Cash Management

Cash management refers to ordinary transfers, usually of small amounts, between the checking account and other liquid accounts such as savings accounts. For example, if an organization anticipates having excess cash for a few months, the organization may open an account that earns more interest and temporarily hold cash there. (See Financial Management FAQ 16: How Should We Invest Our Short-Term Cash Balances?)

While these tasks are typically managed by staff, the board has a responsibility to oversee cash management and periodically review staff work. In most boards, the finance committee meets periodically with finance staff to review cash management guidelines and practices.

Endowment Funds (now called permanently restricted net assets)

Endowment funds, also called permanently restricted net assets, are created when donors designate contributions to a fund where the principal amount of the gift (the amount of the contribution) will not be spent, but will be maintained in perpetuity, for the purpose of producing income for the organization. In a term endowment fund the donor has specified that, after a stipulated passage of time or after the occurrence of some event, the principal amount may be spent as well. Most endowment funds specify that the principal will be held in perpetuity, but that earnings on the principal may be used for the organization's operating expenses.

The board's key responsibilities with endowment funds are to ensure that the principal is maintained and that the endowment is invested wisely. Assets held in the endowment fund (cash, stocks, bonds, land, works of art, etc.) should be managed prudently, according to guidelines which the organization has adopted for management of the funds. When organizations need cash, either because of an ongoing deficit or short-term cash deficits, they are tempted to borrow from endowment funds. Any such loans from the endowment fund should be approved by a formal vote of the board and a repayment schedule should be established. Because such loans put the principal of the endowment fund at risk, they should be discouraged.

It is the responsibility of the board to establish guidelines for the management of the endowment fund. These guidelines are typically discussed by the finance committee, which makes recommendations on policy to the board. Some of the most important guidelines to establish are the following:

• Shall the principal be maintained at face value or should the endowment be managed so that the value of the endowment increases at the rate of inflation?
  
  For example, if an organization has an endowment fund valued at $2 million and the earnings are used for current purposes, over time the endowment funds purchasing power will be reduced, although it will still show on the books at $2 million. Some organizations choose to reinvest an amount of the earnings equal to inflation in the endowment fund, in essence defining maintaining the principal as the principal adjusted for inflation.
  
  This is sometimes achieved by adopting a spending rule. For example, some organizations assume long term inflation at four percent and average portfolio return at nine percent, and thereby adopt a rule to spend five percent of the average market value of the endowment over the next three years.
  
  
• Shall gains on contributed, non-cash assets be treated as additions to principal (and, therefore, to be held in perpetuity), or as income (and, therefore, available for current expenditure)?
  
  For example, imagine an organization that receives a contribution of ten shares of stock, valued at $1,000 each for a total of $10,000. A year later, the organization sells the stock, now valued at $1,100 a share, for a total of $11,000. Must the organization now keep $11,000 in perpetuity, or can it keep $10,000 in the principal, and take $1,000 into income for current purposes? (In some cases a donor may place restrictions on the contributed assets such as specifying that a donation of stock cannot be sold.)
  
  
• How often will we withdraw the cash resulting from interest income from the portfolio and into the checking account of the general operating fund?
  
  Some organizations choose to take the earnings from the principal out of the investment accounts only once a year. Others pull out the earnings quarterly, or even monthly. Of course, the longer the intervals between withdrawals, the more income will be realized (because the income will be earning interest, too, until it is withdrawn).
  

Maximizing Income Through Prudent Investment

Whether assets belong in an organization's general fund, its endowment fund, or other fund, these assets should be invested wisely. Key decisions the board should make related to investments are:

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• Should we hire a portfolio manager or investment advisor, or make our investment decisions?
  
  Organizations with substantial assets often hire a portfolio manager. Organizations with fewer dollars to invest usually rely on the expertise of a board member or the finance committee.
  
  The portfolio manager, typically employed at a bank, brokerage, or an investment advisory firm, is responsible for making in vestment decisions for the organization. The portfolio manager will meet with the finance or investment committee to learn about the organization 's financial objectives and other concerns, and then make investment decisions throughout the year to meet those objectives. The portfolio manager should give the organization a monthly or quarterly written report which shows all the trades made in the period, the investments at the end of the period, and the value of each investment.
  
  Portfolio managers and investment advisors are generally paid on a retainer basis (a flat monthly fee) for their services, although some are paid as a percentage of the portfolio and others by commission on trades (the latter creates an incentive to make frequent transactions). Great care should be taken in selecting a portfolio manager and the finance or investment committee should routinely review the manager's performance in detail (usually by making comparisons to the returns in the financial markets and the returns on mutual funds which have similar investment objectives as the organization), just as they should when working with other professionals such as auditors and attorneys.
  
  Some organizations that have identified and agreed on an investment strategy choose to invest directly in a mutual fund that with similar investment objectives, rather than hire a portfolio manager.
  
  
• Should we create an investments committee?
  
  Organizations with little investment activity often choose to have their finance committees oversee investments. Some organizations with substantial investments choose to create a second committee to oversee investments. One common arrangement is for the investments committee to be chaired by an experienced member of the finance committee, and to include both other board members as well as non-board members, with board members comprising a majority of the investment committee. Having non-board members on the committee allows the organization to use the expertise and perspectives of individuals who may not have the time or other qualifications to be members of the board.
  
  In some cases, the investments committee or the finance committee makes specific investment decisions themselves, such as to move funds from Treasury bonds into mutual funds, to sell a particular stock, etc. In other cases, the committee selects and meets regularly with the portfolio manager to review investment decisions, and if necessary, recommends changing to a new manager.
  
  
• What guidelines should we establish for the investments committee or for the portfolio manager?
  
  The following questions are examples of concerns that boards take up in investment management. Often these questions are discussed primarily in the investments and/or finance committee, where committee members are more likely to be familiar with financial terms and the implications of financial decisions. In some organizations these questions are left to the investments or finance committee, while in other organizations proposed guidelines are brought to the whole board for approval. The answers to these questions will change over time as the organization's needs change; the appropriate committee must be in touch with board concerns, as well as with the following questions.
  
  
• Is our primary objective short-term earnings or long term equity growth?
  
  An investment that provides higher returns may not grow as much in equity. For example, a stock with relatively high dividend income may not increase significantly in its par value. Conversely, a piece of real estate may not provide much rental income, but over time may increase greatly in value and could be sold at great profit. Organizations with large portfolios will want a diverse portfolio that balances investment types; other organizations may choose different objectives as their program plans and cash needs change.
  
  
• What level of risk is acceptable to our organization?
  
  In general, the higher the expected return on an investment, the higher risk of losing the principal. Some organizations may feel comfortable only with investments that are virtually risk-free (despite low returns), such as savings accounts within FDIC-insured limits or U.S. Treasury bills and notes. Such low-risk investments typically are expected to earn less than higher risk investments such as stocks or money market funds. But if the company or the money market funds goes bankrupt, the organization may lose its investment entirely.
  
  
• Should we establish any non-financial guidelines for investments?
  
  Some organizations specify a preference for stocks in locally owned companies; one drug/alcohol abuse organization specified that no investments be made in companies that manufacture alcoholic beverages. Socially responsible investing is an example of utilizing non-financial guidelines.
  
  
• How quickly must our investments be convertible to cash?
  
  For example, do we want a certain percentage of funds liquid, that is, convertible to cash within, for example, five days?

These guidelines only touch on the important and often complex questions that boards must address in effectively managing investments. Most boards delegate their responsibilities to the finance committee in both oversight of staff work and setting financial guidelines. The finance committee typically brings major policies to the board for approval, and makes annual or quarterly written reports to the board on how cash and investments are being held, and on earnings performance during the previous period.