If you’ve already read my piece on budgeting as a team sport, you know that a clearly defined financial sustainability goal is one of two things you need before a budget process can begin. Financial sustainability itself is generally defined as an unrestricted operating cash surplus in each year equivalent to a small percentage of your operating expenses, plus any additional amounts needed to repay borrowings on a line of credit, donor-restricted funds, margin loans, or board-designated endowments within 5-10 years. Many institutions also factor in the impact of significant deferred maintenance.
I often see boards struggling with setting expectations or misunderstanding their role in governance versus management, in the absence of a clear definition and stated annual goals. A well-crafted definition of financial sustainability gives the leadership team a concrete target and timeline, and gives the board meaningful progress to monitor.
This process starts with the leadership team answering a series of questions:
1) Does financial sustainability mean break-even, or running a surplus?
Countless times, I’ve heard “we’re a nonprofit, we shouldn’t budget a surplus”. Nonprofit is a tax status. It means we don’t pay tax on the profits we generate because we reinvest them back into achieving our mission. I believe the goal should be to generate a surplus, especially as we will endure almost two decades of economic uncertainty. This surplus will be essential to weather future storms.
2) Is this on an unrestricted cash or an accrual basis?
For some institutions, there’s little difference between the two, as depreciation is designed to be a proxy for debt principal and capital repair and replacement. But as more institutions struggle, capital repairs are set aside to maximize cash flow. I would argue that the goal should be to break even on an unrestricted accrual basis, as this is the picture we present to the outside world through our audit, the Department of Education, accreditors, and others. Cash is still king, though, so if accrual basis still results in a cash flow deficit, that needs to be addressed. (Note that I’ve ignored donor-restricted activities here, as they generally cause us to look more financially healthy than we are, and we can’t access those funds until they’re spent on their restricted purpose.)
3) Is this unrestricted operating or non-operating?
We all have our own definition of operating activities, but generally, unusual activities, endowment earnings in excess of the annual approved spend, and changes in retirement obligations not funded by cash are considered non-operating. Given the nature of these activities, I generally advocate for focusing on the operating basis.
4) How will we consider strategic priorities?
I rarely see a strategic plan that results in more profit. Strategic plans often add costs without clear revenue metrics, such as spending money on retention initiatives without articulating how much retention will improve or how that translates to revenue. The impact of these investments should be clearly measured and factored into operating activities, including whether they should be funded by operations at all.
5) Will we fund building maintenance and accumulated deferred maintenance beyond the current annual cadence?
Many of us are underfunding capital, creating a backlog of deferred maintenance. Will our definition of financial sustainability allow this to continue? Conversely, can we reduce our normal capital budget cadence to achieve our targets? I advocate for setting an annual amount and not allowing reductions to achieve an annual goal. We also need to set an annual cadence that prevents the sudden closure of critical buildings and infrastructure, so a basic capital plan may be needed to determine a minimum amount.
6) Do we expect to pay back obligations without a defined debt service schedule, such as a balance on a line of credit or borrowings from endowment and restricted funds?
The interest cost should be considered in our decision. A line of credit is an important tool, but if it rarely zeros out or if it carries a persistent annual balance, that’s a signal that it should be treated as long-term debt requiring a repayment schedule. This means that a certain amount of debt service should be added to the annual goals.
7) Will we include or exclude higher endowment spend rates and unusual releases from restrictions?
This is very common in recent years, and I suspect it will become even more common—taking an extra draw from endowment to meet annual operating budget needs. In years when we take these additional draws for operations (capital needs may be different), will those draws count toward meeting our annual goals? My answer is no. Similar to reducing capital spend, this allows short-term goals to be achieved at the cost of long-term goals.
8) What timeline is financial sustainability expected to occur on?
This depends heavily on the financial situation of the institution. For an institution with little or no unrestricted net assets excluding plant (UNAEP), you’ll need to consider how you’ll fund deficits while implementing operating changes, whether that means selling property or borrowing from your endowment. The more access to capital you have, the more deliberate and extended this process can be. If you don’t have the luxury of time, these goals will need to be more aggressive. You’ll also need to consider how the answers to the above questions impact the gap you are trying to close. I have institutions that have set goals on two separate time horizons, five years and 10 years, in order to prioritize the above goals.
9) What are the annual goals in each of the next 5 to 10 years?
Setting annual expectations matters more than just naming a five-year target. It demonstrates progress and keeps you on a path toward sustainability. One of the most significant (and often unexpected) realizations is how difficult it is to make incremental improvements each year. Without enrollment or revenue growth, this often leads to what I call death by a thousand cuts. An annual goal provides clarity: if you need to improve your bottom line by $10M over five years, you could set a goal of improving by $2M per year. That makes your budget expectations very clear.
Next steps for aligning financial sustainability
Once the leadership team works through these questions, take those same questions to the board to ensure alignment. Negotiation and discussion are important here. I’ve encountered trustees who believe it is necessary (and possible) to achieve break-even in a single year through expense cuts—not understanding that this would necessitate teaching out academic programs or eliminating sports teams. These conversations are essential to building a shared understanding.
Once your definition of financial sustainability and the timeline are agreed upon, the board’s responsibility is to monitor progress each year through budget approval and mid-year forecasts. and to agree on expectations for achieving annual goals. For example, if enrollments are lower than originally budgeted, is the leadership team expected to reduce expenses to achieve the bottom line set in the budget?
Future market pressures will create significant and unpredictable enrollment headwinds. Every institution should consider developing operating metrics and benchmarks to identify opportunities to maximize revenue and reduce expenses—avoiding death by a thousand cuts.
Once this framework is defined, develop a simple matrix that can anchor the conversation at board meetings:
| Timeline | 5 Year | 10 Year + |
| Break even on a cash or an accrual basis? | Cash ($4M target) | Accrual ($9M target) |
| Unrestricted operating or non-operating? | Unrestricted operating | — |
| Operating and strategic priorities? | Ensure goals don’t sacrifice operating and strategic priorities | Ensure goals don’t sacrifice operating and strategic priorities |
| Interest payments annually, with slow principal reduction at $1M/year | None | Fully fund depreciation (slow rate of deferred maintenance) |
| Paying back obligations without defined debt service (borrowing from endowment $6M, restricted funds $4M, line of credit $10M)? | Interest payments annually, with slow principal reduction at $1M/year | Interest payments annually with slow principal reduction at $1M/year |
| Include or exclude higher endowment spend rates and unusual releases from restriction? | Excludes unusual releases; reduce spend rate to 5% or less ($1.6M = 0.5%) | Excludes unusual releases; reduce spend rate to 5% or less ($1.6M = 0.5%) |