Financial Strategy

Social enterprise is a means to achieve sustainability through earned income; however, it is important to note that financial objectives differ among organizations. Unlike the microfinance field, the financial objective of a social enterprise is not by default viability (generating sufficient income to cover all costs).

Social enterprises don't need to be profitable to be worthwhile. They can improve efficiency and effectiveness of the organization by:

• reducing the need for donated funds;
• providing a more reliable, diversified funding base; or
• enhancing the quality of programs by increasing market discipline. 1

Nonprofit organizations have varying financial motives for incorporating social enterprises into their organizations, ranging from income diversification to full financial self-sufficiency:

• Income Diversification -- For many nonprofit organizations, social enterprise serves as a strategy to diversify their funding base, decrease reliance on donors, and recover or subsidize program costs. In these cases, the social enterprise offers a means to reduce program deficits and employ resources more efficiently. Organizations seeking means to diversify income may set modest financial objectives. For example, the costs of a program previously 100% grant-funded now covered 40% by earned income is success for many organizations.
• Financial Self-Sufficiency -- Financial self-sufficiency is achieved by increasing nonprofit organizations' ability to generate sufficient income to cover all or a substantial portion of their costs or fund several social programs without continued reliance on donor funding. Organizations seeking to maximize profit will opt for external subsidiaries expressly for the purpose of funneling money back to the parent organization. Experienced nonprofits may use complex structures and have multiple mixed enterprises and income streams.
• Cost Savings and Resource Maximization -- This financial objective is usually combined with financial self-sufficiency or income diversification and is concerned with optimizing resources and leveraging assets for economic, social, and community development.
  • Cost savings--is achieved by sharing back office functions, optimizing systems, and streamlining efficiencies to increase business performance and margins.
  • Resource maximization--is achieved through leveraging the nonprofit's financial assets, tangible assets (space, equipment, plant, building, etc.), and intangible assets (proprietary content, methodology, relationships, goodwill, name recognition, skills, and expertise).

• 1. Dees, Gregory, Enterprising Nonprofits, Harvard Business Review, January-February 1998.

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Financial Spectrum of Social Enterprise

The level of social enterprise self-sufficiency is based on financial objectives, the type of enterprise, and its maturity. Social enterprise methodology does not dictate breakeven or profit-making; rather, financial performance is appraised by the ability of the social enterprise to achieve the financial objectives it has set.

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Methods of Income Generation

Social enterprises use a variety of methods to generate commercial income to sustain operations. At any given time, a social enterprise may use one or a combination of methods, based on the type of enterprise and business strategy.

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Access to Capital

Social enterprises, like any other business--micro or corporation, need capital to grow. It's not only a question of financing, but also of the right kind; capital must correspond to social enterprise financial needs, business cycles, and maturity. Furthermore, like any other business, the best make good use of borrowed capital and their own risk capital.

Access to capital, however, is a constraint social enterprises continue to face. The reasons are fourfold:

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External Financing vs. Revenues Over Time

Legend: SE = Social Enterprise; Y Axis = Money; X Axis = Time;
External Financing = all financing (grants, loans, contributions) minus revenues (internal financing)

Total expenses can be divided into three subcategories (moving upward along the Y-axis):

• SE Business Expenses include all costs found in similar businesses that are strictly for-profit, with no consideration for social impact and mission.
• SE Social Expenses comprise additional expenses incurred because of the social focus of the SE, such as special workplace or benefits requirements. Together, the SE Business Expenses and the SE Social Expenses total the total SE expenses.
• Program Expenses, in this context, represent expenses incurred to support social programs outside the SE.

From Time 0 to Time A (moving along the X-axis), the SE goes through a start-up phase requiring a lot of external financing. Expenses increase faster than revenues. This is a critical phase during which decision-makers must carefully weigh business expenses based on their potential for generating future revenues.

From Time A to Time B, the SE goes through a growth phase during which external financing is still required, but revenues grow at a faster pace than expenses, leading the way to traditional financial sustainability.

The SE reaches its first breakeven point in Time B, at which point the SE becomes sustainable as a traditional business (a business that does not incur additional social expenses). The difference between all Business Expenses and Revenues between Time 0 and Time B represent the total business investment over that period of time (light gray area on the chart). Even the best management team implementing the best business model cannot succeed in bringing a business to that critical point if decision-makers fail to recognize (and budget) the level of external financing that will be required over that certain period of time, both of which can vary greatly based on a variety of factors (all of which are considered during the business planning phase).

From Time B to Time C, the SE still requires external financing, but only to cover part of its Social Expenses (part of which is also covered by SE Revenues). Depending on the model, some social enterprises never grow beyond that point, in which case they serve in a context in which both SE Revenues and external social subsidies can be effectively leveraged to create social impact.

In Time C, the SE might be reaching a second breakeven point, at which all SE expenses are covered by revenues. Additional SE revenues now generate a profit that can fund social programs outside of the SE.

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