Federal Funding Freezes Raise Importance of Cash Reserves

With changing federal policies and budgets, nonprofit funding is in flux. From large research universities to local community groups, many are feeling the pinch. But a new tool can help nonprofit decision-makers boost their organization’s financial resilience.

When Federal Dollars Fall Short

How important is government funding nationally? Roughly 30% of US nonprofits filing an IRS Form 990 in 2022 and 2023 report receiving government grants. This translates to over 100,000 nonprofits securing $303 billion annually. Additionally, more than 35,000 nonprofits rely on government funding for over half of their budgets.[1]

Faced with the prospect of shortfalls, many organizations’ first inclination is to turn to private philanthropy for help. But private foundations would need to increase their giving by 282% to fill the gap. That’s unlikely—especially as they grapple with their own uncertainties, including increased scrutiny for DEI initiatives, shifting policy priorities, and looming changes to the tax code.

Plus, federal funding cuts affect more than just direct grants. Many local and state grants rely on federal money, especially for social services like childcare for low-income families, healthcare and Medicaid payments, and housing for the homeless.[2] A recent Urban Institute study shows that government funding—federal, state, and local—accounts for about 33% of nonprofit revenue each year.[3]

With uncertainty looming, what proactive steps can nonprofit decision-makers take right now?

A Shortcut to Scenario Planning

Now is the time to assess financial resilience. At Bernstein, we conduct a thorough assessment of each organization to model the right level of cash reserves. We then identify any gaps in short-, medium-, and long-term needs and help clients strategize to address them. The first step is to assess overall risk, focusing on cash inflows and outflows.

While each organization is unique, we recommend first considering your exposure to four common risk categories:

1. Revenue risk
2. Spending risk
3. Timing differences
4. Borrowing capacity

 

Revenue risk captures the challenges that organizations face around incoming cash flows. Does the organization generate more revenue than expenses—or do they run a deficit? We measure the stability, reliability, and concentration of income sources. Organizations dependent on federal funding might face a very different revenue risk profile in the future than they have in the past.

Spending risk gauges the inherent flexibility of an organization’s budget, alongside any restrictions on expenditures. Can the organization quickly downsize if revenue is interrupted? Are they vulnerable to demand spikes in economic downturns, disasters, or other unforeseen events? These questions help us better understand the composition and elasticity of expenses, and how those limitations factor into our overall risk picture.

Significant timing differences between revenue and expenses could put the organization at greater risk, as they may need extra reserves to cover temporary shortfalls. Think of organizations that receive the bulk of revenue through an annual fundraiser yet dole out funding for programs and operations throughout the year. Significant timing differences require careful consideration when it comes to striking a balance between cash versus short/intermediate reserves.

Finally, we consider the ability to borrow. Is there an existing credit line, borrowing source, or the wherewithal to create one? In an emergency, another option could be to margin your investment portfolio—after consulting with your CPA on the potential tax implications. These strategies are often overlooked despite their ability to create a cushion during times of need.

Translating into Time and Money

After evaluating the various risks, we quantify a reserve amount starting with the most immediate needs. The number of months in reserve that should be held in cash is driven by the organization’s level of risk. Higher risk translates to more months of reserves.

Organizations experiencing reduced government funding may need to have a strategic conversation about replacing lost revenue. How much are they willing to spend from reserves, and for how long, before they can reach a new equilibrium between revenues and operational expenses.

Aligning the Allocation

After determining the time frame and dollar values for the reserves, we align the allocation to the time horizon and associated need for liquidity. Reserves earmarked for immediate cash flow and expenses would be allocated to cash instruments or short-duration income-producing bonds. For periods longer than a year, we would incorporate increasing amounts of bond exposure as the time frame lengthens.

When Grants Disappear: Strategic Moves for Survival

Imagine an urban nonprofit dedicated to supporting marginalized communities. They’ve just learned that a recurring federal grant won’t be renewed this year, cutting their total revenue by 10%. Demand for their services is rising while supply costs continue to climb. Plus, there’s worry that future grant renewals for contract work may be at risk. Now, they’re at a crossroads, unsure if their operating budget is in jeopardy.

With just three months of cash reserves, the organization faces a $500,000 shortfall in their operating budget and is unsure what to do next. The staff and board have discussed whether to cut spending, scale back programs or staff, diversify fundraising from non-governmental sources, or a combination of these strategies.

Using Bernstein’s Reserves Analysis Tool, the organization starts by cataloging and evaluating their situation and cash flows. They assess four risk categories to pinpoint where their risks lie. Key questions include: 

• How much of their funding is tied to federal or state/local sources that might be impacted? 
• Can they shift to other revenue sources? 
• How flexible can they be if downsizing is necessary, and do they have significant fixed costs? 

In the end, the group increased their cash reserves by 25% to allow for the uncertainty around federal grants. They also drafted a diversified fundraising plan—stewarding noncash gifts from existing major gift donors—to boost present and future revenue. Bernstein provided guidance, customizable tools, and actionable resources throughout the process.

In a world of uncertain federal funding, nonprofits must proactively strengthen their financial resilience. By assessing risks and diversifying revenue streams, organizations can better navigate funding challenges and secure their future. Now is the time to act and ensure stability in the face of change.