mind:
- Industry standards, such as rating agencies, to determine credit quality
- Recent financial performance and current financial health
- Capital “life cycle” considerations
In discussions about financial targets, emphasize how performance expectations drive the organization’s need for:
- Risk capital
- Operating and working capital
- Operating reserves
- Facility reserves
Step 2: Calculate your affordable capital capacity
Your “affordable” capital capacity is equal to your organization’s affordable debt capacity (as determined by the performance targets you set in Step 1), plus or minus:
- Any excess or deficit cash flows
- Any philanthropic contributions
In other words, your affordable capital capacity is the amount of money your organization can reasonably borrow, plus cash generated from programs or activities, plus contributed support.
Calculating your capital capacity will help you see the capital implications of key goals, priorities, and strategies in your current strategic plan.
Step 3: Create and analyze planning scenarios
Adopt an interactive planning process that lets interested parties — board members, staff, and partners such as marketing firms — evaluate strategic options through modeling. Effective modeling allows all parties to assess the organization’s capital needs. Modeling also helps people understand the implications of different actions before they finalize decisions.
In “typical” financial planning, staff and consultants leave a meeting and independently “crunch the numbers” for discussion later — sometimes after weeks or months. Conversely, real-time modeling includes financial guidance during early discussions. Stakeholders can evaluate a variety of options and make decisions efficiently and cost-effectively in a real-time setting.
Evaluate each planning scenario across four key drivers of future financial performance:
- Environmental impacts, such as changes in market demand, competition, and program or service obsolescence
- Growth from operations, by program or service
- Value of strategic investments
- Impact of management actions, particularly on revenue enhancement and cost savings
Step 4: Assess and revise the plan
Assess the plan’s strategic initiatives and their underlying assumptions, based on their affordability, which you calculated in Step 2. Build ownership of the plan’s goals to ensure that staff and board members are empowered and accountable.
This process will help you prioritize strategies that support your organization’s mission. It will also identify resource or capital constraints that will require attention or investment in order to execute your mission.
What will you gain?
Strategic capital planning is a more focused approach to strategic planning. It more directly addresses the challenges and opportunities of connecting your capitalization needs to your plans.
To be successful, key stakeholders will need to agree on your organization’s financial targets. This process emphasizes understanding the value of strategic and capital investment opportunities and financial tools. These tools will help you evaluate the future impacts of your capital investment decisions.
Meeting current and future challenges and opportunities head-on will increase your organization’s ability to:
- Translate strategic options into financial terms
- Deepen board-level understanding of risk and return on investment
- Align and integrate strategic, development, operational, financial, and facility plans
- Foster organization-wide focus on variables affecting financial success and capital access
- Address market changes through an aggressive set of strategic actions
- Communicate the vision and plan to external capital sources
|How can your board help?|
|Board members can add value to the strategic financial planning process by: