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Strategic Capital Planning Links Two Keys to Nonprofit Success
Capitalization and sustainability were two buzzwords floating around the nonprofit sector during 2012. Clearly we know that both are vital for nonprofit survival. But tomorrow’s nonprofits would benefit from more than just an abstract discussion of these concepts. The key question is how to practically achieve capitalization while delivering on mission.
I often see a disconnect between the concepts of strategy and capital. It seems many organizations set strategy, then manage to and live with the financial and capital results. Instead of talking about strategy and capital in separate conversations, we should be talking about strategic capital planning.
Strategic capital planning: a disciplined approach
At its core, strategic capital planning is the systemic, ongoing process of linking capital investment to strategic and operational plans. A disciplined strategic capital planning process involves four key steps:
1. Establish targeted financial performance expectations
The first step is to develop a consensus about overall financial expectations. How large should the operating margins and cash reserves be? What debt coverage ratio is appropriate? The answers to these questions should be developed at the outset of the planning process with the involvement of management and the board. Answers will provide a baseline understanding of the organization’s current debt and capital capacity, and be the basis for evaluating strategies developed during the planning process. To more strongly connect financial performance with capital requirements, discussions about financial targets should emphasize how performance expectations drive the organization’s need for various forms of capital, including risk capital, operating and working capital, operating reserves, facility reserves, or endowments.
2. Define “affordable” capital capacity
In its broadest sense, capital capacity is integral to the financial health of nonprofits. Affordable capital capacity can be defined as being equal to an organization’s affordable debt capacity (as determined by the performance targets set when establishing financial expectations), plus or minus any excess or deficit cash flows, plus any philanthropic contributions. In other words, current affordable capital capacity is the amount of money an organization can reasonably borrow, plus cash generated from programs or activities and contributions.
Having discussions about affordable capital capacity should help identify the specific drivers of an organization’s business model that, when coupled with assumptions about what the future holds (inflation, availability of contributions, required capital investments, etc.) form the basis for a capital planning model.
3. Create and analyze scenarios incorporating key strategic, environmental, and capital variables
Nonprofit leaders should adopt an interactive planning process that allows interested parties (i.e., management and board members, staff, and partners such as architects and marketing firms) to evaluate strategic options through modeling. Effective modeling lets all parties participate and evaluate the capital needs of the organization. It also encourages understanding of different actions and their broader implications. There is tremendous benefit in knowing the impact of tactical initiatives before they are executed.
In “typical” financial planning, staff and consultants leave a meeting and independently crunch the numbers for discussion sometimes weeks or months later. Conversely, real-time modeling yields financial guidance during preliminary decisions. Stakeholders can evaluate a variety of options and make decisions efficiently and cost-effectively in a live setting.
4. Assess and revise the plan and its assumptions based on affordability for the organization
The fourth step is focused on assessing strategic initiatives and their underlying assumptions, based on their affordability. Remember that affordability was defined at the outset of the planning process. This helps leaders identify and prioritize financial and capitalization strategies that support the organization’s mission, in addition to resource or capital constraints that will require attention and/or investment in order to execute the mission.
All too often, strategy and capitalization are treated as disparate ingredients that hopefully reinforce one another. But with a renewed approach to strategic planning, nonprofits can more directly address the challenges and opportunities of connecting strategic plans with capitalization needs. To be successful, organizations will need to agree on their financial targets, and will need financial tools to evaluate the impact of strategic and capital investment decisions.