Managing Cash Flow in Crisis
When managing cash flow in times of crisis, sometimes cutting costs is not enough to keep nonprofits in the black. HighGround Associate General Counsel Marion Armstrong was recently #OutofOffice at the 2020 TXCPA Conference and shared how nonprofits can increase their income by revising their endowment’s spending policy.
PART 1 - Marion outlines what a nonprofit must consider when defining “income” in an endowment’s spending policy.
TRANSCRIPT: This is a follow-up of what I heard Steve saying right before I got disconnected about cash flow projections. That’s a big thing everyone’s watching right now and I think a lot of good commentary has come up about cutting what we can and looking at creative ways to save on cost. But then when we get to where we’re looking at essential programs, essential personnel, things we want to continue doing and are not on the table for cutting or reducing, we need to look for places where cash might be available to help sustain nonprofits during a time when fundraising may be down because events are cancelled and annual giving may be down because of the economic and financial insecurities that our donors are facing. Endowments is an area where we can look to increase our spending policy if that’s necessary - if we’ve looked at our cash reserves and we may need a bit more for the year. We can talk a little bit about spending policies in general and what endowments are and what they’re intended to do for nonprofits.
Endowments are restricted funds generally in a gift instrument – that could be an endowment agreement or could just be correspondence from the donor that came in with the gift – that indicates the fund is intended to be a permanent fund, so the principal of that fund will be preserved and the income will be spent annually for the ongoing operating needs of the charitable organization. The word “income” – particularly as we are here at the TXCPA Conference - may be a little confusing because it is different from accounting “income.” Under the Texas version of the Uniform Prudent Management of Institutional Funds Act (UPMIFA), “income” is considered to be determined under a spending policy that the organizations can evaluate annually. There are some rules for how we determine income and some of the conditions that a charity has to consider are: 1) the duration and preservation of the permanent fund (which is presumably permanent), 2) the purpose of the organization and the purpose of the endowment fund, 3) general economic conditions can be a consideration when you determine how much is appropriate to spend in a given year, 4) the possible effect of inflation or deflation, 5) the expected total return from the fund, and 6) the other resources available to the institution, which in a year like this may be a really valid consideration. So, as we look at those things, this may be a year where we want to increase that spending policy above what we had planned. Your organization’s governance will determine how to go about that. It might be a board approval process to look at the spending policy to increase the percentage or it may be something that staff determines. But looking at the endowment assets available to you and what would be a prudent spending policy in a year like this is certainly a task that could be undertaken for cash flow issues.
PART 2 - Marion explains the prudent endowment spending limits set by UPMIFA.
TRANSCRIPT: The statute [UPMIFA] does have a rebuttable presumption of imprudence. For smaller organizations, if your endowment is under $1 million, going above 5% creates a rebuttable presumption of imprudence in your spending policy. So, as you look at what assets are available to you, you really need to be able to credibly defend why we’re spending as much as we’re spending. Let’s say our organization is going to spend 6% this year and we’re small, then we just need to be able to show that it was prudent, taking into account all these considerations we’re looking at. For larger organizations, that presumption is at 7% and if you’re a large public university in Texas, you’re up to 9%, which is quite high, but those limits are in the statute. They’re not a prohibition necessarily, but it’s certainly wise to consider that if you’re going over that amount, you need to be able to defend that choice.
PART 3 - Marion answers how best to document changes made to an endowment’s spending policy.
TRANSCRIPT: Moderator: Is there a best practice that you would consider in how they document or what they document as they’re making the changes to these endowment policies? Should they take it before the board for approval? If so, what should they document in the minutes? Should they formally amend their policies? Do you have a best practice that you would recommend?
Marion: I don’t know that there’s one best practice. General points that I can make are that whatever the process is for setting your spending policy, that needs to be followed for any changes that you might make to your spending policy. As to how you document it, I would just recommend that you document it; the conversations that took place, whether on the board level or staff level, and what specifically we’re changing and potentially why, what economic considerations potentially, what factors were taken into account to set this spending policy, and how long we anticipate it lasting. A spending policy is part of an organization’s investment policy so to the extent that it may have an impact on your investment policy - because we may have a little bit higher allocation to cash right now just to make sure we have the liquidity there to cover our needs, but we are planning to pull that back down within a certain number of months. So just thinking about the details from a cash flow perspective and documenting what your organization has decided to do in the normal way that you would. Whatever that process is, it needs to be consistent for this as well.
PART 4 - Marion highlights the difference between “donor-restricted” and “board-designated” endowments.
TRANSCRIPT: Moderator: One other question on that that I think would be really helpful for some of the folks on the phone is distinguishing legally – there are some misconceptions around this from an accounting perspective – but distinguishing legally from what is termed “donor restricted” and what is termed “board designated” endowments and how they stem from the two of those.
Marion: That’s a great point to bring up. When we talk about endowments in terms of what the statute is considering an endowment fund, that is going to be what Megan called a “donor restricted fund.” That’s a fund where there is a gift instrument in writing and it does run the gamut between a formal giving agreement that maybe the organization signed along with the donors or it can be a lot more informal, a written note from the donor when they sent the gift that contains some kind of restriction on the spending of that fund. So, there will be a written restriction that says, “this is an endowment” or it may use other words like, “this is a permanent fund to use only the income annually.” Any language like that creates a donor restricted endowment. And I should say, as you think about your spending policy, if your gift instrument has a very specific definition of income or it has its own spending policy, that’s going to supersede the statute. So, anything that’s in there may limit your freedom to look at or change the spending policy, so make sure you’re looking at those giving instruments. Now the other thing Megan referenced is “board designated endowments.” Those are going to be assets that your organization has that did not come in under an instrument that would restrict those funds to endowment. But they’ve been set aside by the board as funds for our permanent use and we’re treating them like an endowment and using the income but they’re not donor-designated endowments. The big distinction there is that, for those assets, they were board designated as endowment and they can be board re-designated for our current needs if we need to. So, there’s going to be less restriction on what’s available from that pool of assets. You may have some more flexibility in being able to utilize or spend down those funds if you need.
PART 5 - Marion discusses the benefit of engaging with donors of restricted funds.
TRANSCRIPT: For gifts that have that endowment restriction and they’re restricted as to what we can spend and/or restricted as to how we can spend it (if it’s for a particular program or use), if the donors of that fund are all living - a lot of our endowment funds are given by an individual or a family, some may be a memorial fund or a fund given by a pool of donors and it would be less feasible logistically to get in touch with those, but if we’re assuming this is a donor couple or family who are all living – it may be a delicate conversation from a development standpoint but I think sharing with those folks the circumstances we’re in today is important. Having living donors where you can engage in that conversation and get their written consent to make changes that will enable you to spend those funds to the benefit of your general charitable purposes, that’s a great opportunity to unlock those funds, if you will, to make them available for spending that you need in this time.