posted by Anjali Deshmukh, Associate Director and Angela Francis, Senior Associate Nonprofit Finance Fund

Welcome to Research Friday! As part of a continuing weekly series, each Friday we invite a nonprofit scholar, student, or professional to highlight current research reports or studies and discuss how they can inform and improve day-to-day nonprofit practice.

There are over 1.5 million nonprofits in the United States. Of those, three-quarters (almost 1.2 million) have annual budgets under $1 million, and most are even smaller. What these organizations lack in size, however, they make up for in impact. They respond to localized needs, are absolutely critical to community building, and are staffed by people with deep knowledge and caring for the communities where they live and work. These organizations often serve communities that have been abandoned by countless others. Yet, in the Nonprofit Finance Fund’s (NFF) work with small nonprofits (most recently through our Capital and Capacity for Economic Recovery Initiative), we’ve found that these essential organizations often struggle to match available funding sources to their actual needs, which results in a number of challenges. So what are some of these challenges, and what makes small nonprofits different from their larger counterparts? Our new report, Small Organizations Solving Big Problems, explores this question.

Unlike large organizations, small nonprofits often do not have in-house financial expertise, making it hard for them to closely align their finances with their strategy. The executive director often assumes leadership through deep knowledge and understanding of the organization’s programs but has significantly less experience in finance. Due to resource constraints, they often handle finances themselves, relying on part-time bookkeepers who aren’t deeply enmeshed in the organization’s strategic goals. Without internal expertise and real-time financial tools (such as cash flow reports or program profitability assessment), data-driven decision making is just not possible.

Wearing many hats is the norm for staff at small nonprofits; that’s the reality of organizations that run lean. But with all of their resources going directly into program delivery, small nonprofits cannot invest in their infrastructure - let alone provide reasonably competitive compensation for their employees. While this is a common problem for nonprofits of all sizes, it’s especially pronounced within small organizations. To keep infrastructure and occupancy costs down, these organizations may borrow free space in a basement or operate exclusively with donated (and outdated) computers and servers. To cut down on administrative expenses, the executive director may work nights and weekends to deliver programs, run the organization, fundraise, and pay the bills. Funders encourage and applaud their grantees for such resourcefulness and creativity, but at a certain point this model becomes unsustainable.

Another challenge for small organizations lies in the break-even mindset: an organization that devotes nearly all of its resources to programs will have a hard time justifying a surplus. But generating a surplus is the primary means for many small nonprofits to accumulate savings. Although this challenge affects many nonprofits, it really hits home for small organizations. Because unlike larger agencies, small nonprofits have very limited access to credit, which can be essential when managing government payment delays or other risks. Without a cash cushion on hand, small organizations can be deeply vulnerable to closure in times of economic crisis.

The bright side? Sometimes smaller organizations can weather a storm better than their larger counterparts by shifting resources more nimbly. They also tend to have more flexible business models and the ability to adjust to a changing environment more rapidly. Sometimes, wearing all those hats even comes with advantages. When employees collaborate freely across skill sets, it speeds up the internal learning process and leadership can more easily develop new ways of thinking.

Nonetheless, small organizations need a range of key supports, and they often have a hard time securing them. Below are five tips to help small nonprofits improve their financial management skills amid budget constraints:

• Pay as much attention to financial practices as you do to mission. If you don’t have adequate resources to develop your own financial tools, borrow templates from a peer organization or bring on staff or board members (or both!) with expertise in nonprofit finance.
• Recruit board members based on an assessment of needs. Small organizations often need more than just governance and fundraising support from the board. Put in writing the function that your board is meant to serve, revise expectations as your organization evolves, and work towards specific goals in terms of board composition and purpose.
• Embrace in-kind donations - but have a concrete plan for replacing volunteer labor or worn-out equipment when necessary. It’s OK to turn down donations that your organization does not want or need.
• Beware of facilities. We call it the Edifice Complex! We’ve seen organizations jump at cheap purchases and then drown under the unseen costs of upkeep. Depreciation is a very real cost that must be addressed and planned from the beginning.
• Growth is not always good. Be wary of the mission creep and imbalances that can come from tacking on new programs. Added revenue means added expenses!

Following are our tips for supporters of small nonprofits:

• Fund important capacity needs like financial reporting systems, development staff, and improved technology. Organizations are most effective when they’re operating with the appropriate infrastructure. Mission returns from these investments can be just as large as those from a program grant.
• Fund what already works, rather than only offering funds for new or innovative approaches - especially when funding small, local organizations that are filling a real community need.
• Encourage long-term planning for facility replacements and repairs by funding planning and contributions to building reserves. Solely funding urgent requests validates an “emergency only” approach to facility management.
• Match grant administration to grant size. It’s simple but so often overlooked! When developing application and reporting requirements, a $5,000 grant should come with different reporting expectations than a $500,000 award.
• Timing is everything! Consider the impact of payment timing on your grantees’ cash flow. For many small nonprofits, the arrival of the check is just as important as when grant is awarded.

You’ll find more tips and examples in our report, Small Nonprofits Solving Big Problems.

Editor’s note: A version of this post originally appeared on NFF’s Money and Mission blog at the Chronicle of Philanthropy.

Anjali Deshmukh is an associate director and Angela Francis is a senior associate with Nonprofit Finance Fund (NFF). A 501(c)3 nonprofit, NFF pushes for improvement in how money is given and used in the sector. Since 1980, they have worked to connect money to mission effectively, so that nonprofits can keep doing what they do so well. NFF provides financing, consulting, and advocacy services to nonprofits and funders nationwide.

Like this article? Get another! Read Donnalee Sarda's "How a small nonprofit survived the Great Recession."