Ever met a successful business professional who, offhandedly, remarks how simple it is to run a nonprofit, compared to a “real” company?

He or she never tried to manage a portfolio of restricted grants.

How do I know that? Because there’s no analog in the for-profit world. Restricted funding is the one area where nonprofit accounting is far more complex than business accounting. It complicates management. Handling it well is both art and science.

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Restricted funding can create a paradox – nonprofits that appear to be highly successful can literally grow themselves to death. Two authors, Ann Goggins Gregory and Don Howard, coined a catchy term several years ago: the Nonprofit Starvation Cycle (see their article here). Three words tell a cautionary tale. This cycle happens when an organization commits itself to new spending, without ensuring adequate funding of its core expenses.

Restriction is a legal requirement, and you don’t have the option of spending restricted funds outside grant requirements (a big no-no). An overly-restricted funding portfolio can drive a nonprofit into bankruptcy or closure, and getting more designated money can actually make things worse.

Managing restricted funds can feel like a shell game. When nonprofits get into trouble, it’s usually because they got wrapped up in the game, rather than scripting their role.

Why play the game at all? One reason: restricted grants and contributions are as appealing as ever to donors and public agencies that often want to support a particular program or initiative. Many assume that the organization can “keep the lights on” through some other vague means, and some don’t understand how important or costly core operating capacity is. These facts of life are unlikely to change anytime soon. So, game on.

The basic problem here does not lie with funders, however. There are pathways for nonprofits to capitalize on funding opportunities and maintain healthy business models. The challenge is that it’s usually not intuitively obvious where trouble may lie in an organization’s revenue structure. A leap of faith – “let’s take the available funding, make sure services are available, and work out the details later” – can’t substitute for a mindful financial strategy.

Here are six suggestions for playing and winning the restricted funding game.

1. Know your costs – and ask for full funding.

Do you know the full costs of each of your organization’s programs and activities? If you do, you’re in elite company. In two applied research studies covering over 80 nonprofits, Public Interest Management Group found that less than one-fifth of organizations studied had data on full activity costs. That means more than 4 out of 5 nonprofits may essentially be flying blind when it comes to restricted grant budgeting.

There are two reasons you need to know full costs of all of your activities:

  • First, when you pair cost data with revenues generated by specific activities, you can proactively make strategic choices that will impact your financial sustainability.
     
  • Second, you’ll know how to price your restricted grants.

You read that right. You are pricing programs to funders. If you were a car manufacturer, you wouldn’t sell cars for less than the full cost of producing them. Same’s true here. Nonprofits need to ask for full funding in every grant request or contract negotiation.

To ask for it, you need to know full costs. This is not necessarily intuitive! It requires analysis. There are DIY methods like Matrix Mapping, or you may want to engage a consultant. Either way, knowing full costs and ensuring you price grants correctly can pay huge dividends.

2. Know (don’t assume) your restrictions.

Suggestion #1 requires some time and effort. This one does not. I’ve worked with nonprofits that have assumed restrictions on grants based either on what the request was, or some informal sense of what the donor wanted. Neither of these things determines a restriction.

What does? It’s the specific wording in the grant award letter or service contract. Surprisingly often, an award letter’s wording is much less restrictive than the request. Fee-for-service contracts may not cover full funding of services, but they often have no restriction at all on how the money may be spent.

This means that you may have a lot more flexibility than you think.

3. Distinguish “hard” vs. “soft” money.

I look at restrictions two ways: There are hard restrictions, which are tightly defined (such as funding for a new project, a particular staff position, etc.), or more general limits, such as funding a large program that is in the organization’s core budget, and is subsidized by unrestricted dollars. I call the latter type of grant soft restriction, because you can use it for its restricted purpose while dislodging unrestricted funds, which in turn can cover core operating expenses.

Soft-restricted funds behave a lot like unrestricted dollars. Being savvy about this distinction (which requires being on top of the numbers) can help you raise more money, because you can give donors appealing options without jeopardizing core functions.  Many successful nonprofit business models employ this approach, which can help you manage restricted funds more flexibly.

4. Charge all of your indirects.

This is slightly different from full-cost pricing, above, and every bit as important. Now I’m focusing on accounting for funds already committed to you.

You want to demonstrate that you’ve used all restricted funds for their intended (and required) purposes. (Otherwise, you should plan to return any unused money to the donor.) You can and should allocate all legit indirect costs to each grant’s expenditures. In my experience, most nonprofits do not do this!

Keep in mind that indirect costs may often be nearly as high – and sometimes higher – than direct costs. It’s not only necessary to know your full costs; you need to bill those costs to those grants.

5. Proactively plan restricted fundraising and spending.

Very simply, you can get a few legs up on the Starvation Cycle by integrating your fundraising plan with a grant management plan, which will guide spending. Don’t assume you’ll be able to just work it out if you get all the grants you plan to go after!

Before and after you get grants, be clear how all restricted dollars will fit together in the puzzle, and how you will fund your core operating budget.

6. Be willing to just say no.

This is the simplest suggestion to make, and the hardest to follow.

What if you have the opportunity for a million-dollar grant to fund an exciting new initiative? Let’s say your indirect expenses will be $250k, but the funder limits “overhead” to 10% of grant funds. If you don’t know where the other $150k will come from, you can politely tell the funder “no, thanks.”

Better yet, you can use the opportunity to help educate the funder about your cost structure, and the realities of running an organization. They may be able to restructure the grant to be partially unrestricted, or may even change their policy.

Either way, your business model will be the winner.

Strategic pursuit and management of restricted funding is a big part of our business planning process.  The common theme of the six suggestions above is that they all put you out in front of one of the most challenging management issues nonprofit leaders may face.