Business Model Considerations: The Government-Contracted Nonprofit

This is the second of five articles that will cover business model considerations of five major revenue sources: earned income, government, foundation, individual donor, and membership funded. It was produced as a part of the Nonprofit Financial Commons Course, The Five Nonprofit Business Models Revealed. We are indebted to Hilda Polanco, John Summers, and Ruth McCambridge for their thoughtful observations and contributions to this piece. This unique series is designed to discuss business model considerations including required infrastructure, inherent risks, and capitalization needs. The whole collection accompanies a series of seminars also available on this site.

Government funding comprises the federal, state, and local dollars awarded to nonprofits to support a wide range of public policies and commitments in fields such as healthcare, transportation, income security, job training, social services, community development, environmental protection, and more. Government dollars differ from private dollars in one distinctive way — they generally come with an onerous combination of:

an unusually heavy administrative burden (reporting and compliance, reimbursement requests, audits), and
often not paying the full costs of service even while requiring that the full realm of agreed-upon service be provided.

This latter characteristic requires that the organization raise other dollars, not only to essentially subsidize these government contracts, but also to account for other capital needs like reserves, cash flow, and working capital. Taking government money may also lock you into further requirements such as salary caps and programmatic models that may not be an exact fit for your values, the community’s stated needs, the labor market, or other important contextual concerns. It is imperative in these organizations for leadership to do a constant monitoring and refitting of puzzle pieces, as well as well-timed and targeted advocacy, to make the whole system work.

Thus, government funding can be a reliable source of long-term, multi-year funding, but primary reliance on it can create a few different kinds of chronic needs and risks for nonprofits.

Other considerations in terms of risks/challenges associated with government funding include the following:

1. Allocations of resources from the government generally flow from political processes that can have a significant effect on funding availability. Changes in administrations or legislative balances can spark new funding opportunities or eliminate funding altogether. This applies at every level of government and creates an advocacy mandate for the wise nonprofit.

2. Contracting and payment of contracts regularly fall victim to bureaucratic obstacles and delays, requiring organizations to amass working capital and/or take on debt (with unreimbursed interest costs) to allow for smooth day-to-day operations.

3. Operating infrastructure necessary for managing government contracts is often intensive in terms of systems, technology, and staff. The capital requirements for establishing such systems can be a barrier to entry unless an organization can subsidize those start-up costs.

Size and Entry Considerations

Small nonprofits seeking government money for the first time should be wary. The idea of getting your foot in the door may be more costly than anticipated, because regardless of whether the grants and contracts are small or large, the application, administrative, and reporting requirements are much the same. This means that small contracts can result in disproportionately high “transaction costs.” Taking government money requires building additional infrastructure, and consideration should be given to necessary improvements to, and the overlap with, existing administrative processes, as well as the possible duration/renewability of the contract.

Growth Considerations

Managing the growth of a nonprofit built primarily on government contracts can be tricky. Government contracts generally pay less than full cost of service, and even those dollars are restricted. This creates a dynamic where growth through government contracts also engenders a proportionate need for growth in other funds. In other words, if you do not raise additional money from other sources in proportion to government contracts and grants, you will erode cash, margins, and organizational flexibility very quickly and be headed towards a cliff.

All of that said, some organizations do manage to create systems with a measure of equilibrium. What follows are some of the practical staffing, technological, and other capacities needed for this business model.

Finance Roles and Staffing

The success of any nonprofit organization requires continuous collaboration between the finance, program, and development teams. Government funding in particular requires appropriate finance staff experience and skills to ensure both compliance with funding requirements and maximization of revenue. Key roles related to the successful management of the government-funded nonprofit include:

Staff Member	Roles and Responsibilities
Executive Director	The ED plays both an advisory and a political role in government revenue. When evaluating new and existing government funding, the ED will advise on matters related to staffing and infrastructure expansion. Many government awards have a political component for which the ED will serve as the public face of the organization and a key liaison with funders.
CFO / Director of Finance	The CFO evaluates current government funding as well as new funding opportunities from an organizational bottom-line perspective, understanding the revenues associated with each contract as well as the costs of delivering contracted services, including indirect costs. In cases where government contracts do not fully cover those costs (which is the majority of cases), the CFO quantifies and works with other leaders to develop a plan for funding that gap. The CFO projects and manages cash flow for the organization to ensure that delayed government payments do not jeopardize the organization’s ability to meet its financial obligations. The CFO is also ultimately responsible for the management of budgeting, reporting, and compliance related to government contracts.
Controller / Finance Manager	The controller (supported by staff accountants) is responsible for accurate accounting that supports financial reporting on government contracts.
Budget and Contracts Manager(s)	For organizations with a high volume and/or complexity of government funding streams, a contract manager prepares invoices and ensures compliance with the terms of the funding agreements (including spending only on authorized expenses). A budget manager is responsible for developing contract budgets and budget modifications and supports or manages the overall budgeting process for the organization.
Program Director	The PD is responsible for ensuring proper staffing, training, and compliance on programs supported by government contracts. This includes ensuring that staff members:· understand how to deliver services, · have proper training and/or certifications, · understand program outcomes and how to track required metrics of service delivery, · receive training on government-mandated software systems, and · have a schedule of due dates for data collection and submission.
Development Director	The DD should be informed of all new government awards and may contribute to development of funding proposals. They may be called on to raise additional private funds to make up for gaps between what government pays and the full costs of delivering services.
Board of Directors	The Board’s role is to understand what government funding does and doesn’t cover, to make strategic decisions on acceptance of government funding, and to assist in additional fundraising efforts to underwrite any gaps in revenue that government funding may generate.

Accounting Software Systems

A robust, well-designed accounting software package is the cornerstone of financial reporting and decision-making. It is also essential to managing government revenue. Compliance with government rules and regulations often requires much more rigorous accounting practices than funding received from foundations or individuals.

At a minimum, the accounting software must be able to track the following dimensions:

Dimension	Purpose
GL Code	Captures natural revenue and expenses, such as salaries and supplies
Program	Identifies of expenses incurred for a specific program or project
Funding Source	Tracks revenue and expenses to a specific contract or award

Many popular, lower-cost accounting options can track at least three dimensions. Beyond these, most software packages at the low end of the price scale do not have the ability to track sub-programs or restrictions. These are often handled outside the system and can require time-consuming manual work or additional steps to capture.

True fund accounting software can track the three main dimensions above as well as additional dimensions such as sub-programs, activities, locations, and restrictions. The high costs of implementation and annual licensing are most often a barrier to entry for many organizations. Still, despite the higher cost, it may be worth investing in fund accounting software to maintain staff efficiency, streamline reporting, and ensure accuracy and compliance with government requirements. This is especially true when there are numerous contracts to manage. Significant savings in staff time and efficiency (not to mention accuracy of reporting) may help offset the initial costs of implementing fund accounting software.

Other Software Systems

In addition to accounting software, government funding will likely require additional software to manage contracts effectively. The two most common types of additional software are:

Client and case management databases
Data and metrics databases

Prior to engaging in any new government funded contracts or grants, it is recommended that an organization evaluate the data collection and reporting requirements as they relate to client service delivery and demographics to determine whether the current internal data capture system is properly set up and staff are fully trained on its usage.

In many instances, the funding government agency will have its own database that the organization’s staff must access and utilize. This often brings with it the need for additional staff training time, which should be factored into overall programmatic planning and expenses.

Controls and Processes

Government funding comes with stringent, often time-consuming compliance regulations that go beyond the level at which many nonprofit organizations operate. Depending on the level of compliance required by a government funder, additional staff time and expenses should be included in budget planning to ensure enough resources are available.

This list of controls and processes is intended as a starting point and is not comprehensive. For each government contract, an organization will need to review and understand all controls and processes required for compliance and plan accordingly.

Control / Process	Description
Cost Allocations	Government funding requires a well thought-out and documented system of cost allocations to assign costs to the appropriate programs and contracts without “double-dipping.”
Cash Flow Management	CFM provides advance notice of any expected periods of low cash to cover operations.
Working Capital	Delays in receipt of payments require an organization to have working capital or a line of credit to cover expenses.
Billing and Collections	Billing requires a large investment of staff time, and a designated staff member should be appointed to manage collections.
Single Audit Requirements	Federal funding may trigger a specialized audit process that requires additional record-keeping (and expense).
HIPAA	Depending on the type of service delivery, HIPAA compliant policies, procedures, and software may be required.
Annual Staff Compliance Training	Certain types of service delivery may require additional annual staff training, which is usually provided by the government agency.
OIG Exclusion List Compliance	For Medicare, Medicaid, and all other federal health care programs, an organization is required to ensure that no eligible individuals are currently excluded from participation.

Key Performance Indicators to Monitor

Success in any endeavor starts with proper monitoring against planned operations. This is especially true for organizations with government funding, where profit margins are low or nonexistent and additional revenue will be needed to underwrite gaps in funding. In addition to monitoring revenue gaps, sustainable operations that include government funding should also include the following key performance indicators:

Key Performance Indicator	Purpose
True Cost of Programs	Allows for the identification of revenue gaps left by low government reimbursement and administrative overhead rates.
Units of Service	For contracts where service delivery is tied to the number of units delivered in order to draw down funding.
Contract Spend Down	Close monitoring of spending helps ensure that the full amount of the award is collected when changes in program delivery, staffing or other events affect the original plan.
Receivables and Collections	Metrics for monitoring receivables and collections include whether all billing for government awards is current and whether collections are on track (including monitoring number of days between submission of invoices and receipt of payment).
Liquidity / Cash Flow Management	Close monitoring of available cash is needed to manage the long delays in receipt of government funds.

Political Risk

Relatively unique to government funding is its sensitivity to political changes and to the priorities of the elected officials who set budgets and priorities on the expenditure of public funds. After a change of legislative or administration personnel (especially if that change is a party shift), programs may face funding cutbacks and need to quickly raise funds from other sources and/or scale back operations (or, on the other hand, may find an opportunity to increase funding or expand programs). The reality is that shifting political winds can derail even the best laid organizational plans, and a solid advocacy approach — ideally with engaged constituents — can help to mitigate political risk. But this element of the work is itself unfunded by government sources, requiring an investment from the agency and an independent infrastructure.[1]

While engaging in efforts to influence the continuation (and even expansion) of public funding of their work, government-supported nonprofits in particular should also prioritize scenario planning to foresee where changes in political administrations may take their organizations and decide upon actions to be taken under various contingencies.

Final Overview

Government funding can be a reliable source of long-term, multi-year revenue but tends to bring with it high proportions of restricted money, slow cash flow, and high transaction loads. For organizations looking to expand into this area, understanding the complex nature of effective contract compliance and management is essential to success, as are advocacy, scenario planning, and the built-in requirements for subsidies from other sources. For organizations already receiving government funds, regular monitoring is necessary to ensure revenue maximization and overall sustainability of government-supported programs.

[1] Note that 501(c)(3) organizations are permitted to engage in some lobbying activities to influence legislation, so long as those activities do not constitute a “substantial part” of the activities of the organization. For more information, see https://www.irs.gov/charities-non-profits/lobbying.