Examining Nonprofit Liquidity Issues: A New Look at Government Contracts

New York’s Human Services Council (HSC), which helps member organizations address and meet human service needs more effectively, issued a report this month that served as a call to action—and a cautionary tale—for all nonprofits.

As we’ve discussed on the Nonprofit Standard blog, the nonprofit world was shaken last year when New York’s Federation Employment and Guidance Service (FEGS) filed for bankruptcy, a move no one saw coming. In our previous post, we addressed the financial problem that ultimately caused the downfall of this established and otherwise successful organization – a lack of transparency and understanding around the entity’s liquidity and cash flow.

What the new HSC report asks nonprofits to consider is the factor that caused the gradual weakening of the organization’s financials in the first place, as well as what led, in part, to the closures and mergers of other human services organizations, including Alianza Dominicana, GroundWork, Steinway Child & Family Services, Day Top Villages, and Palladia. Why is it that 60 percent of human services nonprofits are financially distressed? What is the systemic issue threatening the sector?

The answer, in part: underfunded government payment rates.

Like many human services organizations, which have a higher rate of insolvency than other types of nonprofits, FEGS was funded in large part by public contracts with the government. Over several decades, the government has outsourced many legally-mandated support functions to nonprofits, which are nimbler and can administer these services at a fraction of what it would cost the government to handle them directly. In New York City alone, government human services contracts are estimated at more than $5.8 billion in value for the current fiscal year.

While an offer of a government contract may initially seem like a boon to a nonprofit, there’s a catch that nonprofits must consider carefully: most of these contracts only pay about 80 cents or less for every dollar of actual service delivery costs. Combine that with the fact that these contracts often dominate provider budgets, and you’ve got lots of organizations with a large and unexpected budget hole that is nearly impossible to fill with private funding. This issue with government contracts is likely why organizations with budgets between $10 million and $49 million are more likely to be in financial distress than organizations with budgets of less than $1 million.

What happens to a nonprofit that accepts underfunded government payment rates?  Over time, underfunding leads to inadequate investment in the nonprofit’s facilities, potentially leaving them in disrepair and opening the door for safety risks. It can force nonprofits into paying low salaries, leaving some employees to depend on safety-net programs like food stamps and Medicaid. Nonprofits may find themselves repeatedly borrowing to make rent or payroll, followed by accrued interest not covered in government contracts, or they may fail to consider the regulations, procedures, multiple audits and other administrative costs that accompany government contracts.

To help human services organizations plan for and prevent these issues, the HSC identifies three common problems with government contract-funded programs and recommends solutions for each:

1. Programs are developed without consulting the human services providers responsible for implementing them, resulting in ineffective or unworkable programs. The HSC recommends that providers be involved in the design of programs at the outset and that wasteful oversight procedures be replaced with more meaningful approaches, to ensure providers are being financially and programmatically responsible. In addition, providers should be certain that funding is available to invest in the organization’s future – including new information technology and capacity building and training – to ensure that the transition to Medicaid Managed Care benefits the organization and those it serves.

2. The grants rarely cover operating costs, and payment is frequently late or unpredictable. The solutions to this problem are simple, though that’s not to say they will come easily. Contract payments must be timely and must fully cover operating costs, including indirect costs (such as infrastructure) frequently dubbed as overhead. Building maintenance, accounting, human resources, information technology and other administrative work are vital to operations and for “keeping the lights on.” Contracts should also allow for inflation and other unanticipated expenses.

3. The sector lacks adequate risk assessment. The HSC says that providers will need to accept responsibility for identifying and addressing risks to protect the organization and those it benefits. To do this, they will need to establish an RFP rating system and put financial and programmatic reporting systems in place that allow them to quantify the impact of changes brought on by contract work. In addition, they should request that private and government funders underwrite the monitoring systems needed.
In this report, we see just one of the major causes for nonprofits’ liquidity and cash flow problems. This systemic (yet often overlooked) underfunding issue further highlights the need for nonprofits to produce transparent and robust financial statements that make boards and other leadership aware of liquidity issues before they go so far as to incapacitate the organization.

For more, read the full Human Services Council report here: http://www.humanservicescouncil.org/Commission/HSCCommissionReport.pdf.