By Jerry Wolf
Nonprofits have their antennae up as headlines appear on an almost daily basis. For example:
- Government Funding Cuts Put Nonprofits at Risk Across the Nation
- S&P 500 Drops 4.3% in First Quarter of 2025
- NASDAQ has its biggest quarterly pullback, 10.4%, since 2022
Couple this with a May 2022 Harvard Business School report, “Nonprofits in Good Times and Bad”, that concluded that revenue for nonprofits is procyclical, declining during bad times and increasing during good times. [1] Reductions in grants, drops in endowment values, and general revenue reductions may be beyond the control of most nonprofits. However, this article points out variables that may well be within the control of many nonprofits – it’s a question of recognizing the signs when they appear.
“Past performance is no guarantee of future results”
This phrase is generally treated as a warning label: Don’t assume an investment will continue to do well in the future simply because it’s done well in the past.
As finance people, we are used to seeing or hearing this warning, especially when we deal with investments. However, the same warning applies to organizations as well, especially in the current environment, when so many nonprofits depend on a shrinking amount of government grants.
Bankruptcy statistics bear this out. Since the start of Covid, the US has averaged about 20,000 business filings a year. The nonprofit sector is not immune either. As reported by NetworkDepot.com:
- 68% of nonprofits plan to cut programs and services in the next one to two years.
- 47% of nonprofit organizations report rising operating expenses.
- 42% of nonprofits report a lack of adequate finances/resources.
- Only 50% of nonprofits are successful, and 30% of them will cease to exist after ten years.
There are many reasons that nonprofits encounter financial problems. Some may be abrupt such as the loss of a major funding source. Other reasons may be more subtle with the root causes growing over time. As financial advisors for our clients, we need to not just report on where our clients have been but also guide them on where they might be headed.
As finance people, we focus on details. We want to make sure there’s a debit for every credit and those financial statements balance. That’s certainly important. But how we present this information to guide decision makers is even more important. Well before walking the C-level and boards through the numbers, there are indicators that all should be aware of and understand. These may be obvious to us as finance people but they won’t be obvious to all concerned:
- Is financial information presented regularly in a clear and concise manner
- Is the organization current on audits and 990 filings
- Does the organization have 3 or more months of coverage for operating expenses
- Is there a strategy for fiscal sustainability
- Are there appropriate internal controls in place
- How does the organization plan to fund growth
- Does the organization invest in fundraising
- How does the organization service its debt
- How dependent is the organization on grants
- How will the organization meet matching requirements on grants
Case Study
Let’s look at a case study that highlights the significance of key financial indicators. What could lead a world-famous nonprofit that started in 1889 to file for bankruptcy 122 years later? The data was there, several years before 2011, that indicated the eventual downfall of Hull House.
Many in the world of nonprofits have heard about the wonderful work of Jane Addams and Hull House. She co-founded Hull House in 1889 after visiting settlement houses in England. Hull House was one of the first settlement houses in the US and within a few years there were hundreds. Hull House’s programs focused on helping European immigrants settle in the US. Hull House provided classes focused on English language skills, child care, and apprenticeship programs, among other services. Ms. Addams helped create the ACLU and, in 1931, was the first American woman to receive the Nobel Peace Prize.
Hull House filed for bankruptcy in 2011 and closed in 2012! In the case of Hull House, there were many “tells” long before it closed its doors. What were these signals and what could have been done to save the organization. Many of these answers are relevant to what nonprofits are facing today given the current climate of nonprofit funding.
First, at a 10,000-foot level, a few of the accounting “tells” were taken from Hull House’s 990 filings:
1998 | 2002 | 2010 | |
Revenue Concentration: % of Revenues from Grants and Contracts | 90% | 94% | 90% |
Revenues Less Expenses | -4.3% | -2.1% | -4.3% |
Current Ratio | 2.4 | 2.9 | .8 |
Net Assets | $1.0M | -2.0M | -$5.0M |
A deeper dive over the period from 1998 to 2010 paints a more detailed picture.
- Net Assets
The first “tell” should have been 2001 when Net Assets fell below $0.
Several factors led to this:
- Revenue Concentration
Hull House depended on federal grants and contracts, mostly through the State of Illinois. Its total revenues grew from $9 million in the 1990s to a peak of $40 million in 2001. This growth was funded by grants from the State of Illinois as Hull House expanded its programs in Foster Care, Domestic Violence, Head Start, and Job Training. Overall, about 90% of total agency funding was through grants and contracts.
The Dot.Com bubble forced the State, over just a few years, to reduce overall spending on social welfare programs by $4.4 billion. As funds became scarcer, the State lengthened its payment cycle to six months. This put a strain on Hull House’s liquidity.
- Operating Losses
From 1998 through 2010, Hull House rarely had an operating surplus.
While many nonprofits often have operating losses, they compensate through active fundraising and reliance on endowment income. As we shall see, this was not the case with this organization.
- Collections
As Hull House grew from $9 to $40 million, it increased its role as a subrecipient to the State of Illinois as its primary funding source for its core programs. As the State faced its own fiscal problems following the Dot.Com bubble of 2001, it delayed payments to agencies like Hull House.
At first glance, this did not impact Hull House as its Days in AR did not increase. However, the above chart does not fairly present how this delay in payments effected Hull House. While the agency’s days in AR never reached two months, it received advances on its grants and contracts. In one of its last audits, for the year ended June 30, 2010, Hull House showed deferred revenue for its grants and contacts of $1.5 million, an increase of over 30% from the previous year. Most government grants and contracts are on a cost-reimbursement basis so advances would be treated as deferred revenue. Without these advanced revenues, the Days in AR would have been significantly higher.
- Fundraising
Facing falling revenue, Hull House did not invest in fundraising. While it reported expenses for fundraising, donations were not a major source of revenue, except in 2007, when fundraising returned $7.59 for every dollar invested. This was only after Hull House had almost exhausted its portfolio by the end of FY 2006.
- Use of Endowment
In 1998, Hull House had almost $5 million in its endowment, 63% in investments.
Investments grew from $3.1 million in 1998 to $3.9 million in 2005. Still, the growth during this 7-year period was about 26%, or an average of 3.7%.
Once Hull House’s own investments were liquidated, the organization went to the Jane Addams Hull House Association Foundation, which existed exclusively to manage the endowment funds of Hull House, for loans. In 2008, before the loans, the Foundation had about $2.5 million in assets, primarily in publicly traded securities. Hull House’s president and CEO was also listed in the same position for the Foundation starting in 2001.
Faced with annual losses, Hull House started to sell investments to fund operations. By the end of 2007, investments had fallen to $875,000 with balances of $0 thereafter.
Impacts
Fiscal challenges eventually led to consequences for staff. Personnel costs were about 65% of total expenses. Other major expenses were the costs of operating 40 sites to serve Hull House’s 60,000 clients.
Staffing peaked at 550 employees in 2009 but fell 15% the next year. However, the fiscal situation effected staff long before. In 2002, Hull House had frozen its pension plan and deferred contributions making it difficult to recruit and retain staff. By 2009, it had defaulted on its pension obligations.
Conclusion
Occam’s razor is the problem-solving principle that recommends searching for explanations constructed with the smallest possible set of elements. Looking back 15 to 25 years, the “simpler explanations” for Hull House would probably be:
- Lack of revenue diversification
- Rarely reporting an operating surplus
- Minimal fundraising
- Limited back-office resources
- Cutting employee benefits making Hull House less attractive to top tier personnel
The Board may not have fully understood the intricacies of federal grants and contracts and this was compounded by the increasing turnover on the Board.
As Hull House showed negative net assets in 2001, the Board and C-level personnel should have initiated a plan for addressing sustainability of the organization. Looking back, the trend was clear in 2001 but it took 10 years to fully play out. The financial warning lights should have been flashing long before a bankruptcy filing.
There are lessons here for grantees (subrecipients) involved in federal programs. Grants are useful for funding operations but dependency comes with its own problems.
Jerry Wolf
Jerry is a Director in the Fiscal Services practice of MGT Impact Solutions, LLC. Jerry is based in Chicago. He has 40+ years of financial consulting experience with EY, MAXIMUS, Public Consulting Group, and MGT. He holds a BA from Washington University in St. Louis, and MA and MBA degrees from The University of Chicago. He is a licensed CPA in Illinois. He also lectures in Nonprofit Finance at the Crown School of Social Service Administration’s Social Sector Leadership Program at The University of Chicago.
[1] “Nonprofits in Good Times and Bad Times” by C Exley, N Lehr and S Terry; May 2, 2022
