Chapter 24
Management Controls: Toward Accountability for Performance
Conventional ways of writing suggest we should begin a gradual wind-down right about now and then close with a safe, straightforward discussion of management controls in the nonprofit environment. We should talk about responsibility centers and cost centers and profit centers and all of those other pieces of financial terminology that serve mainly to complicate the obvious. We will do that. But we need to move beyond conventional thinking to position nonprofit institutions for the future, and that challenge is by far the more important one for these final chapters.
Nonprofit organizations reflect the environment in which they were created, and for years, the same command-and-control approach that won wars, mass-produced billions of dollars' worth of consumer goods, and built millions of housing units in this country and around the world served the industrialized world's nonprofits quite well. Management controls were the linchpin that made it all work. Managers exerted their influence on a nonprofit through a system of explicit controls, and the organization moved forward in a linear fashion. Things didn't change much, and when they did, it was usually in a reasonably predictable fashion with plenty of notice. Nonprofit financial management systems were essentially an afterthought, designed with a minimalist's brush and expected to run to keep up with programs' evolution.
Management Controls circa 1980
The conventional formula for management control pivots around the idea of responsibility. Certain points on the organization chart are designated as responsibility centers, meaning that whoever is in charge of that point must either produce something or make something happen. Typically, those in charge are given responsibility for producing profits (profit center), controlling costs (cost center), or generating revenue (revenue center). If circumstances warrant, a fourth category for managing investments might also be added (or it might be considered a profit center). Different organizations may use different language to define these functions, but, for the most part, they all mean essentially the same thing.
Within each responsibility center, the tasks may or may not be broken down into smaller units of responsibility and so on until we reach the smallest possible unit of functional responsibility. Management's job is to plan the work of each unit, set the direction, organize all appropriate resources, and then control them. The impact of the organization is equal to the sum of all the individual functions controlled by the responsibility centers.
This style is suited to the nonprofits that the old national economy spawned: sprawling universities; complex museums; large, site-based programs for people with mental illness and people with intellectual disabilities; and large hospitals. These types of nonprofits all require a major investment in property, plant, and equipment and the people and control systems to keep them running.
Throw out all of that conventional thinking for the future and start over again. In the industrialized economy, it was enough simply that these types of institutions existed. In the future, they will also need to perform. Government as a provider of direct services has been in retreat for decades. The commercial sector must strip down and compete in a global economy. What's left is a steadily increasing middle ground that must be tended by honest brokers, the time-honored role for nonprofits. But this time, those brokers have got to produce in a different way, and to do so, they must reorient their financial systems from command and control to performance.
Beyond Management Controls in the Twenty-First Century: How to Do It
As society demands greater emphasis on performance and as nonprofits work to respond, there is a key fact that may or may not be reassuring, depending on one's perspective: We are all making it up as we go along. This is not a commentary on the competence of our overall performance but rather an acknowledgment of a sobering reality. We simply have not demanded that nonprofits organize for and deliver performance up to this point, so we are not all that good at it.
Plus, the landscape is shifting rapidly. Government at all levels must deal with the threat of shrinking resources as well as increasing demands, and the nonprofits that they work with are being forced to change accordingly. The health care system, a major chunk of our total gross domestic product, is in the early stages of inevitable massive change to cope with aging baby boomers, and no one yet has the slightest idea how it will all turn out. Higher education will eventually have its day of change, too. The one constant in these and other settings is that there will be a greatly increased demand for performance.
The obvious questions are: How do we do it? How do we organize for performance? How do we even define performance? What is the connection between the resources that go into a nonprofit and its performance? What is the proper role of the funder? The consumer? The manager? One key element of this admittedly broad question is the work of financial people, especially the CFO. We will spend some time trying to tease out the future role of the CFO.
Messages
Nonprofits of all kinds can move beyond simple management controls and toward a performance orientation. The first critical ingredient is a clearly articulated mission. Having an understandable and widely accepted mission focuses an organization and makes decision making easier. It becomes an organizing principle as well as a foundation for measuring progress.
The nature of information gathering and processing must change in any organization the closer it moves to outcome-based management. Financial information typically takes up the greatest concentration of data processing resources in most nonprofits. In the future, it will have to share the power with outcome measures.
Performance-based nonprofit management will stress performance comparisons, better known as benchmarks, and individualized benchmarking has already become easier. All that is needed now is the emergence of centralized authorities, such as governments, trade associations, research groups, private advisors, and even foundations, to develop and disseminate benchmarks for use by their constituencies.
Performance-oriented nonprofits routinely and consistently ask consumers what performance means and how they are doing it. Surveys, it is safe to predict, are going to proliferate in future years until we figure out better and more efficient ways of soliciting formalized and statistically valid feedback from users.
The nonprofit committed to performance will also flatten itself. Pyramid-like, hierarchical style no longer works for most nonprofits. In its place is a flatter organization, made possible by improvements in communication technology and made necessary by the economic squeezes of the past decades and the latter part of the first decade of this century. It no longer takes as long to get information from one level of the nonprofit to another, and this eliminates the need for at least part of the formerly intervening level of management at the middle of the pyramid. At the same time, executive levels will take a more direct role in managing internal performance standards, in part because funders will demand it and in part because there will be fewer managers to do it, anyway.
Finally, the serious nonprofit manager will look for generally accepted performance standards and will eventually seek outside validation of its performance. Right now, few such independent verifiers exist. Accrediting and licensing bodies fill part of the void but only a small part. Universities, research groups, and consultants are workable sources of performance verification at the moment, but in general, there is a real lack of independent expertise available to conduct performance reviews. As funding sources increasingly ask for details on what was accomplished as opposed to the more traditional focus on what was spent, the traditional financial audit may even take on a more outcome-oriented flavor. It is even possible that an entirely new class of performance-verification entities will be invented to meet the demand for independent attestation of results, somewhat similar to the circulation confirmation services that newspapers and magazines currently employ.
How to Prepare—Changes in the CFO Role
As stated earlier, the practical implication of the preceding chapters is that the financial role in the average nonprofit is changing. Here's a trail map of what those changes will probably look like.
A More Coequal Role for the CFO with the CEO
Study the proceedings of the high-profile corporate corruption trials from the early years of the twenty-first century—and the current ones, in all likehood—and you'll notice a subtle change. For the first time, the CFO of each of these companies was accorded status as a near-partner with the CEO. The financial person who formerly was nearly invisible to the casual observer has been placed side-by-side with the individual responsible for the corporation as a whole.
This is emblematic of a parallel change in the nonprofit sector as well. Eventually, the IRS Form 990 will put more pressure on the chief financial person to help design and maintain systems than ever before. Implicitly, this suggests that regulators expect more from financial staff than previously.
For many nonprofits, this amounts to little more than an external recognition of reality. Many nonprofit CEOs long ago discovered that it was in their interest to have a strong, competent, respected CFO who acts as a partner in formulating strategy and reporting to the board of directors. What could be different for nonprofits is that that financial partner, who used to operate out of sight of most outsiders, may be called into the spotlight more regularly in the future.
Greater Separation between the CEO and the CFO
Ironically, this external effort to link the CEO and the CFO in financial accountability may also create a little daylight between them. Currently, the IRS Form 990 that nonprofits file each year is considered an informational return with little at stake, even for the person who signed it. But the IRS now requires things such as explicit confirmation of management policies, oversight of compliance activities, and so forth.
With little at stake before, the CFO who was so inclined was able to defer his or her responsibility to the CEO in these matters, who in turn didn't even need to think about whether to accept it. But as demands for an explicit acknowledgment of basic governance, programmatic, and financial accomplishments grows, the streetsmart nonprofit CEO will demand personal assurances that the work has been done before signing off. This will set up the possibility for a pointed inevitable internal dialogue about whether the organization has accomplished its minimum expectations. Which, of course, is exactly what regulators intend.
What will really occur here could be a forced choice between professional standards and administrative expediency. Experienced, professionally trained CFOs, especially those with a credential such as a CPA, have a professional duty that goes beyond their immediate employer. Increasing the demand for accountability from the nonprofit CFO, even if indirectly, will increase the likelihood that, in some cases, the individual will feel it necessary to say no to the CEO, the board, or whoever in the organization may ask him or her to violate the standards of his or her profession.
Greater CFO Involvement in Technology
Most nonprofit managers probably correctly regard Sarbanes-Oxley as a somewhat distant federal law not directly related to nonprofits but which has an indirect impact. But one of the biggest implications of that law's implementation is that financial managers are being drawn headfirst into matters of information technology to an unprecedented extent, and one of the most time-consuming aspects of the law is its insistence on certain standards in electronic financial controls.
The same will be true in the nonprofit arena as the tenets of Sarbanes-Oxley are accepted as the gold standard and board members see the indirect applicability in a nonprofit setting. This effect could be hard to spot, because it will be couched in terms of the need to ensure that controls are sound and up-to-date, that policies are being followed, and so on. It is the practical implementation of seemingly innocuous provisions that will continue to bring the CFO into the technology realm to a greater degree. You may have internal controls in place, but because so much of your record keeping is electronic, how can you be sure that they are working as intended?
Greater Need for CFOs to Think Strategically
What distinguishes a truly outstanding CFO from an ordinary one is his or her ability not only to keep the information flowing accurately but also to think strategically. Budgeting is currently one of the most common areas in which a nonprofit CFO is called on to think carefully about the financial future, but this is a somewhat narrow demand because the budget horizon is often only a year, and allocations are frequently limited by either the funder or the way it was done last year.
Thinking strategically means having financial input into decisions ranging from what revenue sources to pursue (“Foundation A gives smaller grants but allows us to draw down money when we need it, thereby improving our cash flow”) to capital improvements (“Installing a new boiler system will lower our heating costs by 35 percent, partially offsetting the cost of financing it”).
This is one area not driven by increased interest in accountability. Good CFOs already do this kind of thinking, but as a nonprofit grows larger and more complex, the need for moving beyond simple accounting and reporting will grow as well.
There is little more valuable to a thriving nonprofit than a strategic CFO. And there is probably nothing harder to produce. To understand why, think back to your school years. When your age was measured in the mid-single digits, you began to learn how to write with either your left or your right hand, whichever felt most comfortable. By the time you left high school and then college, the act of handwriting seemed second nature. Now imagine someone told you that in order to complete your next stage of professional development you needed to immediately start writing with your other hand.
Implausible, right? It is implausible in the context as described. But your CFO almost certainly went through a similar experience. And if she is new, she may be going through it right now without your realizing it.
Orientation to time is personal and enormously powerful. People tend to gravitate to an orientation to time that is most comfortable for them, whether that means a day-to-day, month-to-month, or year-to-year orientation. We make important choices such as an occupation partly on this basis.
The inherent problem with the CFO position is that it is arguably the only professional role in which most such nonprofit executives begin with a determined and almost exclusive orientation to the past and then get slammed by the requirements of a CFO's job to look far into the future. It's a bit like hearing in an interview, “Congratulations, you're hired. Now start writing with your other hand.”
In many nonprofit organizations, there's also an implicit need to go well beyond the normal job boundaries for a CFO. Smart CEOs recognize this, even if they can't do much about it.
It's Called ACCOUNTING for a Reason
To appreciate the culture shock that a new CFO may experience, consider how he or she arrived in that position. Most likely he or she studied finance in college and then set out on one of the typical financial pathways, such as auditing or bookkeeping. In both cases, the newly minted auditor or bookkeeper is dealing almost exclusively with the original books of entry, the chart of accounts, or various reports. The job likely involves putting various transactions in the correct category or double-checking that the categorization or the calculations were correct.
What all of these things have in common is that they involve decisions made in the past by someone else. The records are literally historical, and the accountant usually cannot change anything about the transactions except how they are documented (or accounted for). Young entry-level financial personnel may not even need to evaluate most transactions except to be clear about the categories in which they are entered.
To advance in the world of accounting and bookkeeping, it is necessary to master the rules, both literal and figurative. Again, the rules were often made sometime in the distant past by other parties, and the financial person must be able to understand and interpret those guidelines. The fact that all of the records were created by others' actions further cements the tendency to look back.
It's not hard to see how accountants and other financial specialists can begin to regard their nonprofit as a static landscape of other people's actions that mostly need to be properly categorized and reported according to rules that have been handed down from an acknowledged financial authority. All of these elements add up to a world in which most puzzles and mysteries have a predetermined answer, or at least a number of correct answers. This is comforting because most of the time the correct answers do exist, and they just require a bit of hard work or good training to get them.
Now envision that same financial staff person as a CFO trying to advise the CEO and the board about which of three banks to use as a source of capital for the upcoming expansion of the organization's largest building. The calculations of the budget and even the projections may not be difficult. But when the board members want to know the new CFO's feeling about the best financing plan, it is possible that nothing in their formal training would have prepared them for the question. Even if the CFO feels knowledgeable about it, all those early years of working with the results of other people's decisions could make it hard to suddenly start looking deep into the future.
Appreciate the Abrupt Change
Here is perhaps the essence of the new CFO's problem. Training in finance or economics tends to be linear in nature and to involve lots of calculations. That means that a traditional CFO's early training is in areas in which there is a demonstrable right answer. Mathematical calculations have the simplifying property of being right—or wrong. It's a binary choice. Applying that kind of effort to bookkeeping and accounting problems resembles those binary choices. And following accounting rules also requires an understanding of how to apply rules and policies consistently, which is a comparable task. But good decisions about policies and complex choices are not binary. More important, they are meant to shape the future, not the past.
A new CFO's supervisor can help the most by understanding the abrupt 90-degree turn that the CFO has to achieve to be successful in the new role. But executives of all kinds have to be attuned to the future so it may not seem as much like the major change in personal operating style that it is. In fact, for many personalities, the change in professional time orientation that an executive role brings is so attuned to their natural personalities that they may not even recognize how challenging it can be for others.
Frame the New Role
This is where a shrewd CEO can make a difference. A CEO who is comfortable with thinking for the long term should be able to frame the new CFO's role in a way that allows the individual to concentrate on the technical details they gravitate to while trying on a long-range mind-set.
In the hypothetical example of choosing a new banking partner, the CEO might note that evaluating the numbers in three different lending proposals is a fairly conventional calculation but that the complexity comes from things like the banks' customer relations capacity, the type of borrower they work best with, or even the bank's prospects for remaining independent.
Meet Your New CFO
It's a safe bet that the nonprofit CFO of the future will look just like the CFO of the past, with higher expectations. Small nonprofits will want to look for someone who can move beyond simple bookkeeping toward managing and controlling financial affairs. Other nonprofits will expect their financial function to take on greater internal importance and move toward more compliance with external accountability demands. All nonprofits should expect the financial function to receive more external scrutiny and to be able to articulate a new balance with the CEO. All organizations can expect an emerging role for technology in internal financial matters, necessitating a CFO more skilled in managing information electronically. And the prized catch for a streetsmart CEO will be a financial person who can do all of the preceding, and whose eyesight extends years into the future, not just the next 20 feet.