“Long-gone are the days when organizations were criticized for having excess liquid cash on hand,” says Keith Ekenseair, a partner with FROST, PLLC. “In today’s economic times, many organizations are tossing out the notion of maximizing interest income because they are struggling to have adequate cash to meet current operating needs.”
In a downturn economy, private contributions decline as donors are less inclined to give; earnings from investments shrink along with their capital market values; and community needs increase – hitting nonprofits with a funding triple whammy.
Many generous donors have given significant funds to nonprofit organizations in the form of endowments. These funds may be permanently restricted, which means the nonprofit organization cannot utilize the original contributed amount for any purpose for perpetuity. However, these endowments typically allow the organization to utilize the investment earnings and fair-market value appreciation over the original donor contributed amount to meet the organization’
Endowment funds may also be impacted by law restriction such as the Uniform Prudent Management of Institutions Funds Act of 2006, which is a robust set of guidelines about what constitutes prudent spending and explicitly requires consideration of the duration and preservation of the endowment fund.
“Given the current stock market, bond yields and certificate of deposit rates, investment earnings are fundamentally low, which means nonprofit organizations may struggle to have sufficient resources to meet their increasing program needs,” Ekenseair says. “The current situation brings to light the fundamental risk that some nonprofits, corporations and individuals have historically taken for granted – investment risk.”
The three basic types of risk associated with investments are credit risk, interest rate risk and foreign currency risk.
Credit risk is the risk an entity holding an organization’
“A common example of this is with the pricing of bonds, where the fair market value is determined by yield,” says Ekenseair. “Bonds held to maturity will not suffer any loss of principal, but not every bond is held to maturity.”
With a growing global economy, foreign currency risk is becoming more common. Foreign currency risk is impacted by the exchange rate – which can be adversely affected in the same way that interest rates can.
With the recent bank failures, government bailout programs, current economic uncertainty, declining investment earnings and portfolio values as well as new complicated instruments available to investors, there is certainly significant risk involved.
“All organizations including nonprofits need to dust off their cash and investment policies and update them to adequately address the risks associated with depositing or investing cash,” says Ekenseair.
