When Nonprofit Finance Fund’s fourth annual State of the Sector Survey of nonprofit financial health came out a few weeks ago, I tried to convince a journalist about the urgency of covering the results. My pitch didn’t work.

“So you’re saying that nonprofits are facing a financial crisis. Well, that’s not news. They’re always complaining about not having enough money. What’s new?”

To be fair to the skeptical journalist, the results do seem to show that nonprofits in the US have returned to a pre-crisis level of crisis. Half report they felt financially stable in 2011. And while disappointing, perhaps it is not news that three-quarters of government-funding recipients report that their funding does not fully cover their costs. Or that payments are coming later and later while the bills keep piling up. We’ve come to expect nonprofits to find ways to keep their doors open despite seemingly-permanent financial stress.

So why our concern? After all, our society has become accustomed to expecting nonprofit organizations to survive rather than thrive. But put some of these survey findings alongside an understanding of likely economic and political trends in the next few years and it becomes clear that something quite different, and alarming, is happening.

We are seeing a structural shift in the burden being placed on nonprofit organizations. For the fourth year in a row, our survey reported rising demand for most organizations, with nine out of 10 “lifeline” services organizations reporting increased demand and as many anticipating even further increases in 2012.

Unfortunately most organizations are ill-prepared to handle this increased burden. Funding is not keeping up with increased demand. Federal stimulus money flowing through states in 2011 helped mask social service spending cuts that are going to bite in 2012 and likely get worse in ensuing years. Fewer than half the organizations surveyed report having more than three months of cash on hand to cover costs.

As funding gets cut and delayed, nonprofits are finding all sorts of ways to cope with continued economic pressure. They are making tough choices—to cut services, dip into cash reserves, delay payments to vendors. And they are acting in inspiring ways— drawing more on volunteers, working longer hours for the same pay, etc.

But these stopgap measures are as unsustainable as they are inspiring. They are not an adequate response to the bigger forces at play: decreasing government support and the unwillingness of many private foundations to evolve funding practices. If we want to ensure that critical services are delivered while we work toward securing a just and vibrant future for more people, we must rethink the way we fund solutions to our most pressing social problems.

Private funders are not going to be able to fill the entire gap left behind by retreating government commitments. But they could play a core role in strengthening many crucial organizations by offering the right type of flexible funding in a timely way. Following three simple principles could transform the contribution private funders make:

  1. Put the “profit” in nonprofit: Assuming that nonprofits should make do with breakeven operations earned on the backs of overworked staff is a miserly strategy in the best of times and a dangerous one in a period of long-term cut-backs. Funders need to encourage nonprofits to run structural surpluses to create cash reserves against future risks, rather than treating the presence of profit as evidence of mission drift. Nonprofits can only create surpluses if they get to run budgets that more than cover their costs. Funders should reward nonprofits that execute projects efficiently by letting them keep their profits to create operating reserves.
  2. Overcome the overhead ratio: Funders need to know how effectively an organization converts funding into outputs (and ultimately outcomes). But focusing on overhead ratios as the only proxy for efficiency has validated behavior that is making the sector more frail than it needs to be. Spending on people, infrastructure, systems, and information is not necessarily wasteful “overhead” but investment without which any organization will ultimately fail.
  3. Know yourself: Are you a “build” funder looking to help grantees build healthy organizations or a “buy” funder looking just to procure project outputs at the cheapest price? If you are a build funder then provide the type of flexible capital an organization needs to build a sustainable business model. At NFF we call this “philanthropic equity” or “change capital”—it’s not general operating support (that pays off structural deficits) but money an organization can invest in people, systems, or innovation that will ultimately allow it to cover its costs sustainably.

Yet funders are only part of the equation. Our Survey revealed that only one in five nonprofits feels comfortable discussing with their funders their basic financial conditions, such as operating reserves or facility finance plans. Contrast that with the 54% percent who feel comfortable talking about expanding programs.

This discomfort discussing basic financial health likely arises from two problems:

  1. too few nonprofits managers and foundation program officers have the skills and tools to understand and communicate an organization’s financial condition; and
  2. even when financial needs are clear, the power dynamics in the funder/grantee relationship prevent honest discussions about crucial financial needs.

In April, NFF partnered with GuideStar to tackle the first problem with the launch of Financial SCAN. This online platform allows anyone to quickly generate a report on the financial health of more than 240,000 US nonprofits, including charts of financial trends with descriptions of financial metrics that matter and a guide to interpreting them (all in layman’s English!). Financial SCAN gives funders and nonprofits a common language to discuss finances beyond project budgets.

User-friendly tools are a start. But funders have a particular obligation to lead discussions with grantees about their financial health, as power dynamics make it difficult for grantees to initiate these open discussions themselves. These conversations may force all of us out of our comfort zones, but falling back on business-as-usual assumptions and practices is only going to lead to the even more uncomfortable realities of what will happen as we stretch the social sector beyond the breaking point.

(Still skeptical like my journalist friend? Well, check it out for yourself. This year we built a user-friendly web interface to share our Survey results. You can easily filter the 4,607 responses by sub-sector, geography, or annual expense size by visiting NFF’s Survey Analyzer.)

Antony Bugg-Levine is CEO of Nonprofit Finance Fund. You can find him on Twitter @ABLImpact.