Is Bigger Really Better?

• Published date: 01 September 2016
• DOI: http://doi.org/10.1002/nml.21209
• Author: Joanna Woronkowicz
• Date: 01 September 2016

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N M  L, vol. 27, no. 1, Fall 2016 © 2016 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com) DOI: 10.1002/nml.21209

Journal sponsored by the Jack, Joseph and Morton Mandel School of Applied Social Sciences, Case Western Reserve University.

Is Bigger Really Better?

THE EFFECT OF NONPROFIT FACILITIES PROJECTS

ON FINANCIAL VULNERABILITY

Joanna Woronkowicz

Indiana University

This study investigates the effect of a capital facilities project on nonprofit financial vulner-

ability metrics. The author employs a difference-in-differences technique to model the rela-

tionship between facilities investments and financial vulnerability indicators using data

for a matched-pair sample of nonprofit organizations that invested and did not invest in

a facilities project. Overall the findings suggest that investments in facilities are associated

with temporary increases in an organization ’ s net assets ratio and decreases in its surplus

ratio after a project is completed, and that the costs associated with facilities projects (for

example, debt) place strain on nonprofit finances. The study ’ s findings have implications

for the financial management of nonprofit organizations, particularly in regard to the

associated costs of capital expansion.

Keywords: financial vulnerability , facilities , capital , arts

FOR MANY NONPROFITS the ability to deliver on mission largely relies on the suitability

of its facilities. A nonprofit organization can own or rent a facility, but owning tends to be

financially more risky. Facility ownership is a long-term decision and is more difficult to alter

than the lease of a facility. Even beyond costly investments in land and property, a nonprofit

that owns a facility tends to have higher maintenance costs than a nonprofit that rents. Finally,

physical capital deteriorates, and the cost of replacement (that is, building a new facility or

renovating an existing one) can have substantial impact on a nonprofit ’ s financial position.

Like any investment, capital facilities projects are risky endeavors that can either strengthen

or weaken a nonprofit organization ’ s balance sheet. The goal of investing in capital is to

increase marginal revenue more than marginal costs. However, the failure to capitalize on

investments or accurately predict organizational expenses related to facilities investments can

substantially weaken a nonprofit ’ s financial position.

This study provides an empirical understanding of how substantial investments in facilities

projects affect indicators of nonprofit financial vulnerability. The author employs a differ-

ence-in-differences (DiD) technique to model the relationship between investing in facilities

projects and financial vulnerability indicators using data for a matched-pair sample of non-

Correspondence to: Joanna Woronkowicz, Indiana University, School of Public and Environmental Aff airs, 1315 E. 10th

Street, Bloomington, Indiana, 47404. E-mail: jworonko@indiana.edu.

Nonprofi t Management & Leadership DOI: 10.1002/nml

80 WORONKOWICZ

profit organizations that invested and did not invest. Overall the findings suggest that facili-

ties projects are associated with temporary increases in an organization ’ s net assets ratio and

decreases in its surplus ratio after the project is completed, and that the costs associated with

facilities projects (for example, debt) place strain on nonprofit finances.

Nonprofi t Financial Vulnerability

In their seminal study, Tuckman and Chang ( 1991 ) addressed the idea of nonprofit financial

vulnerability from an organizational finance perspective. They defined a nonprofit as finan-

cially vulnerable “if it is likely to cut back its service offerings immediately when it experiences

a financial shock” (Tuckman and Chang 1991 , 445). The authors argued that the likelihood

of cutting back is directly related to a nonprofit ’ s flexibility in withstanding a financial shock,

such as a recession or the loss of a major donor.

According to Tuckman and Chang, there are four financial indicators that determine a non-

profit ’ s ability to be flexible in times of financial shock—net assets,

1 operating margin or sur-

plus, revenue concentration, and administrative costs—and each is related to overall financial

vulnerability.

1. Net assets:  e diff erence between an organization ’ s assets and liabilities. A nonprofi t ’ s

level of net assets is related to its ability to borrow. Nonprofi ts that can leverage net assets

in borrowing are less likely to alter program service off erings following a fi nancial shock.

2. Surplus:  e diff erence between an organization ’ s revenue and expenses divided by total

revenue. Nonprofi ts with greater surplus can operate at reduced surplus levels following a

shock; hence, they are less likely to alter programmatic services.

3. Revenue concentration:  e proportion of income an organization receives from its various

sources of revenue. Because fi nancial shocks are less likely to aff ect multiple streams of

revenue, nonprofi ts with more sources of revenue are better able to withstand the impact

of shocks on program off erings.

4. Administrative costs: After a financial shock, a nonprofit will typically try to decrease

expenses. Because cuts to administrative costs are preferred to those to program expenses,

nonprofits with higher administrative expenses have more options to reduce overall

expenses.

A handful of scholars applied and tested variations of the Tuckman and Chang (1991)

framework for financial vulnerability using data from the National Center for the Charitable

Statistics (NCCS).

2 Greenlee and Trussel ( 2000 ) used program expenses to operationalize

nonprofit financial vulnerability and defined a vulnerable organization “as one that reduces

program expenditures (deflated by total revenues) in each of three consecutive years” ( 203)

between 1986 and 1995. They compared financially vulnerable organizations to non–finan-

cially vulnerable ones based on the criteria Tuckman and Chang developed and found that

the Tuckman and Chang framework is valid using their method of operationalization for

three out of the four financial indicators.

In follow-up studies, Trussel ( 2002 ) and Trussel and Greenlee ( 2004 ) further specified the

method by which they operationalized financial vulnerability by including an organization

that “had more than a 20 percent decrease in its fund balance over three years” (Tr ussel

2002 , 20) in one model and both a 20 percent and 50 percent decrease in net assets over