Portfolio Theory and Nonprofit Financial Stability

This article r~iodels arid tests for the /actors that irijlitetice firiaricial predictability for a nonprofit orgatiization. Firiaticial portfolio tlieoty is used to niodel a tiotiprofit organization’s optitiial cotnbitiatioti of reveti~i ~ streanis i i i order to tnitiiniize Jitiaticial risk. The optiriial conibinatioii offiiiiditigfi-0111 govei-~it~ient mid other sotirces depends 011 tlie variance arid covai-iance between the soiwces ofreveiitie. Datafrorti tion~~rofitfoster care organizations in New York State are used to show tliat tioriprofiit organizn~ions that are more Rcpendetit on goveriinient fiinding as a soiirce of reveiiiie Jiave t i~orc predictable reveiiiies. Financial predictability is a goal for the managers of nonprofit and for-profit organizations alike. In the for-profit sector, portfolio managers seek to minimize financial risk given an expected financial return. They choose from a set of investments with a minimum level of risk for a given expected return. An increase in expected return is possible only with an increase in unpredictability or risk. Similarly, managers in the nonprofit sector seek to provide a certain level of services (a given level of expected return) while minimizing unpredictable changes in revenues (risk). Like for-profit portfolio managers, nonprofit managers can also choose combina-tions of risk and return by selecting different streams of financing. An increase in the share of investment devoted to solicitation of donations may increase the expected level of donations, but, given the unpredictability of donations, the risk or annual variance of these revenues will increase