Difficult Economy Changes the Way Institutions Must Manage Their Resources

March 26, 2012 by Leave a Comment

We have witnessed churches and schools that appear to operate somewhat blindly, as though stopped in time, living in practices of the past, a past that enjoyed a more stable and abundant economic environment and a much larger “volunteer” religious workforce. In some cases today, financial juggling enables the continuation of programs and practices that are neither viable nor sustainable.  We observe the financial juggling in many (albeit, well intended) forms: drawing down reserves; not paying assessments, insurance premiums, and other bills; or, some combination of these practices. In a phrase, perhaps we share a growing concern over the quiet liquidation of financial resources.

Prudent Management Requires Financial Reserve

Institutional Finance wise financial management Prudent management of any organization includes building and maintaining an appropriate financial reserve as a hedge against temporary fluctuations in revenues or expenses and/or to fund capital needs.  The distinguishing feature of these events is that they can be either transitory or have the effect of transforming cash into a depreciable asset.  In either case, the financial health of the organization, over time, is maintained or enhanced.  Today, unfortunately, accumulated financial reserves are being liquidated in a futile effort to reckon with recurring shortfalls or support unsustainable operations.

Informed or Uninformed Leadership

Informed or uninformed, this practice of the leadership of many churches and schools ultimately leads to a financial predicament.  Emotionally wed to past practices and the status quo, they desperately need a genuinely dispassionate and objective interpretation of financial data by a third party to commence a data driven discernment and planning process.  Organizations that, over a three-year period, annually draw down accumulated reserves in excess of $25,000, should be assessed to determine the long-term impact of such draws on the long-term financial health of the organization. 

Our time-proven, data driven discernment and planning process classifies viable and sustainable entities.  This mechanism enables leadership to evaluate options when a situation is still a “problem” rather than a “crisis.”  Contact us today.

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Institutional Finance: Debt Management

February 7, 2012 by Leave a Comment

Debt management is a process that extends over time. It begins long before you borrow your first dollar and ideally continues long after you have made your first loan payment. Donors reward prudent debt managers by parting with their hard earned dollars. Donors often have a higher standard for debt management practices for organizations they support than they do in their personal lives. Lenders and investors reward borrowers who carefully manage their debt by offering lower rates.

Capital Improvement Program

The process of managing one’s debt begins by developing a capital improvement program (CIP). The CIP is a short-range plan, usually four to ten years, which identifies both necessary and desired capital projects and equipment purchases. Key elements of the plan include a prioritization of each project and a proposed timeframe within which funding for the project should occur. At this stage of development the CIP looks more like a Christmas wish list.
Elevating the CIP above the status of a “wish list” is accomplished by incorporating a funding plan for desired projects. It is common for desires to exceed capacity. The crafting of a final CIP is as much an art as a science.

Some projects may be funded out of accumulated cash – so called “pay-as-you-go” projects. Other projects will be paid for over time – so called “pay-as-you-use” projects. This latter category requires the issuance of debt or the entrance into a lease to fund the acquisition over time. Best practices for debt financing and lease financing are virtually identical.

Financial Feasibility Studies

Adequate financial feasibility studies (affordability studies) should be performed for each project to be financed in order to determine the adequacy of pledged revenues to support the loan/lease. Concurrently, the institution will assess the depth of community support for incurring debt. Institutions that rely on donations must be particularly aware of the depth of donor support before any financing is arranged least they receive an unwelcomed surprise.

Generally, institutions should only incur debt or enter into a capital lease as proposed in the CIP. An exception to this rule is the case of extreme financial emergency which is beyond the institution’s control or reasonable ability to forecast. In either case, a good rule of thumb is that total annual debt service requirements should not exceed 25% of gross annual revenues.

The institution should be especially cautious of any financing instrument that cannot be easily and clearly explained to its community.

Instituional Guidelines for Issuing Debt

The following guidelines will need to be adhered to when the institution finds it necessary to issue debt or enter into capital leases (collectively referred to as “debt”): a) The issuance of debt will be subject to the most careful review and must be secured by covenants sufficient to protect the lender or investors and the integrity of the institution.
b) Whenever feasible, loan proposals will be competitively solicited.
c) Whenever feasible, the loan will be structured to provide for an approximately equal annual debt service payments over the life of the loan.
d) The amortization of any loan will not exceed the useful life of the capital project/facility or equipment for which the borrowing is intended, and the loan debt will normally be amortized in twenty (20) years or less. Longer amortization periods often prove problematic because after two decades facilities are often in need of repair and renovation.
e) Interest earnings on the debt reserve or net assets, if any, will be used only to pay debt service on the loan.
f) Prepayment penalties will be carefully evaluated to determine their necessity, and if possible, avoided.
g) Variable rate debt whose interest rate resets more frequently than annually should undergo a higher level of due diligence given the added stress it can create on an organization’s revenue stream when interest rates spike.

It is most prudent if institutions avoid the use of short-term borrowing to finance operating needs. In most cases, this only delays and does not solve operational problems. It is generally better for organizations use accumulated reserves to address revenue fluctuations.

Capital Leases

Capital leases may be used to finance equipment purchases when the following conditions are met: 1) the total cost of the purchase exceeds $10,000; 2) the useful life of the equipment is greater than three (3) years; and 3) the financing rate is less than or equal to the current investment rate.

Having entered into a loan or lease agreement there are a few ongoing activities in which an organization should engage. The institution should periodically review its original financial projections that supported the issuance of debt or the entrance into a lease obligation against the actual performance, thereby monitoring its ongoing ability to support those obligations. Similarly, the institution should analyze the sufficiency of its projected cash flow prior to applying capital campaign prepayments toward principal reduction.

Financial Review

Annually, someone within the organization should review loan terms and conditions, especially loan covenants, to assure compliance. Many an organization has “technically” defaulted on its loan by not paying attention to the loan documents. Technical defaults, like payment defaults, give the lender the right to terminate the loan agreement. Many a borrower has witnessed a loan that was favorable to the borrower collapse because of a technical default. Attention to loan covenants is especially critical if you have issued debt subject to state or federal securities regulation.

Finally, institutions should periodically monitor their outstanding obligations to identify opportunities to reduce interest cost through refinancing.

If an institution adheres to this debt management framework demonstrate good stewardship to donors, credit analysts and lenders.

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Institutional Financing: Budgeting

January 23, 2012 by Leave a Comment

The Purpose of the Budget

The budget is one of the most important documents the Institution prepares because it identifies how the mission shall be met through its various ministries and how those ministries are to be financed.  Multiyear budgets are advocated because they better illustrate the impact today’s decisions have on future resource availability.  In this post the term Institution means either a church, school or similar organization.

A budget is a tool that assists the Board and management in assessing the Institution’s operations relative to a benchmark and in arriving at sound decisions.  This analysis is especially important when inflows and outflows of cash are mismatched.  Many Institutions have fluctuations in their cash flow during the fiscal year.  Surpluses must be retained to cover the fixed costs of operating the Institution during times when cash flow is traditionally low.

The Institution shall prepare an operating and capital budget (the “budgets”) including revenue and expenditure projections.  Ideally, each budget will cover a multi-year period.  The recommended budgets shall be reviewed and approved by the Finance Council prior to submission to the Board.

 

The operating budget preparation process

The operating budget preparation process allows decisions to be made regarding expected resource levels and expenditure requirements for the levels and types of ministry to be provided in the upcoming fiscal year.

The first year of the multi-year budget plan shall be the proposed annual budget.

As a general rule, the proposed budgets must be balanced.  Balancing the budget by a planned spend down of accumulated assets or the creation of a deficit budget should require the unanimous approval of the Board.  The Institution must be particularly careful to understand the cause(s) necessitating deficit spending and deal with structural or recurring issues before they jeopardize the Institution’s financial health.

The Institution will budget revenues and expenditures on the basis of a fiscal year.  If the Institution has sufficient resources budgeting an accounting will be on an accrual basis, otherwise revenues will be estimated on a cash basis and operating expenses on an accrual basis.

 

What is in the Budget?

The proposed budgets will contain the following:

a)  Revenue estimates by major category or general ledger account.

b)  Expenditure estimates by program levels and major expenditure categories or general ledger account.

c)  Debt service summarized by loans detailing principal and interest amounts by fund.

 

The proposed budgets will also contain the following information:

a)  Proposed personnel staffing levels.

b)  A detailed schedule of capital projects.

c)  All programs or services will have a direct link to the Institution’s articulated mission statement and list of approved ministries.

d)  Any additional information, data or analysis requested by the Board or needed to support budgeted items.

 

Making Priorities

In formulating budget requests, priority will be given to ministries deemed by the Institution to hold the highest priorities.  New ministries or service levels will be funded through identification of new resources or reallocation of existing resources.

Budgeting procedures will attempt to identify distinct ministries and to allocate budget resources to perform the functions and activities of the ministries.

The Institution will budget to maintain funds available for unforeseen events wherein serious loss of revenues or assets is threatened or has occurred.

 

Adopting a Budget

The Board will adopt the budgets no later than sixty (60) days prior to the start of the new fiscal year.  The Finance Council shall schedule its review to provide the Board with ample time for review, and if necessary, revision, prior to the adoption of the budgets.

Parishes with schools shall consider a budget timeline that enables the parish budget to be approved prior to the registration and re-registration of students, the letting of teacher contracts or agreements and the setting of tuition rates.

A quarterly report on the status of the budgets and trends will be presented to the Finance Council and the Board within thirty (30) to forty-five (45) days of the end of each quarter.  The quarterly report should compare actual revenues and expenses to budgeted amounts.  More sophisticated analyses would be seasonally adjusted and could include historical comparisons.  In addition, the quarterly report shall include updated revenue and expenditure projections through the end of the fiscal year.

Once the budget is approved it should not be modified during the course of the year.  The Institution may need to modify its practices based on improved information, i.e. reduce expenditures because revenues are lagging, but the budget remains unchanged.

 

In Case of a Deficit

If a deficit is projected during any fiscal year, the Finance Council will recommend that the Board take steps to reduce expenditures, if possible, increase revenues or, if a deficit is caused by an emergency, consider using the undesignated net assets to the extent necessary to ensure a balanced budget at the close of the fiscal year.

The Institution will plan and control expenses so as to work within approved budget amounts, reporting to the Finance Council and the Board any line-item expense variances in excess of ten thousand dollars ($10,000) or such other amount as is appropriate for the Institution, and the reason for these variances.

Although certain categories of the operating budget lend themselves to specific percentage increases, for the most part, all expected revenues and planned expenditures for each budget year should be determined for specific programs or functions using the appropriate activity levels for the year.

 

Budget Assumptions

A statement of the assumptions which guides the budget process shall accompany the budget beginning with the development process through its implementation stage.  Assumptions shall be reviewed annually by the Finance Council.

 

Budget Distribution

Once adopted, budgets ought to be widely disseminated throughout the Institution to both internal and external audiences.  A budget document communicates key priorities associated with the Institution.  Internally, individuals need to be held accountable for their actual performance against projections.  Externally, people will be more willing to give if the messages they hear are compelling, ones that align vision, mission and ministry.

No more than 25% of the church’s operating budget shall be used to subsidize any one program or ministry if a church has no debt.  This threshold should drop to a maximum of 20% if a church is indebted.

 
If you have any questions or need help with this process, please Contact Us so we can help your Institution with it’s budget.

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Long-range Church Financial Planning

December 19, 2011 by Leave a Comment

Talking Out of Both Sides

Recently I attended a parish meeting to discuss long-range financial planning with about 20 parishioners. As is my custom, I invited the parishioners to interject questions as they arose. One woman challenged me about speaking out of both sides of my mouth because I was in fact advocating both “Abundance Theory” and “Scarcity.” It was a very good question that deserves greater attention.

Permit me to set the stage. The parish faced a $100,000 budget imbalance in FY 2011-12. The finance council bridged the gap with several one-time fixes. The question for the parish is what to do this coming fiscal year since the underlying situation was never addressed. The juxtaposition of “abundance” versus “scarcity” is a question of timing: “How much time do we have to address the situation and how have we prepared for life’s random chaotic events?”

What is the normal response by a parish to $100,000 budget imbalance? Parishes that believe the shortfall is an anomaly will spend down their accumulated reserves, assuming they have amassed such reserves, and operations go on as usual. Parishes that spend every last operational dollar have far fewer options in times of financial distress. The responsible among these parishes choose to trim the expense –side of their budgets. The least responsible out there fund their ministries by not paying diocesan assessment, by not making requisite insurance, health care or retirement payments to diocesan run programs, by not making tax payments to governmental units, by not maintaining their facilities or some combination of the aforementioned. The key point here is that the accumulation of reserves enables a parish to buy time before making the decision to “cut” the budget!

How to cut a budget can often be a contentious issue. Programs develop constituencies that become emotionally attached to their particular ministry. Ideally, you need to assess programs devoid of this emotional attachment or the parish may become locked into outdated or marginally used programs. Decision-making in the Church is best done when discernment is based on facts rather than emotion. The key for any parish is to protect those ministries that attract donors. Regrettably, few parishes fully understand which ministries parishioners value most.

The other side of the budgetary equation is the revenue side. In the short-run parishes can enhance revenues by having the leadership (Pastor) request parishioners make one-time gifts or to increase their weekly giving. Sustained increased stewardship is usually the result of a carefully planned and implemented process. Such “processes” are usually measured in months if not years. Revenue enhancement therefore is generally thought of as an intermediate to long-term solution. Whereas the infusion of reserves or expense cuts are immediate solutions.

Charles Zech, noted Catholic researcher an author, in his most recent book “Best Practices in Parish Stewardship” notes there is a three step process for increasing the stewardship in most parishes. First, you need to capture parishioners; they need to become vested in their parish. This can happen through any one or more of the myriad of ministries that parishes can offer. Remember, people are attracted to excellence as opposed to mediocrity. Offering a plethora of ministries may not be as desirable as offering a few very good ministries.

Zech goes on to state that once people become engaged in their parish they will begin giving back to the parish in the form of their time and talent. Treasure follows the personal investment parishioners make in their parish. That is why sustained increased stewardship is rarely a short-term solution.

It is this transition from the short-term to the long-term that permits one to concurrently espouse “abundance” and “scarcity” theories. Like most things in life we are not relegated to merely black or white but are blessed with multiple shades of gray inbetween.

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