By Marcus Coetzee, 7 July 2021.
Last week, a new client asked me the following question, “How can we earn more income and gain more control over how we can spend it?”
This resulted in a productive and impactful discussion. I thought it would be useful to share the highlights with you, and link to other articles and presentations that explain some of the principles in more depth.
Non-profit organizations need to increase their income, and have more control over how this money can be spent, in order to increase their social and environmental impact, and to reduce their financial risk. This is all part of becoming a ‘sustainable’ non-profit organization.
1. There are different sources and types of income
Non-profit organizations can have a mixture of different types and sources of income. Types of income typically include things like grants, donations, revenue and investment income. Sources of income include clients, customers, foundations, corporate social investment departments, government departments, members and investments.
Having a diversity of income sources can reduce the financial risk of any one income stream being terminated. But at the same time, it is wise to focus your efforts on just a few of these types and sources of income, otherwise your attention and efforts may be spread too thinly.
2. Some types of income are ‘restricted’
Income that is ‘restricted’ has lots of strings attached. This means that you have little power over the types of expenses that you can use this money to pay for.
Some donors will also limit the amount of money that you can spend on overheads. I strongly believe that this does more harm than good since the ratio of overhead to operational expenses depends largely on an organization’s business model and context.
Income in the form of grants is defined by a contract with the donor that specifies the activities, outputs and outcomes that the funds must be used for, and sometimes the budget limitations for each expense line item. In contrast, income in the form of donations is unrestricted and so much more flexible – it must just be used ethically to further an organization’s mission.
Revenue is also ‘unrestricted’ income, but you will need to deliver the goods and/or services that you promised in return for this money. Investment income is also ‘unrestricted’.
3. Five approaches to earning more income
There are multiple ways for a non-profit organization to get more income. The best approach depends on your context, business model, capabilities and assets. It is impossible to generalize and state that one approach is better than another. Here are five approaches that I have either helped clients to implement or seen others implement successfully.
3.1 The first and most obvious approach is to fundraise more effectively.
Fundraising is primarily the process of securing donations and grants from various sources.
Nowadays fundraising requires a specialist set of skills. Organizations must either develop their own capabilities or employ or contract a specialist.
It has become infinitely more difficult to raise funds than it was when I first joined the non-profit sector in 1996. There are hundreds of thousands more non-profit organizations in South Africa than in the 1990s. Competition has emerged from within the private sector. Fundraising has become a fiercely competitive process.
Too few organizations have realized that fundraising tends to be easier and more successful when your organization has cultivated a good brand that serves as a magnet for opportunity, and has learned to market itself effectively. This is achieved primarily through positioning oneself clearly in the minds of your intended audiences and then engaging in proactive public relations activities that make the right sort of noise and encourage productive conversations. I work with some organizations that have become so skilled at doing this, that most of their donors approach them and are flexible about the terms of their relationship.
3.2 The second approach is to change how your organization does its budgets and apply another budgeting technique.
Most non-profit organizations use one of four budgeting techniques that I call ‘organization-based budgeting’ where they present their donors with a portion of all the costs that are relevant to the proposed project. Their donors choose the line items, and the proportion of these line items, that they want to fund.
Donors typically pay too much attention to the cost structure of organizations. I would much prefer them to focus on how a project will achieve its impact and whether they are getting a good social return for their funds. This is what truly matters to their beneficiaries and cause, instead of the internal cost structure of a nonprofit organization they are giving money to. Skilled fundraisers are able to focus the conversation on this.
There are three other budgeting techniques that an organization might be able to use. Output-unit budgeting focuses the budget on the unit cost of the outputs to be achieved. Outcomes-based budgeting does a similar thing but focuses on the outcomes and changes that the organization will achieve in the world. Finally, activity-based budgeting uses a charge-out rate to cost each activity.
These three budgeting techniques can enable an organization to generate a surplus/profit, but the feasibility of this is dependent on its context and the amount of bargaining power it has with its donors.
3.3. The third approach is to earn revenue from customers or clients.
Revenue is defined as the income earned from selling goods or services to customers or clients. I define customers as being individuals whereas clients are organizations.
Non-profit organizations that earn more than 25% of their income in the form of revenue may consider themselves to be social enterprises.
The tactics for earning revenue depend on the organization. For example, a non-profit organization that serves homeless children cannot charge these beneficiaries a fee for their services as this would be both immoral and non-viable. In contrast, a non-profit organization that advocates for strategies to mitigate climate change might be able to charge corporations and government departments for its consultancy services. Similarly, an organization based next to a college might have the means and opportunity to run a very profitable coffee shop.
Non-profit organizations in South Africa can earn revenue to support their mission. They can also retain their accreditation as Public Benefit Organizations with the South African Revenue Services, and their ability to issue S18A certificates, provided they meet certain conditions. For example, they must keep the revenue and associated expenses separately in their accounting system and they must not let their revenue activities distract them from their mission. They must also make provision for income tax which may be levied on this sort of income. I have gone into more detail in the presentation, ‘Social enterprises: don’t let legal forms get in the way’. Suffice to say, these obstacles can be overcome and there are specialists such as NGO Law SA that can help you to do so.
There are also some instances where an organization will need to house these business activities in a subsidiary (i.e. privately-owned company) as part of adopting a hybrid structure. In such cases, the financial benefits to the non-profit organization would assume the form of revenue as a result of invoicing the private company for any services rendered to it. This may help to absorb the overheads of the non-profit organization. The non-profit may also earn income from dividends declared out of the profits of the subsidiary company, but this is technically classified as investment income.
To earn revenue, an organization must learn to think like a social enterprise and examine its capabilities and assets, and how it can use these to generate income. Capabilities are things that an organization is extremely good at doing and assets may be things like its property, brand or technology. I have outlined a methodology for doing this in my presentation, ‘When are business ideas good ideas?’
I believe that any revenue-generating activity or ‘business venture’ should be able to either generate a net income in excess of 5% of an organization’s total income or absorb overheads to the same proportion. Otherwise, it will prove to be too much of a distraction and not worth the effort given the risks involved. In other words, the opportunity cost will be too high and there are other things that the organization should rather focus its efforts on.
Finally, I have worked with many non-profit organizations over the years that were using either donor funding or their financial reserves to subsidize loss-making businesses that had no hope of ever achieving this threshold. We promptly made some necessary endings and shut these businesses down.
3.4 The fourth approach is to earn income from investments.
For the purposes of this article, I define investments as income in the form of dividends or interest that emerges from a separate legal entity that the non-profit organization does not have to manage or oversee on a day-to-day basis.
Investing requires that a non-profit organization has some savings that can be invested or is able to raise finance (i.e. take out a loan or get investors to buy equity in a business that the non-profit organization owns).
The most stable and generally sensible option is to put your savings in an investment fund that is managed by a licensed financial services provider. There are a wide variety of investment funds available, and I suspect most non-profits organizations pay insufficient attention to them.
Another option is to buy private equity in an existing company. For example, I have had clients that have had sufficient funds to buy shares in office buildings, airlines, hotels and independent power producers. These investments are somewhat more risky, and while I have seen them make some gains, I have also seen non-profit organizations lose millions of Rands in this way.
Finally, non-profit organizations can set up an ‘unrelated’ business that will function independently of it and have its own legal form and management team, though it might make use of one of the organization’s assets that it owns (e.g. land in a prime location).
When evaluating how investments can be used to increase income, an organization must consider the effort, risks and opportunity costs associated with these investments. My supposition is that these will turn out to be much greater than anticipated. For this reason, I caution non-profit organizations from embarking on this fourth approach, unless they have developed a specific capability to find and manage their investments.
3.5 The fifth approach is a roundabout approach to having more disposable income, and this is to optimize one’s cost structure
There is a delicate balance that non-profit organizations must maintain between their fixed overheads and their income. On one hand, organizations may need a certain size of fixed overhead in order to function and achieve economies-of-scale. But on the other hand, their overhead may become bloated over time, and lose the flexibility to expand and contract relative to their income at the time, and this will inevitably create a cash flow crisis.
There is value in striving towards a lean cost structure as this will enhance financial sustainability and free up potential money that can be used for more important expenses.
I would like to close this article by reiterating that it is wise for non-profit organizations to dedicate the time and effort to consider how they can increase and diversify their income sources, and gain more control over how they can spend this money.
How this can be done will depend on an organization’s business model, context, capabilities and financial position. There is unfortunately no general rule that a particular approach or type of business would be better than another.
Nevertheless, it can be an exciting and empowering endeavour to find ways of improving your income.