0.13 Chapter ten: the complexities of nonprofit financing  (Page 10/10)

During this period, the extraordinary level of spending from the endow­ment was hidden by the tremendous performance of the equity markets. In 1985, for example, the average total return in the equity markets was 31.6 per­cent.

Because of the importance of endowment to an institution like the Society, the deleterious impact of its 1980s endowment spending record cannot be exaggerated. During the period between 1974 and 1988, realized gains spent by the Society exceeded the 5 percent spending rate by more than $11 million.

Figure 10.1 shows the cumulative impact of the Society's spending policy on the growth of the endowment since it first exceeded the 5 percent spending rate in 1974. The assumptions of the model are as follows:

• Spending is limited to 5 percent of the moving average of the end-of-year mar­ket value of the endowment for the three previous years.
• Because the timing of flows into the endowment (in the form of spending) and out of the endowment (in the form of capital gifts) are unknown, it is assumed that the Society earned the benefits of capital appreciation on half of those funds during the year.
• Between 1981 and 1993, actual annual investment returns as reported by Fidu­ciary Trust International, Inc., are used to calculate annual appreciation. Those figures are not available for the period between 1975 and 1980. For those years, total return is estimated using a weighted combination of average stock and bond annual returns published by Cambridge Associates.
  Kennedy and Schneider (1994).
  The ratio of equities to bonds in the weighted average is 75 percent to 25 percent.

This model isolates the impact of the Society's spending from the endowment since 1975. It uses the Society's actual investment performance and the actual cap­ital gifts received, and it follows the board-designated spending policy. It reveals that had the Society operated within the 5 percent spending policy, by the end of 1993 the market value of its endowment could have been nearly $84 million, instead of the actual value of approximately $5 million. Under this scenario, the justifiable 5 percent spending from the endowment in 1993 would have been $3.5 million!

Conclusion

The total dollar value of gifts, grants, and contributions in a report from the development office represents only a small part of the revenue picture of a large nonprofit. Is that grant restricted? Can it all be spent this year? Which grants are for endowment? Is the income from that endowment unrestricted? These ques­tions illuminate just a few of the many issues that must be taken into account be­cause nonprofit donors can direct their gifts to specific purposes. Managing these distinctions requires close administrative control to ensure that sources of sup­port are matched with intended uses.

But the complexities of managing a large nonprofit institution go beyond the restrictions on gifts and grants. Research has shown that expenditures at many nonprofits grow at a rate in excess of inflation, exerting pressure on revenues to keep pace. For institutions that cannot rely on earned income or government appropriations to provide significant revenue, investment income from the en­dowment emerges as the most important source for providing that growth. Sadly, part of the value in studying the Society's recent history is the fact that it provides such a clear illustration of how not to manage this important resource.