How Nonprofits Should Prepare Financially for Funding Uncertainty

Start by identifying where the organization is most vulnerable. Leadership and the board should understand:

• How much revenue comes from the organization’s largest funders
• Which grants or contracts are expected to renew during the next 12 to 24 months
• Whether funding is concentrated within one government agency, foundation, program, or donor
• Which programs would be affected if a particular funding source were reduced or eliminated
• Whether reimbursement-based grants are creating cash-flow pressure
• How much of the organization’s revenue is recurring versus dependent on new awards

An organization may appear financially healthy overall while still being highly exposed to the loss of one major funding source.

The budget should not assume that every grant will renew at the same amount or on the same schedule. Management should identify the funding assumptions that have the greatest effect on the organization and discuss what would happen if those assumptions change.

Rather than preparing one annual budget, nonprofits should consider developing several possible scenarios. For example:

• A base scenario based on the most likely funding outcome
• A downside scenario that assumes a delay, reduction, or loss of significant funding
• A more severe scenario that assumes several funding challenges occur at the same time

Each scenario should identify the decisions that would need to be made. Could the organization delay hiring, reduce discretionary spending, renegotiate contracts, modify a program, increase fundraising efforts, or use operating reserves?

Scenario planning is most useful when it is completed before the organization is under pressure. It allows leadership and the board to establish priorities and decision points rather than reacting after cash has already become limited.

Financial statements often describe what has already happened. Nonprofits should also identify economic indicators and internal key performance indicators that may provide an earlier warning of financial difficulty.

These indicators may include:

• Days of cash on hand
• Budget-to-actual revenue and expense variances
• Grant renewal and fundraising pipeline activity
• Donor retention and average gift size
• Accounts receivable aging and reimbursement delays
• Changes in program enrollment, membership, or service volume
• Staffing vacancies and turnover
• The percentage of revenue coming from the organization’s largest funders
• Broader economic or government funding trends affecting the organization’s programs

The most useful KPIs will depend on the organization. The goal is not to create an overly complicated dashboard. Instead, management and the board should identify a small number of measures that can signal when financial assumptions are beginning to change.

It is also important to establish thresholds that require action. For example, a decline in cash below a certain number of days, a significant increase in receivables, or the nonrenewal of a major grant could trigger additional board reporting or implementation of a contingency plan.

Nonprofits should not wait until a grant decision is announced to communicate with their funders.

Regular conversations can help the organization understand the challenges its funders are facing, including changes in priorities, investment performance, government appropriations, donor expectations, or demand from other grantees.

These discussions can also help the nonprofit understand whether a funder expects changes in:

• Award amounts
• Renewal timing
• Program priorities
• Reporting requirements
• Payment schedules
• Restrictions placed on grant funds

Funders may not be able to make commitments far in advance, but open communication can provide valuable information for financial planning. It also gives the organization an opportunity to explain the effects that funding reductions or payment delays could have on its programs and the people it serves.

One of the most effective ways to prepare for funding uncertainty is to intentionally build an operating reserve.

Many nonprofits cannot simply pause their services when financial uncertainty arises and then restart them several months later. Clients still need assistance, employees still need to be paid, facilities must remain open, and contractual obligations continue. Holding a portion of unrestricted resources back during financially stronger years can help the organization sustain its services during a more challenging period.

The board should establish a reserve goal based on the organization’s operating model and financial risks. For many organizations, a reasonable starting goal may be enough unrestricted and readily available resources to support approximately three to six months of operations. An organization with highly concentrated funding, unpredictable reimbursements, limited access to credit, or services that cannot easily be reduced may need a larger reserve.

The appropriate target should not be selected arbitrarily. Management and the board should consider:

• The reliability and diversity of revenue sources
• The timing of grant and contract payments
• The organization’s ability to reduce expenses quickly
• The predictability of demand for services
• The likelihood that funding disruptions would affect multiple programs
• Access to a line of credit or other liquidity
• The cost of maintaining essential services during a transition

The reserve does not necessarily need to be funded all at once. The organization can establish a multi-year plan to designate a portion of annual operating surpluses until the target is reached.

A formal board-approved reserve policy should describe the reserve’s purpose, target amount, permitted uses, approval process, and expectations for replenishing the reserve after it is used.

Nonprofits should look beyond total net assets when evaluating financial flexibility.

An organization may report significant net assets while too much of those resources is held in donor-restricted net assets and is therefore not available to support general operations. Other resources may be tied up in property, equipment, long-term pledges, endowments, or other assets that cannot easily be converted to cash.

Leadership and the board should understand the difference between:

• Total net assets
• Net assets with donor restrictions
• Net assets without donor restrictions
• Board-designated reserves
• Unrestricted cash that is currently available for operations

A strong balance sheet does not necessarily mean the organization has strong liquidity. Financial planning should focus on the resources that are both unrestricted and readily accessible.

Organizations should also consider whether fundraising efforts are generating enough flexible operating support. Funding for a specific program can be valuable, but the organization must still pay for finance, technology, insurance, human resources, facilities, leadership, and other infrastructure necessary to operate that program successfully.

Funding uncertainty cannot be addressed through the annual budgeting process alone. Management should regularly update cash-flow projections, funding assumptions, and financial scenarios as new information becomes available.

Boards should receive financial information that explains not only where the organization stands today, but also what management expects over the next 6 to 18 months.

The earlier an organization identifies a potential funding challenge, the more options it will generally have. A nonprofit that monitors the right indicators, communicates with funders, builds operating reserves, and understands the availability of its resources will be better positioned to protect both its financial stability and its mission.

The goal is not to eliminate all financial uncertainty. It is to ensure that uncertainty does not automatically become a crisis.