From Our Director
A Note on Financial Sustainability for Social Enterprises
Professor Dennis Shaughnessy, February 2012
Traditional businesses find a path to financial sustainability by growing their revenue, improving their gross and operating margins, increasing their free cash flow, efficiently managing both capital expenditures and working capital, and building their asset base. Achieving these financial performance indicators typically result in easy access to financing and higher stock prices.
High impact social businesses are also built and managed to achieve these financial goals, except that social businesses value social impact over profit, and unlike a traditional business (especially a publicly traded one), they use profit as a tool for making a meaningful social impact. Well run social businesses often create foundations to which they can contribute their excess profits, to further their mission. This is a “hybrid” structure that is perhaps the most effective approach to achieving broad, sustainable impact.
For non-profit social enterprises, income generating activities (IGAs) enhance financial sustainability by reducing dependence on the generosity of donors or the budgets of grant giving foundations and government agencies. A charity without IGAs is perhaps the most vulnerable enterprise model from a financing standpoint, but to be sustainable must establish to donors that they are efficiently and effectively achieving the impact goals that they share with their donors.
What are the keys to financial sustainability for leadership of an impact driven enterprise? Here are nine suggested steps for insuring financial sustainability for social enterprises.
1. Aggressively grow your revenues
Whether your revenues are from product sales (price times units sold) or donations and grants, double-digit (10% or more) revenue growth is critically important to building and maintaining a dynamic, high impact organization
2. Incrementally improve your gross and operating profit margins
Efficient and productive enterprises carefully manage the costs of making their product (or delivering program services) and the expenses of operating or administering the organization. Your gross profit (revenue minus costs of production or service) and operating profit (gross profit minus the firm’s expenses) are the fuel for achieving impact.
3. Carefully manage your working capital
Being a good balance sheet manager is important to the efficient use of capital from any source, from cash and cash equivalents to payables to receivables and inventory. A well managed working capital account (current assets minus current liabilities) can be a buffer against short-term revenue downturns.
4. Efficiently invest capital in needed growth projects
Capital expenditures, or “cap-ex”, is an important use of cash and should always be done using the managerial tools of return analysis (ROI, IRR, NPV, breakeven analysis). Investing in the business or the mission should be done with the intention of creating value for all stakeholders.
5. Continuously increase free cash flow
Profits are important, but cash is the lifeblood of all enterprises. Free cash flow (operating income (or EBIT) plus depreciation minus capital expenditures (cap-ex) should be nurtured and steadily increased to insure that the enterprise has the resources it needs to achieve its strategic impact goals.
6. Steadily build your asset base
It’s important to build a “cushion” of cash and other key assets in order to manage through and survive any down cycles or unexpected disruptive events. For non-profits, this “surplus” is key to moving forward with impact-driven activities even when current donations are down.
7. Use low-cost debt in manageable amounts as a financing tool
If you need debt to finance operations, be sure to actively manage institutional debt– to avoid it managing you. Care in obtaining the best available terms for your particular circumstances (interest, term, repayment schedule) is essential. Low cost debt can be an effective tool for funding a variety of mission-related activities that generate income.
8. Engage with the new “impact investing community”
There is a growing community of investors, mainly wealthy individuals often organized into social investment funds, who are interested in investing in the mission of social businesses and enterprises rather than donating. They can invest with equity or debt, with lowered expectations for returns. This “patient capital” can be a valuable source of growth financing for impact enterprises.
9. Confidently make your case to all of your stakeholders
If you are successful in the preceding eight steps, then the final step is to clearly and forcefully make the case to all of your stakeholders why your enterprise deserves their continued financial support. Stakeholders in a high impact business include investors and lenders, donors and grant providers, clients (including poor families) and customers, impacted communities, and employees. Financial sustainability is what makes your mission and social impact both meaningful and lasting for all of your stakeholders.