Opinionista Shelagh Gastrow 7 May 2018

How do non-profits ensure their long-term financial viability?

For many organisations, short-term investment by donors with high expectations of immediate impact as well as intolerance for anything that might go wrong, creates a very fragile financial situation.

With over 150,000 non-profit organisations registered with the Department of Social Development, there is on-going pressure for funding for organisations that do not trade. The long-term financial sustainability of this sector is what often keeps board members and non-profit leaders awake at night.

In addition, donors themselves are concerned about the viability of the organisations they support and there is a move to provide technical assistance and training in fund raising. However for many organisations, short-term investment by donors with high expectations of immediate impact as well as intolerance for anything that might go wrong, creates a very fragile financial situation.

There is also a trend in the developmental space to move towards for-profit social entrepreneurship in the belief that the market can solve social problems. While this has certainly created more energy in the small enterprise space that provides services to the poor, systemically there is rarely a market solution to some of the real challenges we face.

In fact, many of our socio-economic problems arise from market failure. The creation of a civil society sector is critical to our democracy and besides welfare services, this sector has been most vibrant in the research, policy development and advocacy space. This can relate to a wide range of issues including health, education, environment, anti-corruption, free media and human rights. There will always be organisations that are largely dependent on grants and philanthropy.

In a research report on Financial Sustainability for Non-profit Organisations conducted by the RAND Corporation in 2012, “the goal of financial sustainability for non-profits is to maintain or expand services within the organisation while developing resilience to occasional economic shocks in the short term (eg short-term loss of programme funds, monthly variability in donations)”.

Most non-profit organisations are currently exploring ways to supplement the donor income they receive, as fund raising has become increasingly difficult in the existing environment. One way of doing this is through income generation through fees charged for services. However, there is confusion about what is permissible in terms of their tax exempt status.

The recently released Davis Tax Committee report (including recommendations) clarifies what trading is permissible by NPOs in terms of the existing Act. First, if an NPO has reserve funds or banks their grant funding in a high interest bearing account from which they can draw down regularly, income from interest and dividends is tax exempt.

When it comes to active trading or income generation, this is only tax exempt if directly related to the organisation’s sole object outlined in its founding constitution. For example, if an organisation focusing on HIV prevention runs HIV and Aids awareness-raising and training programmes for clients and is paid to do so, that would be tax exempt.

However, if the same organisation decides to establish a biscuit factory, ie not aligned with their core business, that would need to be ring-fenced and taxed like any other business. Whilst these non-aligned income generating projects have had the odd success, they often contribute to substantial mission drift on the part of the non-profit organisation as attention is drawn away from its key purpose towards the money-making machine.

Very often, further investment has to be made into new human resources as the organisation’s staff are not skilled in the requirements of the unrelated business. Like many for-profit start-ups, lots of these businesses fail and the NPO has to manage that financial loss. There are no guarantees of success.

Other conditions related to income generation through services that might draw attention from the Tax Exempt Unit at SARS include the fees charged which should at least be 85% related to cost recovery for the organisation and whether the tax free activity is not in unfair competition with taxable businesses.

Some organisations that own their own premises often have excess office space which could be let out as a source of income. However, the core business of the organisation is not property rentals and therefore they cannot draw non-taxable income this way, except to let out 10% or less of the space available.

How then do non-profits ensure their long-term financial viability? This can never be guaranteed even for a for-profit, but there are some principles that should be kept in mind to create a level of resilience that would see an organisation through a bad year. Good financial planning is important so that an organisation can predict what it would need going forward, rather than merely facing an annual crisis.

It is crucial for organisations to be flexible in a fast-changing society, but taking on random projects often drains resources. A level of forward planning relating to the organisation’s purpose, focusing on key programmes including what these really cost the entity is important. Costs are not just the programme costs, devoid of overheads and staff, but the full cost to the organisation needs to be understood and budgeted.

Another principle is diversity of income. Start-ups often only have one or two donor supporters, but it is imperative that an effort is made to grow this pool. Diversity is not only about more donors, but ensuring that they come from different sectors such as the corporate sector, private philanthropy, international sources and even government.

At the same time, efforts should be made to develop a reserve fund. Reserves enable an organisation to be flexible, to survive crises such as the exit of a critical donor, balancing uneven income flows or to manage a difficult leadership transition. They can also be used to provide for specific skills when required or a useful evaluation.

Another trend to ensure sustainability is the importance of building a strong stakeholder base, including partnerships with other organisations and institutions that complement the organisation’s work. This is attractive to funders, but also strengthens the organisation’s reach and positions it as a key player in its sector.

Ensuring the long-term sustainability of a non-profit organisation is a juggling act. Different from for-profits that have greater control over their products, NPOs need to ensure that the social impact they make is their key outcome and that needs to satisfy various stakeholders, including donors and the communities they serve. There is a greater minefield of relationships required to ensure viability, reputation and partnerships, but this needs to be underpinned by clarity around purpose together with sound financial planning. DM

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