How NFP's maintain financial resilience?

Rebuilding Resilience

The world continues to be impacted by the global pandemic in varying severity across regions, however many economies, in particular the Australian economy, have emerged from the downturn on the back of extremely stimulatory policy and economic re-openings. The Australian economy has now transitioned to a more moderate pre-COVID trend growth rate, albeit with higher inflation.

Despite the improvement in economic conditions, there are many charitable organisations that continue to face detrimental impacts caused by the pandemic. In more serious outcomes, some charities have struggled to continue whilst others have found themselves to be vulnerable and facing business uncertainty. As economic conditions are expected to improve throughout 2022 and beyond, the focus for many charities will be to ensure they increase their service delivery and stabilize their financial position. As these objectives are hopefully achieved through the course of time, many organizations may turn some of their focus to rebuilding financial resilience for future economic stresses. The purpose of this brief article is to consider two major approaches to rebuilding financial resilience, that being developing financial reserves and a corpus.

Building Financial reserves

Financial reserves are funds that your organization can set aside and build over time when your organization achieves a profit or a surplus over your operational and community service commitments. Whilst the concept of achieving and retaining a “profit” may sound counter intuitive for a “not-for-profit” organization, placing surplus funds aside with the objective of being used at a later date to achieve your purpose is deemed financially sensible.

The most common purpose for holding reserves is a “rainy day” fund that is called upon to respond to unexpected changes in financial position and the economic environment. These could include events such as unexpected cuts to funding, staffing and business transformation costs or specific events that excessively call upon the services of your organization. From an investment perspective, reserves for this type of purpose should be invested to ensure accessibility (liquid) and capital preservation. These characteristics typically result in the use of cash management accounts and short dated term deposits. Where reserves may not be required for a period greater than three years, other “low risk” asset classes could also be considered. This could include longer dated term deposits, Australian Government Bonds and highly rated (investment grade) corporate bonds. It is important to seek advice when considering these types of asset classes. Gradually building reserves and creating a buffer against future unforeseen events is an excellent method of rebuilding the financial resilience of your organization.

Creating and managing a Corpus

A longer-term approach to increasing resilience is the creation of a corpus (also known as an endowment) as some organisations may find they do not require a portion of funds in the near term (eg: greater than 5 years). A corpus can be developed gradually through the accumulation of retained surplus, however they are typically created in the instance of large capital events (eg: disposal of a large asset like a property) and through assets that may be bequeathed by donors. An organization could develop a corpus for similar reasons to that of reserves, to build a larger buffer against unexpected events, however the more common approach is to invest such that the corpus grows in value over the long term and provides an annual diversifying revenue stream.

This financial strategy is achieved through two key policy tools – investment strategy and distribution policy¹. Given a portion of funds are not required for a long time, the corpus may be invested in asset classes that carry some risk but may ultimately provide a return greater than that of cash and inflation over longer time periods. These would include asset classes such as equities, property, infrastructure and alternatives. An investment strategy blending these types of assets can be constructed to meet a defined long term return objective and risk tolerance. A disciplined distribution policy can then provide an annual and sustainable distribution, typically ranging from 2% – 5% of the corpus, that contributes to revenue, delivering services and achieving your purpose. The combination of investment strategy and distribution is a delicate balancing act, but it has been achieved successfully by many organisations over the past century. There is a higher level of complexity when investing your funds in this manner and seeking financial advice is highly encouraged.

The effects of the global pandemic continues to be felt in both health and social outcomes and the charity sector as a whole continues to rise to the challenges of the pandemic. Additionally, charities now confront the emerging issue of significantly higher living costs through decades high inflation. As economic conditions improve, the immediate focus for many charities will be to ensure they are able to continue providing their services to the community and their business’ stability. It is important however to have a focus on the medium-long term and taking the opportunities where possible to rebuild business resilience through financial reserves and developing a corpus.

¹ Another term for this is “Spending Policy”