0.13 Chapter ten: the complexities of nonprofit financing

Chapter ten: the complexities of nonprofit financing

Simply stated, an operating deficit is the result of a shortage of current income relative to operating expenditures during a fiscal year. The actions required to reverse a deficit—either cutting expenditures or raising additional revenue—are never easily accomplished, but they are especially difficult for non­profit institutions. Cutting expenditures is problematic because nonprofit oper­ating costs tend to rise at an unremitting rate. Increasing operating income is difficult because a significant portion of a nonprofit's revenues often comes from contributors who choose to restrict the use of gifts and grants to specific pur­poses. These restrictions force nonprofit institutions to do more than just balance the flow of funds into and out of their overall accounts. They must match vari­ous sources of funds with specific uses and carefully manage the growth of unrestricted income to ensure that there are adequate funds to pay for general operating expenses.

The financial struggles of The New-York Historical Society provide a rich and dramatic illustration of these complex issues. Expenditures at the N-YHS have risen steadily since World War II, and at a rate consistently higher than in­flation. Revenue growth did not keep pace, and by the late 1960s, the Society was having difficulty balancing its budget. In the twenty-four years between 1970 and 1994, the Society suffered deficits nineteen times. These deficits put pressure on what had traditionally been the Society's largest and most reliable revenue stream, the income from its endowment, resulting in policies that sacrificed the endow­ment's future revenue-generating potential. This chapter reviews the key aspects of this evolution in an effort to draw out lessons of general importance to non­profit managers and board members.

Expenditures

Since 1960, the total operating expenditures of the Society have increased at a nominal rate of 9.7 percent per year, which is equal to a real rate of 4.6 percent per year. This rate of growth is surprisingly high when one considers that the average annual growth in GDP over the same period was just 2.7 percent. By no means all of this growth in expenditures was the result of programmatic ex­pansion. For example, between 1960 and 1970, operating expenditures at the Society more than doubled, from approximately $402,000 to $887,000,

Other than expansion, what else could account for the Society's high expen­diture growth rate? Research has shown that costs for institutions with labor-intensive processes for producing "output" tend to rise at a rate faster than the overall price level. This phenomenon, often referred to as Baumol's disease or Bowen's law, is caused by the fact that productivity in labor-intensive industries does not increase as fast as productivity in capital-intensive industries. If wage rates and the prices of other inputs remain in relative balance throughout the econ­omy, the unit costs for institutions with low productivity growth will rise relative to unit costs in general.