Magazine article

The Australian Institute of Company Directors’ (AICD) key study of the not-for-profit (NFP) sector, the 2016 NFP Governance and Performance Study, has found that it is time for government, the community and the sector itself to recognise that NFPs must become financially strong to ensure that their longer-term objectives can be achieved. To become financially strong, they must make a profit and build up appropriate levels of reserves.

The study, which was completed by close to 2,000 respondents and included ten focus groups held across Australia, highlighted many of the challenges and opportunities facing the sector in the 21st century.

Many in the community and government still view NFPs with a sense of old world nostalgia and fail to recognise that the sector has evolved quickly as changing market conditions and increasing regulation swamp those who are not able to react and innovate.

In this dynamic environment, where many organisations are no longer “block funded”, NFPs need to have positive cash flow to keep their doors open. Importantly, they need to have sufficient cash reserves to cope with the inevitable lag between invoicing after providing the service, and payment. NFPs also need to build balance sheets with sufficient reserves to ride out the difficult times and maintain a skilled workforce. In essence, they need to aim to make a profit.

AICD NFP sector leader, Phil Butler, notes that there was often a collective intake of breath at focus groups when the idea of turning a profit was mentioned. “Many attendees stated that they didn’t like the word ‘profit’ and that they looked to make a modest surplus or break-even. However in the same groups, others spoke confidently about their focus on achieving a profit margin of about 20 per cent and the need to build this margin year-on-year.”

In addition to the discomfort around the term “profit”, there was also some confusion about the level of profit being budgeted or achieved. It was surprising that a relatively large number of directors could not readily identify the level of profit they were aiming to achieve.

It could also be seen that many directors were very conservative in their oversight of the financial status of their NFP. Relatively few organisations had investigated debt as a potential for growth opportunity and there was discussion of lazy balance sheets being quite prevalent in the NFP sector. Perhaps this is reflective of directors being much more risk-averse in the NFP setting than they would be in their for-profit roles.

There was a similar conservatism within many of the organisations that had built up substantial reserves. Many NFPs had their reserves invested in very low interest options such as term deposits or cash and there seemed to be little inclination to discuss better ways of investing such funds. Other NFPs, however, had sophisticated reserves policies and objectives to achieve return of 5 per cent or more above inflation over the long term. Such policies meant these organisations were able to focus on long-term investments and ignore the volatility of annual returns.

A more strategic approach

A second conundrum facing NFPs emanates from major changes currently occurring in Australian society, particularly in the NFP sector. Many of the surveyed directors reflected on the necessity for boards to adopt a more strategic focus, yet, when asked about their priorities for the coming 12 months, a high percentage focused nearly entirely on operational and short-term issues.

This short-term focus, which has been enhanced by anticipated disruption from the introduction of the National Disability Insurance Scheme (NDIS) and client directed care, is understandable as directors wrestle with changes that will have immediate impact on their organisations.

That said, however volatile the current environment may be, strategic thinking should not be forgotten by boards. When directors were asked about the top three things they could do better, strategic planning topped the list at 33 per cent and oversight of strategic implementation came in second at 32 per cent. These responses were given at a time where 40 per cent of the same directors reported that that their highest priorities in the next 12 months were “responding to changes in our operating environment”; “diversifying income sources” (30 per cent) and “managing costs” (27 per cent).

Clearly directors recognise the need to focus on strategy but are absorbed with operational issues. A longer-term concern is the struggle many boards have in their succession planning for directors who could bring strategic thinking to the table. Some used formal training to build those skills while many simply left it to the individual to up-skill.

Mergers and collaboration

In contrast with the 2015 survey, which indicated an increased focus on mergers in the NFP sector, the topic was not a major feature for the 2016 focus groups. The rate of mergers has not changed since 2015, despite 35 per cent of directors stating at that time that their organisation had discussed a merger in the previous year. Indeed, only 8 per cent of organisations were currently undertaking a merger and 6 per cent had completed a merger in the past year.

In 2016, the study focused on the importance of collaboration between NFPs rather than mergers. Directors felt that collaboration was a major strength of the NFP sector. In fact, many would argue that this is one area in which NFPs outperform other sectors.

Collaboration occurs in many different forms. For some it involved subcontracting services to another organisation (perhaps in another location) that could do the work more effectively than themselves. For others it was a collective effort to work on a piece of advocacy or sharing back office services to enable greater efficiency. The study also found that the level of collaboration between NFPs was likely to grow in almost all areas over the coming 12 months.

Performance measurement

In the 2014 and 2015 NFP governance studies, it was apparent that many NFPs found appropriately measuring their performance to be a challenge. In the 2016 study, it became apparent that performance measurement is gaining momentum, particularly on the back of rapid advancements in technology.

Historically, performance measurement has been more difficult in the NFP sector, but this is now changing with emerging opportunities to effectively measure performance against specific KPIs and assess how well the organisation is achieving its strategic goals.

The cost of performance measurement has previously been seen as inhibiting the development of appropriate performance measures, however changes in technology are helping to reduce the cost substantially and also to make the measurement more relevant.

Importantly, directors expressed reluctance to become “slaves” to technology fads and instead are determined to ensure that they focus on measuring important things, particularly around client impact.

What do we call the sector?

Throughout the study and at a myriad of AICD events, there has been a discussion around the problem of the term “not-for-profit”. Should a group of entities be referred to as to what they are not instead of what they are? “For purpose” is probably the most common alternative to NFP. For others it is “for good” or the “third sector”. The AICD has deliberately refrained from venturing into this debate, however this year’s study has highlighted, perhaps for the first time, some of the reasons that change is necessary. The real need for change may not be in the title of the sector, but rather in the perceptions of the sector by the broader community.

The NFP sector has a long and proud history of serving many of the most vulnerable in our society. The sick, disabled, homeless and disadvantaged have long been looked after by a range of charitable organisations. In doing so, many of these organisations have used volunteers to achieve great outcomes and enlisted the support of the community, which is better off for supporting these ventures.

This very success is now one of the sector’s greatest challenges. In a time when, on average, our citizens have never been wealthier, there is still a perception that NFPs should “run on the smell of an oily rag” and that NFP staff should either be volunteers or receive wages that are lower than in other parts of the economy. Even our tax system continues this imbalance with its range of measures such as fringe benefits tax concessions designed to assist in attracting employees to these lower-paid jobs.

This year’s governance study reflects on the need to change perceptions of the NFP sector. While many organisations may still run on very old structures, there are many more that embrace the 21st century and new ways of doing things. The introduction of NDIS and client directed care has forced many organisations to review their operations and they are among the best at providing excellent services in an efficient manner.

Despite this, the media and broader community portrayal of the sector seems more closely aligned to the society of the 1950s than a modern day Australia. Internationally, there have been calls from NFP reformers such as US entrepreneur Dan Pallotta to change the way we view the sector, however that does not seem to have been understood by the broader community. Even leaders within the NFP sector have a negative perception of the sector. There were observations in the 2016 focus groups that lower expectations are often placed on the CEOs of NFPs than other sectors. This could be seen in comments such as “we are so lucky to have them” in reference to the CEO.

A changing relationship

While there is recognition that perceptions of the sector need to change – from both within the sector and in the broader community – what is essential is that there is a change in the relationship between governments (the biggest funder of the sector) and NFPs.

The study again found directors felt that federal, state and territory governments did not respect the sector. This could be seen in the way that grants were implemented or withdrawn and the nature of reporting requirements.

In Governance of the Nation: A Blueprint for Growth, released in March 2016, the AICD called for five-year funding agreements wherever appropriate for NFPs. This would reduce the terrible cycle of NFP organisations waiting until the last moment before finding out if they would receive another tranche of funding. This is not the way to run a sustainable organisation and to retain highly-skilled employees.

Many respondents to the 2016 study called for the relationship between NFPs and government to become more of a partnership. NFP leaders recognise that society’s big challenges can only be met when government and NFPs work collaboratively and felt an old style “us and them” approach was no longer appropriate.

In addition to five-year funding agreements, it was also highlighted that a last-minute reduction in funding is very counter-productive. It was recommended that, wherever possible, decisions to change or substantially reduce funding should be given with 12 months’ notice thereby reducing the negative impacts on beneficiaries and the organisation itself.