Delayed gratification (financial strategy 2 of 3)

Eyreton Wood - managed by the Isle of Man Woodland TrustThis blog looks at two ways in which organisations need to be willing to forego current spending to secure a healthier future – delayed gratification of the financial sort.

Asset strategy

Fixed assets come in two flavours: tangible and intangible.  Tangible assets are the ones you can see and touch – buildings and equipment mainly; intangible assets are the ones you cannot – brand, intellectual property and knowledge.  What they have in common is that they are both investments in the longer term ability of an organisation to generate revenue and deliver on its mission.  

Tangible assets

Until recently many organisations did not plan for the replacement or renewal of their asset base on the basis that either they were not responsible for the upkeep of the buildings they occupied or that grants would be available to fund a purchase when needed.  As local authorities divest themselves of assets and public funding shrinks, neither of these assumptions will hold true for most organisations.

The twin starting points for developing an asset strategy are:

• What assets do we currently have?

• What assets do we need to achieve our aims?

For each asset that you currently own and want to retain you need to know:

• What do we need to spend to maintain this asset?

• When will we need to upgrade it or buy a new one?

• How will we fund the upgrade or purchase?

• What depreciation charge are we charging on this asset and to which fund on on the balance sheet?  If the depreciation charge is going against a restricted fund balance it is not helping you to build cash to fund the next purchase.

For every asset you want to acquire:

• How will you fund its purchase?

• How long will last?

• How much will you need to spend maintaining it?

• What depreciation charge do you need to factor into your financial projections?

An asset strategy will usually cover a longer period than a business plan, typically 5 to 10 years, and may be needed for several decades if the organisation occupies a large building on a long lease.

Intangible assets

There is a cliché in management literature ‘what gets measured gets managed’ (Peter Drucker).  Intangible assets are hard to value and do not usually appear in the accounts of visual arts organisations.  Partly as a result of this, they are frequently not managed or recognised but they are one of an organisation’s most valuable assets and one of its most likely sources of new income.  

During your next business planning process, do consider these questions

• What intangible assets have we created?

• How do they help us to deliver our core purpose?

• Could we exploit some of them more effectively to attract more resources ot our organisation?

• What do we need to do to keep these assets in good shape?

Reserves

During the last decade there has been considerable talk about the value of and need for reserves both within charity and arts circles. The issue has slipped down the agenda recently as the focus has shifted to balancing the books and to finding new operating models but I believe, not only is it impossible to write a good business plan without considering reserves, but that the current emphasis on income generation makes a good reserve strategy essential to survival.  

For an introduction please listen to the interview at the bottom of this post, recorded earlier this year, with Jon Treadway, then Director, Regular Funding at Arts Council.

In broad terms, organisations need reserves (of the unrestricted or free variety) for 5 reasons:

1. To allow the organisation to deal with unexpected and unwelcome (eg sudden loss or illness of key staff, bad debt, poor trading results) without having to immediately embark on a cost cutting exercise.

2. To allow the organisation to respond strategically to changes in the external environment.  For example, to fund the costs of change if an organisation decides to move to a new business model.

3. To invest in opportunities whether of the artistic or income generation variety

4. To provide working capital, of which more in my next blog

5. To allow the organisation to wind up solvently and pay off all its creditors, including its staff, if the organisation is no longer viable.

In working with clients I am often told that they are aiming for reserves of three months operating costs as that is what the Charity Commission recommends – this is not correct.  The Commission recommends that charities set reserve policies and targets that reflect the nature of the businesses that they are running.  The three month ‘rule’ has arisen because this is not a bad guestimate of the cost of closing down a relatively simple and small charity with no substantial long term commitments eg market rate leases.  

All organisations, whether or not they are charities need to establish levels of reserves that are appropriate to them.  Several years ago PriceWaterhouseCoopers undertook a review of reserves for the Arts Council and included a number of visual arts organisation within their sample group.  Their work produced the following matrix to help organisations determine what their reserve levels should be – I really recommend thinking about where your organisation fits on these two spectra.

As more arts organisations start behaving in more commercial ways they will need to pay attention to the key issues of capital (assets and reserves) in a similar manner to for profit businesses.  I am minded of a comment made by a partner I worked for the in the City: in my early days I asked how he could decide which businesses we might save and which we could not, his reply was simple - the bigger the pggy bank the better the chances!

The next post will continue this theme and look at the r-word – risk.

Thanks for reading

Susan

PS If you are not a fan can I recommend The Artful Manager blog by Andrew Taylor of the Bolz Center for Arts Administration at Wisconsin?  Definitely worth a look if you are struggling to write a new business plan.  

Reserves interview with Jon Treadway

A financial strategy: don't run a business without one! (Part 1 of 3)

Jill Townsley, Till Rolls at Compulsive, Obsessive, Repetitive at Towner courtesy of the artist and Towner A financial strategy is not a list of income and expenditure which, when totalled, equals zero or a small positive number; nor is it the pious statements included in trustee reports about a reserves policy and the management of risk.  A financial strategy sets out how you will secure and spend the financial resources of your organisation in support of your core purpose and aims.  Designing such a strategy is as much an art as a science.  It is an exercise in which you mange the tensions between the urgent (the short term) and the important (the medium/longer term).  It is the place in which the hard choices get made.  It is always a work in progress.

I have set out below the likely components of a financial strategy for a visual arts organisation.  In addition to the brief comments offered, the links will take you to additional ideas, insights and resources.

Funding

Funding models within our sector are changing rapidly and they will continue to evolve both in response to macro economic realities and long-term structural changes in the economy and society – the good times are over!  Against a background of declining public funding, a sluggish economy, static if not falling real personal incomes for many and increasing funder demands for a more diversified income base, organisations need to understand both their existing funding model and the one they want to move to.

What is your current funding model?

• Where does your income come from?
• What is the balance between unrestricted and restricted income?
• What level of risk is associated with each source?
• Are you overly reliant on one source?
• Is your funding model well aligned with your core purpose or are those ‘shoddy compromises’ getting too uncomfortable?

What should your future funding model look like?

• What sources will reduce or disappear?
• What new opportunities can you identify?  What would you need to do to develop these sources?  How long would it take for these new initiatives to pay off?
• What contingencies will you need to make against uncertain income sources?
• Can you reduce your dependence on one or two sources?

Delivery or cost model

Understanding the cost side of the equation is all about where the money goes. If you are going to make the money you have go further (and the alternative is, at best, a smaller programme) it is vital to understand how the resources you are buying deliver the work you do.

• How does your current cost base break down between fixed (i.e. costs you cannot change in the short term without incurring a liability such as salary costs) and variable/direct costs which vary with the level of activity
• What is the balance between staff and other costs?
• Which activities need investment, which activities contribute to overheads and which ones really make profits you can invest in your core activity?  (Will anyone whose café or shop really generates a profit after a full allocation of overheads tell everyone else how they do it?)

How do you want your model to change?

• In general terms the more uncertain your income base, the more flexibility you should aim for in your cost base so you can shrink and grow the organisation as funding waxes and wanes.
• How can you raise productivity within your staff team?  Examples could include: training, better use of technology to reduce costs, redesigning job roles and processes and changing opening hours.
• Could you outsource some functions or share them with other organisations?
• What changes do you need to make if your organisation wants to increase its earned income? Do you need to employ different people or re-skill the ones you have?  Do you need to implement new systems to manage your new business?  Do you need to create new budget lines for investment in new products, start up costs and sales?

This concludes part one of this three part post: next I will take a look at assets and reserves.

Thank you to Matthew Rowe, Jill Townsley and the team at Towner for providing me with the perfect picture for this post: a beautiful and bewitching new work made from till rolls and, as ever, thanks for reading

 Susan