Requiem For A Nonprofit – What Went Wrong?

–Mismanagement Causes Huge Agency Failure

A Word To The Wise For Nonprofits

Rarely do failed for-profit or nonprofit organizations get a posthumous review of what actually went wrong. The collapse of one of the largest nonprofits in the US, the Federal Employment Guidance Service (FEGS) of New York City, is a noteworthy exception. Details of the causes that led to the human service’s demise were aired widely throughout NY media. *This organization had a $250 million budget, with 1900 employees who served 120,000 households covering a range of mental health and disability services, housing, home care, and employment services.

Failure of small nonprofits is rampant for a wide variety of known reasons. For example, “Nonprofits tend to be more trusting of their employees and have less stringent financial controls than their for-profit counterparts.” **

Following are my interpretations of what its board should have done to avoid such a tragedy.

Board duty of care: Outside of fraud being involved, the FEGS failure demonstrates that no nonprofit is too big to fail, probably because of a lack of board due care. Boards have to be acutely aware of the professional financial competencies of their CFO and CEO or well-meaning people who naively believed that loans could be easily repaid. There should have been a well-documented financial l strategy. The nonprofit closed with $47 million in loans/liabilities/debts.

Symptoms of impending collapse: Clearly with $47 million being owed, common financial ratios should have alerted knowledgeable board members to the coming catastrophe. But in the nonprofit environment, it is not unusual to that find directors, even business executives, are unfamiliar with the fund accounting approach used by nonprofit organizations.

In addition, contracting city and state agencies failed in their reviews of the organization’s finances. However, some nonprofits, either intentionally on unintentionally, can saddle contract reviewers and directors with so much information that even the most conscientious can’t spot problems. (Humorously, directors in this category are referred to as “mushroom directors” because, like growing mushrooms, they are kept in the dark an covered with excrement. But this type of tactic was successfully used against IRS auditors in the Madoff debacle.)

Government or Foundation Contracts: In accepting these contracts, nonprofits must be realistic about whether or not there is enough money to cover full costs. They can’t be blinded by what the contract can do for the organization’s client. If adequate overhead funding is not attached to one or more of these agreements, they eventually can cause bankruptcy, because the nonprofit eventually will have to borrow or seek additional donations to cover them.

How Nonprofit Boards Can Avoid Problems

Review Financials: Current financials need to be given to directors monthly, or at least quarterly if the board meets less often. The very detailed budget data can often be difficult for those without budget experience. At the least, everybody on the finance committee needs to be able to intelligently review the income statement and balance sheet. Also, they need to be aware that funding accounting permits some unusual twists—food donations, for example, can be included in revenues, based on an estimate of their value. Consequently, cash revenues and expenditures need to be a focus for directors’ analysis.

Make certain that financials are delivered on timely and complete bases. Problem Example: One CFO didn’t submit accounts receivable reports for nine months because he said he was too busy to compile it. Neither the board nor the CEO demanded issuance of the report. When finally delivered, it was clear that the CFO was listing a substantial number of noncollectable accounts as active ones. Both the CFO and CEO were fired, and the nonprofit had to hired expensive forensic accountants to review the impact.

Gaps Between Revenues and Expenditures: This is the ultimate red flag, if not followed carefully. It may vary from period-to-period in a predictable pattern that everybody understands, but if the gap continues, say for four to six months, strong board action is necessary.

Adopt written financial policies: These are necessary to make sure all concerned with finances are on the same page. Since interpretation is often required in financial decisions, nothing should be left open to broad interpretation.

Contracts with governments, foundations, and others: Make certain that reimbursements for indirect costs are included. If not included, have a benefactor ready to step in to cover the costs.

Consider the old Chinese proverb;

A wise man (or woman) learns from his/h own experience. The wiser man (or woman) learns from the experiences of others.

One hundred twenty thousands households and individuals lost services from an 80-year-old human service nonprofit. There is much to learn from the collapse of FEGS.*

* https://www.councilofnonprofits.org/thought-leadership/what-we-learn-when-nonprofit-closes-its-doors

**   https://www.blog.abila.com/nonprofit-fraud-facts-2016-global-fraud-study/

Dr. Eugene Fram
Dr. Eugene Framhttps://non-profit-management-dr-fram.com/
Eugene H. Fram, Ed.D., is an expert in nonprofit governance, a business consultant and an award-winning emeritus professor of the Saunders College of Business at Rochester Institute of Technology (RIT). He is also the author of six books and more than 125 published articles and has been widely quoted by national media on topics ranging from business to high-performance nonprofits. His blog platforms on nonprofit governance have in excess of 3500 followers. He is a past recipient of RIT's highest award for outstanding teaching and one of a very select group awarded the Presidential Medallion, given to those making exceptionally significant contributions to the university. In 2012, a former student anonymously contributed $3 million to endow an RIT Chair in Critical Thinking in his name, an honor Dr. Fram describes as "a professor's dream come true!" Over his distinguished career, he has served on 12 nonprofit boards overseeing diverse community, national and professional organizations, and also has served on five for-profit boards. His particular passion is helping nonprofit boards perform at high levels as more is expected of these boards today than most people realize. He is the author of Going For Impact – The Nonprofit Director's Essential Guidebook: What to Know, Do and Not Do, and POLICY vs. PAPER CLIPS - How Using the Corporate Model Makes a Nonprofit Board More Efficient & Effective.
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Michael Barnes

I’m not knowledgeable about this specific instance; however, it seems that there should be a simple training for board members on how to read nonprofit financials. Seems to be a gap in the marketplace. Or if it exists, apparently, it is not widely enough distributed.

I’m a big believer in simplicity. Budgets really aren’t that complex. Money/resources in, money/resources out. The slight complexity of in-kind should be relatively simple to explain.

I significantly appreciate the discussion of the need for overhead. This topic can not be overstated. Nonprofits and funders really need to get onboard with this.

And stop expecting free work. The mention of the CFO being 9 months late????? Fire them and get a new firm…oh, wait…I suspect the NPO expected free or significantly reduced cost work.

Nonprofits are a business and need to start behaving that way.

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