Myth #1: A strong, sustainable nonprofit needs an endowment.

The one thing that sustainable nonprofits need is enough income to run their programs and pay for salaries, facilities, etc.  An endowment is one of many ways nonprofits can generate income. But for some groups, it is unnecessary or even a bad idea.

So before deciding to establish an endowment, nonprofits should decide if doing so addresses how income will be used to achieve the mission, when it will be needed, and how much will be needed. Organizations that are in financial crisis, that have limited capacity to attract more donors, or that have short-term missions should avoid establishing endowments.

Myth #2: An endowment must be continuously funded and can never be drawn down.

Nonprofits can choose when it’s most feasible to add to their endowments. For example, if it’s important to increase direct aid during a natural disaster, a relief organization might reduce or even forgo endowment funding for some period of time and redirect donors to an emergency appeal.  Alternatively, the board might continue to fund the endowment regardless of its current needs if, for example, it has a far-reaching goal, such as to eradicate hunger.

While most endowments have permanent restrictions on the use of their principal, others have only temporarily restrictions or even completely unrestricted components that allow the money to be spent. Endowments can also have end dates rather than existing in perpetuity.

Myth #3: An endowment is the same as a board-designated reserve account.

A designated reserve account is a pool of funds established by the board to provide certain types of capital to the organization. There are several kinds of designated reserve accounts: A working-capital reserve can provide funds during normal parts of the business cycle when cash is low–for example, when awaiting payment on a contract. A “rainy day” reserve is available for unexpected challenges or opportunities. Funds can also be reserved to help an organization recover from financial distress or to expand or acquire facilities. These pools are managed internally, though the board may place restrictions on their use.

Endowments, on the other hand, are not intended to fund routine operating activities and are often managed externally or held outside of the reach of the nonprofits’ general business managers.

Myth #4: There are limits on the amount of interest income that a nonprofit can take from its endowment

There are no such legal limits. The amount and timing of distributions is determined by the governing body of the endowment. Interest income is often used to fund board-designated reserves for future projects and to expand current programs and services. Nonprofits should, however, have realistic expectations about the yield on endowment investments. Only a large endowment that is professionally invested to maximize returns is likely to generate enough earnings to make a dent in the operating budget. Community foundations are well suited to manage smaller endowments.

When nonprofits recognize how fluid money can be, they can better assess the types of capital and cash flow they need to support both short- and long-term objectives and avoid making unnecessary trade-offs. They will also be able to tell a more compelling financial story to donors, clearly articulating their rationale and timing needs for a range of funding options including endowments, reserve accounts, grants, loans, and investments.

How does baseball point a path forward for those of us struggling to support a just and vibrant society in our troubled times?

The answer lies in the story of Billy Beane, general manager of the Oakland Athletics, who demonstrated how radical innovation can allow anyone to achieve positive transformation even against seemingly impossible constraints.

Mr. Beane, immortalized in print and film by Moneyball, watched his baseball team lose the 2001 playoffs to the much wealthier New York Yankees. He approached the Athletics owner for more money to spend on salaries and was turned down—the money just wasn’t available. Yet Mr. Beane refused to take that as defeat. He still wanted his team to achieve greatness.

Mr. Beane’s staff members offered to work harder and put in longer hours to help the team win. However, he sensed that even an improved version of business-as-usual would lead to failure. He did not have access to the funding others had used to solve similar problems. He needed to radically reinvent how he ran the team to have any chance of success.

Billy Beane’s journey offers a powerful map for health clinics, homeless shelters, schools,  theaters, and other organizations that weave the essential fabric of our communities. If this sounds like a stretch, consider their parallel path:

Like the Oakland Athletics, these organizations are facing crushing budget constraints. And like Mr. Beane, their first response is often to try to tap traditional financing sources for more money. Operating in a small market, the Oakland Athletics could not sustainably spend more on salaries.

Similarly, given the economic pressures we will continue to face for years to come, we do not have the resources or financing that we used to have to support our social organizations. Yet the needs these organizations address must continue to be met.

So what can we do with lower budgets? I side with the romantics who refuse to accept that we must lower our standards for how just and vibrant our communities can and will be. But like Billy Beane, we are gradually realizing that just getting better at business-as-usual approaches is not going to be good enough for long-term sustainable impact. Even many of our most efficient organizations are going bankrupt.

If we accept these budget constraints and refuse to lower our ambitions, we must embrace radical innovation. Billy Beane adopted data-driven analysis to put together a winning team.

For nonprofits,, innovation will take more diverse forms. It will lead organizations previously competing over shrinking resources to collaborate. It will inspire visionary leaders to rethink their approaches to the problems they want to solve. It will mobilize “complete capital” approaches that draw on for-profit investment alongside charity and government subsidy. And it will require us to support these organizations smartly as they shift from old business models to new, more sustainable ones.

So how can we better support game-changing innovations in the social sector?

For a donor or socially minded investor, a key piece of the puzzle is to look at the organizations you support in the greater context of the social problems you wish to influence. Billy Beane didn’t just think about winning a single game; he lifted his head up to look at the bigger picture of how baseball could be played in a different way. Similarly, for example, do you want to help a single organization or be part of the greater solution to solve homelessness in your community?

Two of Boston’s most important organizations that serve the homeless, Pine Street Inn and HopeFound, asked themselves that question two years ago.  After a careful evaluation assessing how to create the most significant social change, HopeFound and Pine Street Inn recently announced a merger that will allow the combined entity to offer a more comprehensive set of homeless services than either organization could achieve alone. Through the support of the Catalyst Fund, a five-year fund to support the exploration of nonprofit collaboration and mergers in the Boston metropolitan area, homeless men and women will have better access to the services they need to get off the streets, out of shelters, and into permanent housing, bringing us one step closer to ending homelessness in Boston.

If you donate to nonprofits or sit on their boards, you can support these kinds of transformations by keeping an eye on the ultimate social impact you wish to achieve. As a board member, how might the organization you support work with other organizations in the community to achieve its mission? As a donor, what is the full scope of financial resources it takes for an organization to implement the change needed to achieve this kind of innovation? And how can you contribute to that?

The lesson for all of us is that we need to provide flexible, unrestricted funding that can allow innovative organizations to figure out new ways to meet their mission, rather than just paying for the services they have provided in the past. We also need to provide the “change capital” that will allow organizations the flexibility to build the capabilities they will need in the future. Focusing on overhead ratio as a proxy for efficiency when we consider where to donate has never made sense and is only more destructive now.

Like Billy Beane, those of us who work in the social sector must embrace his winning spirit by relentlessly asking, “What works better?” rather than, “What have we done in the past?” And we can all support the practical romantics who are figuring out how to change the game to create the type of society we all want to live in.

Like most nonprofits, they’ve grown used to doing more with less. Their mission commands it. But there’s a growing constellation of organizations committed to furnishing them with enough capital to do more with more.

Owing to its sheer size, the future of American health care is perhaps the most consequential issue facing nonprofits. So, while the healthcare political battles continue in Washington and around the country, nonprofit and philanthropic organizations can’t wait for government wheels to turn. Health-care providers in low-income communities are seeing dramatic increases in demand for services: One center I visited recently has a waiting list of 3,000 patients.

For investors of any kind looking to make an immediate social impact on communities in need and introduce greater efficiency into the market, health-care centers are a great deal. Located in neighborhoods with limited medical-care options, community health centers that have won federal certification are required to serve everyone, regardless of whether they have insurance or can afford the care. In 2010, such centers served 19.5 million patients, 38 percent of whom were uninsured.

These numbers are expected to grow fast. According to Capital Link, a nonprofit consultancy, serving new patients will require more than $16- billion to build or expand facilities.

Though we don’t often think of them this way, community health centers are a critical part of our social and physical infrastructure, true workhorses of our neighborhoods, treating patients, educating residents about healthy behavior, and providing jobs.

One reason these centers are so good at saving money for communities is that their patients are not visiting emergency departments at hospitals where care is much more expensive. In fact, that has prompted some local hospitals to finance community health centers. And the upfront investment in long-term habits like eating healthily, treating diabetes, and monitoring asthma have well-established financial and health benefits that translate more or less directly into cost savings for communities.

Increasingly, communities are recognizing the value of health centers as nonprofit enterprises that consolidate government, private, and consumer dollars. These centers are critical engines of well-being in distressed communities, and we must continue to encourage efforts to ensure that their growth is done smartly and sustainably.

That’s why nonprofits need liability and property insurance, which are critical tools for protecting assets and preserving financial health when the unexpected happens.

However, the insurance trade is a complicated, regulated industry. So I’ve enlisted the help of two seasoned insurance professionals to explain how it works: Pamela Davis, chief executive of Nonprofits Insurance Alliance Group, which insures 10,000 nonprofits across the country, and Valissa Naganashe, an agent at Brownrigg, which insures nonprofits and businesses..

Q: What is general-liability insurance?

Ms. Naganashe: General liability is the most basic form of business insurance. This is the protection you have whenever you or your business will be held responsible for causing damage to a property or injury to a person. General liability covers both on- and off-site services—programs, special events, and meetings—that board, staff, contract workers, and volunteers may be involved in.

Q: Once a nonprofit has purchased insurance, does it have further obligations to the insurer?

Ms. Naganashe: Nonprofits need to regularly communicate with their insurance agent and their board or finance committee about the status of financial, program, and funding obligations. Changes in operations, for example, managing funds for others, adding or abandoning locations, hiring new staff, or undergoing a merger can have a huge impact on both the validity and cost of an insurance policy.

Ms. Davis: Organizations need to report claims–or issues that could become claims–to their insurer as soon as they become aware of them. Private settlements should be avoided for two key reasons:

* The insurance company is not obligated to reimburse any cost.

* The resolution may not be legally binding or might have unintended consequences.

Q: Why do some grant makers ask the nonprofit to name them as an “additional insured” entity on the nonprofit’s insurance policy?

Ms. Davis: If someone is injured doing work funded by a city or foundation, a claim could be made against both the funder and the nonprofit. When the funder is named as an additional insured, the insurance company will (with some exceptions) defend them. These endorsements can often be obtained at no charge.

Q: How can a nonprofit protect itself from theft, fraud, or other bad acts?

Ms. Davis: Good oversight of people and resources is a nonprofit’s first line of defense against bad acts. Nonprofits can also obtain fidelity insurance as a part of their property insurance, which covers the theft of cash or goods.  Make sure that the fidelity insurance covers both employees and volunteers. Separately, every nonprofit with employees should have directors’ and officers’ liability insurance, which includes coverage for “employment practices” (acts directed toward or committed by an employee, such as sexual harassment).

Q: Are there special considerations for nonprofits that own autos or whose employees use their personal cars for work-related business?

Ms. Naganashe: The financial and emotional cost of an auto accident can be devastating, so it is important to maintain insurance coverage. Organizations can get broad coverage for any auto that is owned, hired, borrowed (including employee-owned vehicles), or otherwise used by the named insured. If a nonprofit doesn’t own vehicles, then more limited coverage is available.

Ms. Davis: While some nonprofits may feel that they can’t afford adequate insurance in these tough economic times, the experts caution that nonprofits can’t afford to let policies lapse. Organizations that are experiencing cash-flow problems should contact their insurer to discuss possible cost-saving adjustments to their policies or revised payment plans.

Here’s what it means to prepare:

Shore up the revenue and find your weak spots

Don’t assume that because you have always received a grant from a particular donor that you will continue to receive one next year.  Reach out to your longtime grant makers, arm them today with real information about the value of your work. Do it now even if your annual report is not due until December. Look for reasons to remind them why your work—and hence their money—is essential.

Listen and try to understand how your grant makers are thinking about this crisis; it affects them, too. Virtually every foundation has gone through a reduction of sorts. Sharing is helpful and builds different kinds of bonds.

Seek out information that can be helpful, which means asking your grant makers and your clients for constructive feedback.

If you are not measuring your results, start now. Don’t worry about being perfect or starting a rigorous 10-year longitudinal study. Push yourself to move beyond the anecdote. Jim Collins, the author of Good to Great and other books, had it right:  “It doesn’t really matter whether you can quantify your results. What matters is that you rigorously assemble evidence—quantitative or qualitative—to track your progress. If the evidence is primarily qualitative, think like a trial lawyer assembling the combined body of evidence. If the evidence is primarily quantitative, then think of yourself as a laboratory scientist assembling and assessing the data. … What matters is not finding the perfect indicator but settling upon a consistent and intelligent method of assessing your output results and then tracking your trajectory with rigor.”

Take advantage of networks you have but don’t use.

Think broadly about your networks. Look at your competitors as comrades-in-arms and find ways to complement and enhance your work through partnership. Don’t just say you’ll collaborate because you’re supposed to.

Think of your trustees as spokesmen rather than check writers. If you didn’t recruit someone specifically as a donor, don’t expect that person to turn into one—even if he or she has the financial ability to do so. Everyone should contribute something so you have 100-percent participation (something grant makers like to see).

Board members who can articulate their support for your work, describe the mission, and be eloquent about your advances are as valuable as big donors. Ask them to “talk you up” socially, especially during the holiday giving season.

Get clients and others your organization serves to understand what you need. Staff members are already talking to these people, so this is low-cost and easy.

Spend less and save as much as you can.

Quell the urge to start new things.  It’s expensive and it’s risky.  Unless you have money expressly for this purpose, any extra cash is your rainy-day fund and you will probably need it.

Be purposeful about what you choose to take on and make sure you have a contingency plan in case you have a major cash-flow or other problem.

These adjustments are taking many forms. Some organizations are investing in new ways to deliver programs and services, while others are making their current activities more effective and efficient. Change can mean restructuring operations, collaborating more formally with similar nonprofits or, as now happens with greater frequency, trimming the size of the group’s staff as well as its programs and activities.

Regardless of what form it takes, change isn’t easy for many nonprofits. It’s time-intensive and expensive, and it involves risk.

What makes some organizations more likely than others to adopt change effectively? A history of surpluses? A board that is willing to step out of its comfort zone? An entrepreneurial management culture?

Those traits are important, but they are hardly all that matters.

Based on the Nonprofit Finance Fund’s work with hundreds of nonprofits, here are 10 characteristics we see again and again in organizations that succeed in making strategic changes:

• Leaders who see the whole of the organization and who understand that long-term success in carrying out a group’s mission is much more than just the sum of its programs or projects.

• An entrepreneurial mind-set: an openness to exploring and investing in new services, technologies, and ways to do business that have the potential to create meaningful new revenue.

• Top executives and board members who have a firm grasp on the link between financial performance and the ability of a group to carry out its mission effectively. They rely on data (quantitative and qualitative, programmatic and financial) to inform decision making.

• A commitment to planning and self-reflection, including a management team that knows how and when to seek the advice of outside advisers for strategic planning, producing financial models, and measuring results.

• Adaptive capacity: a culture that values nimbleness, a willingness to test new ideas and make course corrections in the face of errors, obstacles, and new information.

• Board members who understand that social returns require taking risks, risks often involve losses, and experimentation can be costly.

• A track record of strong financial performance, characterized by operating surpluses year after year, sufficient levels of working capital, and the gradual accumulation of one or more reserve funds.

• Access to sufficiently large amounts of flexible and “patient” capital in relation to the proposed plan for transformation and the size of the organization. Such capital, which must usually be available over a stretch of years, is meant to support the errors, risk-taking, and temporary deficits that may occur as the organization pursues a desired change. In that sense, what the organization spends the money on matters less than what it ultimately achieves. We call that kind of investment change capital; it is intended to cover costs until the business model can support itself with reliable revenue.

• A strategy for generating reliable and regular streams of revenue and a commitment to hiring talented people and making other operational adjustments that will be needed to make sure the organization can sustain new approaches to generating revenue over the long term.

• A continuous focus on results among board members, top leaders, middle managers, and all other staff members and a universal understanding of the changes the organization is making and how it will know if it is succeeding.

While not every organization that thrives in a transition to a new way of operating exhibits all 10 of those characteristics, it is impossible to make big changes without those features.

Tell us about your experiences. Which of these characteristics do you think are most important in preparing an organization to make a big change? What would you add?

They are idealistic young people who envision jobs that are the perfect nexus of “helping people” and using what they have learned in their academic studies. They are nurses who hope to run free clinics and fine-arts majors who want to start community theaters.

And they are sometimes for-profit employees looking to make a career switch or nonprofit professionals looking to start or move up in an organization.

These budding nonprofit leaders bring with them the passion for service, creative rigor, and intellectual curiosity required to inspire people and communities. Why is it, then, that so many new managers find themselves burned out, off-mission, and out of cash in short order? In a word, finance.

Many experienced nonprofit executives avoid telling young people how much of a leadership job entails understanding money, in large part because they don’t want to push the most talented people away from nonprofit work. Therefore, new managers often start their careers unschooled in how to raise, save, spend, and invest their organization’s money.

In the words of a seasoned nonprofit executive, organization leaders must recognize that “margin is mission”: Nonprofits are created on dreams but run on money. For this post, I interviewed some successful nonprofit executives about how they mastered nonprofit finance and what advice they had for those considering nonprofit leadership roles.

• Build financial literacy. Learn as much as you can about finance and take college business courses, if possible, says Margaret Huggard, president of Catholic Social Services of Oakland County, in Michigan.  Ms. Huggard, a social worker by training, recalls that early in her career she took several accounting and finance classes because she knew that any enterprise that didn’t understand its cost structure was destined to fail. She said leaders that can’t manage financial data and decisions put their programs, staffs, and integrity at risk.

• Get expert advice. Form strong finance and investment committees of the board or engage outside advisory groups with solid financial experience, says Judy Watson Olson, president of Great Lakes Center for Youth Development, in Marquette, Mich. When she took over as chief executive, Ms. Watson Olson formed an investment committee filled with chief financial officers, bankers, and accountants to help her make decisions about programs with an understanding of how they were financed. Even though Ms. Watson Olson has MBA-level training, she welcomed advice from people who spend every day working in the financial world.

• Look and listen. Stay constantly informed about your financial condition and recognize the rhythms of the operation or organizational ebbs and flows, says Patricia Rosen, president of Care House of Oakland County, a Michigan group that helps abused children.  Ms. Rosen says nonprofit leaders face increased scrutiny of their financial stewardship so they need to articulate and defend their financial position.  Part of that accountability requires leaders to actively and regularly talk to people on their financial staffs, donors, and others who care about the nonprofit.

• Focus on quality. The bottom line of any organization is driven by the quality of its work, says Oliver Ragsdale, president of the Arts League of Michigan.  Clients and donors have choices and they only buy services and support organizations that are appealing and effective. Many nonprofit leaders have difficulty weathering financial cycles, Mr. Ragsdale says, because they too quickly trade quality for savings, thus diluting their future earnings and the impact of their brand.

What insights might you add for people aspiring to leadership jobs?

In particular, people want to know how reserves compare with endowments, because both are ways for nonprofits to help secure the organization’s future.

Reserves are a lot more flexible than endowments—and often more appealing. The money and the interest from a reserve are governed by a nonprofit’s board and can be used for many purposes.

Endowments tend to last a longer time than reserves but are much more restricted. Typically, nonprofits can spend only the interest generated by investing the money in an endowment, and donors can place many restrictions on how the money may be used.

Organizations often spend a good deal of fund-raising energy building up endowments and then find they can tap only a small portion of the pool of money raised. Making matters worse, donors who have recently given to endowments often don’t want to make a second gift for current needs—so nonprofits find themselves in a squeeze to pay for current operations even when they have just completed a successful campaign.

The first question a nonprofit should ask before creating a reserve is what the purpose of the money is. Is it just there in case of a catastrophe or to pay for building maintenance or to provide the kind of capital that can be used to change or transform the organization?

The second question is about the board: Has it defined the purpose, policies, and management that will govern the reserves? The board can always revisit these policies, but it needs to set out the basic rules for spending the money.

The next question is more practical: Does the nonprofit have a chance to achieve a surplus on any of its programs or other operations such that it can create savings and fund reserves?

Once the reserve is in place, it can often be tempting to use that money to meet shortfalls. And that may be a smart course to follow in the short term. However, nonprofits need to develop a plan to replace the lost revenue and get the organization back on a steady and healthy financial course so it’s not constantly falling short of budget.

Just as important, organizations need to explain to donors and others why a surplus is not put toward paying for immediate needs or more services. It’s important to explain that reserves are a safety net in case of crisis and a way to guarantee nonprofits can seize on great but unexpected opportunities.

Reserves are not just a financial tool, however. They are a concrete way to promise the people who count on a nonprofit that no matter how much of a roller coaster an organization faces in a bad economy, it will continue to provide vital services.

The executive directors of children’s museums are some of the most creative people on the planet.

Introducing kids to learning, play, and problem-solving is their life’s work. Yet as I found out when I recently gave a talk to a group of museum leaders, these proven innovators face limits in their ability to experiment, to test fascinating concepts that could substantially improve their organizations’ enterprises or the nonprofit world at large.

For most of them, two things stand in the way of carrying out good ideas: They lack the money to carry out ambitious changes—what the Nonprofit Finance Fund calls change capital–and they are surrounded by boards, donors, and others who fear failure.

Change capital is to the nonprofit world what venture capital is to the for-profit world. It is money that can be used for excellent growth opportunities and to incubate innovation. It is different from “walking around” money or the money used to pay bills and support programs. When providing change capital to a nonprofit, an investor expects a healthy return of monetary, intellectual, or social value.  But this type of financing can be hard to come by, because it requires investors to accept the fact that they could lose money.  The fear of failure is a natural impediment to bold, unconventional thinking.

In an essay for public radio, Jon Carroll, a San Francisco Chronicle columnist, said, “I believe in the power of failure. ,,, Failure is how we learn.”  He went on to say that success is merely “proving that you can do something that you already know you can do.”

Mr. Carroll’s observations are easily applied to the world of nonprofit finance, where nonprofits are often rewarded for their ability to effectively produce more of the same even if there are potentially better opportunities on the horizon.

Tim Harford, author of Adapt: Why Success Always Starts With Failure, says “the whole process of learning from failure means discarding stuff that’s not working” instead of throwing more money and energy into it.

The for-profit world is full of fabulous failures, businesses and products that struck out a few times before hitting on the right formula or model.

Henry Ford failed with two auto businesses before he created the Ford Motor Company, which was immediately profitable. Ford revolutionized manufacturing through a process of trial and error. Nonprofits can revolutionize the causes they serve with capital that allows them to grow, change, and adapt.

At the same time, we seem to be ready as a society to tighten our belts and go down the path of “all cuts, no new taxes” to balance state budgets as well as to trim the burgeoning federal budget deficit. It sounds good to those who believe that government is rife with waste and inefficiency.

But in neighborhood after neighborhood, we will see the devastating impact of budget cuts on social services that will disproportionately punish the most vulnerable in our communities.

Nonprofits won’t be able to make up for the government reductions with money from private donors.  Giving from individuals continues to be sluggish, foundation giving has not yet returned to pre-recession levels, and grant makers are closing programs they started during the recession to respond to the financial needs of nonprofits and the people they serve.

As if these massive cuts to our social safety net weren’t enough, we now see a number of nonprofits sinking below the weight of debts taken on when times were good and the future was bright and seemingly limitless.

If we want these nonprofits to continue to serve our communities, we must help them find solutions to these financial challenges, especially their debt burden. Every day the news reports show more and more nonprofits crumbling under the weight of debts.

Among the recent headlines:

Philadelphia Orchestra Goes to Bankruptcy Court

Deal Could Help Asian Art Museum in San Francisco Fend Off Bankruptcy

So what to do?

We can do nothing and blindly hope that already weak organizations somehow manage to scrape by until revenues eventually return.  We can sit back and lament the “bad decisions” made by some nonprofit groups.  Or we can start thinking creatively and aggressively about how to help organizations lessen or restructure their debt burden.

While bankruptcy is a real option for nonprofits, it is not a very good one. Few organizations have the capacity and ability to survive the long, difficult, and expensive process that a bankruptcy represents.

So how can we facilitate a reorganization process that doesn’t damage the local community (the ultimate “shareholders” of any nonprofit), doesn’t destroy  relationships with grant makers and other supporters, and isn’t cost-prohibitive?

We must explore the role foundations can play in helping to set up guarantee programs or refinancing debt.  And we should see whether the  federal government can put pressure on banks to be more thoughtful about how they can help  nonprofits avoid shutting their doors. There are no immediate answers to the daunting challenges.  But the need is imminent and this is more than just a conversation.  The stakes are incredibly high.

The real risk is not just that one, or several, nonprofits may close their doors and lay off employees, although that is the next shock wave that will reverberate in community after community as the number of nonprofits shrinks.

The real risk is that a battered woman or at-risk child will have no safe haven, that homeless veterans will lose access to mental-health services, and that the hungry will be turned away from food pantries and driven to more desperate measures.  These are the risks we face–on a potentially massive scale–if we choose simply to ignore this challenge.