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Measuring an Organization's Financial Health

 

Things to keep in mind when you are evaluating an organization's financial health:


Guide for the Responsible Donor

 

Background

The nonprofit sector is a collection of institutions within which citizens choose to work together, devoting energies, convictions, voices, and resources to establish what they believe will be better conditions for their families, their communities, their nation, and their world. The sector is fundamentally democratic. Donors, directors, and beneficiaries make up the constituents that ultimately govern the work of its institutions. With over one-half million IRS-determined "public charities" operating in fields that cover the full range of society's work, the sector is vast and complex. It confounds casual observers and direct constituents alike.

Understanding the work of a single organization is difficult as well. Since nonprofit organizations typically are local and embody unique expressions of community values, their missions and objectives vary greatly even when they are "in the same line of work." Unlike business firms, which pursue a common bottom line of profit, each nonprofit organization will seek an essentially unique result from its work.

While their analytical challenge may be greater than that of business investors, donors have an analogous responsibility to allocate financial resources for a substantial sector of our social economy. If anything, the role and responsibility of donors are greater than that of corporate investors. In the business world, investors allocate capital, but revenue from the sale of goods and services ultimately sustains and grows businesses. For virtually all nonprofit organizations, with the clear exception of health centers, donors provide both capital and a significant portion of annual revenue. Donors, not the "dollar voters" in a marketplace, are the final arbiters of life, growth, decay, or death for most nonprofit organizations.

Unfortunately, while undeniably well meaning, donors often do not or cannot perform these profound responsibilities with sufficient care. They may respond reactively and sporadically to requests for donations rather than seeking out and supporting regularly organizations that perform well work that they value. They may demand little, if any, information about organizations' past operating effectiveness, financial health, reasonableness of objectives, and institutional capacity to achieve objectives. Frequently, donors behave as though they have met their responsibilities when they enter charitable deductions on their tax returns, not asking later whether their contributions have been used effectively by recipient organizations.

Much of what we read and hear today reinforces the notion that nonprofit organizations should not be trusted and that we as donors must insist upon our right to know whether organizations are spending their funds efficiently and ethically. We believe that this emphasis focuses our attention in the wrong direction. By concentrating upon the relatively small issue of malfeasance and the often misleading issue of financial inefficiency, this emphasis limits our perspective as responsible donors. The discussion that follows is not about preserving donor "rights" or ensuring "consumer" protection. It is about enabling donor responsibility. Likewise, it is not about uncovering malfeasance or operating inefficiency within nonprofit organizations. Rather, it is about asking donors to take the initiative to identify and support consistently the resourceful nonprofit organizations that do a good job performing work that those donors believe to be important.

What Donors Should Know

Taking donor responsibility seriously is hard work. Nonprofit organizations report no single bottom line. Since the objectives of organizations and the results they seek are so varied and value-laden, it is impossible to point to a simple calculus for performance measurement. Further, operating objectives and values that are important to one donor are not necessarily important to another. Is there a way for donors to make sense of this confusion? How do donors identify resourceful nonprofit organizations that do a good job performing work they believe to be important? Donors might start by seeking answers to the following questions about the nonprofit organizations they are interested in supporting.

Value Congruence

Are the values of the organization with respect to its mission, objectives, and treatment of employees, beneficiaries, and other publics congruent with mine?

Before donors go through the effort of understanding the operations of a nonprofit organization, they will first want to judge whether the organization engages in activities and approaches its work in a way that is consistent with their own values. They should review the organization's mission, objectives, types of beneficiaries, and employment and governance practices to make sure they are comfortable with its direction. If possible, and this is certainly practical in the case of local giving, they should visit the organization. Ultimately, successful organizations must convince donors to give regularly. Donors cannot become consistent givers unless and until they consciously identify organizations with values congruent with their own.

Objective Setting and Effectiveness

Is the organization committed to setting solid objectives, reporting accomplishments that correspond to those objectives, and assessing and reporting whether or not it is performing its work effectively? Donors should assess whether the organization is truly committed to understanding and reporting its own operating effectiveness, e.g., documenting true progress in the accomplishment of its mission. How does the organization know it is doing a good job? Does it set reasonable objectives for performance each year and report its accomplishments clearly? As a good discipline before they give, donors should identify progress on important objectives that they expect will be realized or resolved before they are willing to give the next time.

Institutional Health and Capacity

Does this organization possess the financial health, managerial capacity, and enterprising orientation necessary to achieve the objectives it has set out for itself and evolve as a productive institution?

Once comfortable with an organization's operating objectives, donors should develop the further confidence that the organization's governance, management, and resources are up to the task it has set for itself. Financial analysis can be helpful in assessing an organization's resilience and strength; however, it does not reveal the extent to which an organization is a "learning," responsive, innovative, or enterprising institution. These latter qualities, while difficult to assess, are critical to predicting the beneficial impact a nonprofit organization may have upon its environment over time.

Accountability

Does this organization readily make its financial and operating information available to the public and respond quickly and graciously to reasonable requests for information?

We are all reluctant to place further demands upon the time of nonprofit staff who are working diligently to further their organization's basic mission. On the other hand, these organizations have a contract with the American people. In exchange for their good work and willingness to report regularly and publicly on their operations and finances, we grant them highly favored legal and tax status.

This is no idle exchange. The ready availability of reported information is critical in allocating society's resources, informing public policy, and ensuring the public's confidence in an entire sector. Despite the costs of disclosure, donors must continue to require it of all IRS-qualified nonprofit organizations. If an organization fails to respond to reasonable requests for information, it should be avoided.

Competing Organizations

What are the attributes of other organizations, if any, that share the mission and focus of the subject organization?

One last step remains before donors can truly give responsibly. If possible, they should identify and review other organizations that perform work similar to, or serve the same beneficiaries as, the subject organization. This final discipline will ensure that donors have done all they can to allocate resources effectively to the nonprofit sector. It may also uncover other organizations that warrant attention and support.

What Donors Shouldn't Do

Don't look strictly at ratios.

Donors must look beyond simple financial measures of nonprofit organization efficiency. Very often we are told to look at financial ratios to determine whether a contributed dollar is well spent. Low fundraising ratios, which divide the amount spent on raising money by the amount actually raised, and high program ratios, which divide program-based expenses (those spent on the operating work of the organization excluding fundraising and administrative expenses) by total expense, are often cited as indicative of efficient nonprofit performance.

Unfortunately, accounting practices vary widely. Further, nonprofit organizations face vastly different operating conditions. They work in different fields. They are of different age and size and enjoy varying growth rates, cash reserves, and access to sources of funding. These factors make any judgment of or comparison among nonprofit organizations using simple fundraising and program ratios problematic at best.

Further, what is good performance and what is bad? Is a young, poorly endowed organization that spends money to build the institutional fundraising capacity needed to meet a rapidly growing operating opportunity less deserving of your contribution than one that spends little on fundraising because its cash resources are already plentiful and its growth limited? Finally, even if such comparisons were relevant with respect to financial efficiency, they tell the donor nothing about the operating effectiveness of the organization, i.e., the real outcome of its work.

Don't restrict gifts to specific programs.

When reviewing nonprofit organizations, it is tempting to identify subsets of their work that are most personally appealing and restrict a donation to those purposes. While nonprofit development officers who solicit large donors often encourage restricted gifts, this is a practice that can be destructive to an organization's institutional progress. Yes, donors will always have the right to restrict gifts. But if a donor chooses to restrict a gift to an organization, this restriction should be made with care.

Donors should recognize that confidence in the management and general direction of an organization is far more important both to the overall success of the organization as well as its ability to perform on the specific, preferred program. These managers are closest to the action, and, once donors decide their organizations are worthy of their gift, donors trust managers and organizations' governance leadership to know how those organizations can best respond. By restricting gifts, donors may also restrict the flexibility of managers to adapt strategies to a changing environment. They also could be compelling cash-strapped managers to resort to dysfunctional, grant-chasing strategies that respond more to the vagaries of donor interest than to the evolving needs of beneficiaries.

Don't wait to be asked.

The resource allocation/fundraising process in America is a frightfully expensive proposition. This is because gifts typically are made only after a nonprofit organization goes out of its way, often at great expense, to raise them. Unlike resource allocation in the business world, where investors and companies seek one another out in an information-rich environment, philanthropy is largely a one-way street. By waiting to be asked, donors do several unproductive things. They:

  • base their contributions on non-objective factors such as impulse or guilt;
  • fail to evolve personal philanthropic strategies that yield a more effective allocation of their resources;
  • default to supporting nationally-based organizations with the capital resources necessary to mount direct-mail and telemarketing campaigns, perhaps shortchanging less capital-rich but nonetheless deserving local organizations; and
  • perpetuate costly national fundraising practices.

Don't give sporadically.

In order to become a regular, committed donor, it is important to develop sufficient knowledge about and comfort with organizations. So much of the cost of fundraising revolves around "acquiring" new or lapsed donors. By fostering an ethic of consistent giving, donors can begin to erode these sizeable expenses. However, before becoming regular givers, donors should follow the guide above and make sure the organization:

  • performs work that they deem important and operates in a manner that is congruent with their values;
  • articulates well its own objectives and accomplishments;
  • has requisite resources and/or strategy to achieve its objectives; and
  • reveals its operations and finances for public scrutiny.
  • Further, donors should be cognizant of other organizations performing similar work.

Postscript

Today, being a responsible donor is hard work. Much of the information needed to make judgments in the areas outlined above is not readily available. To acquire it, donors will have to conduct rudimentary research and often question the organizations themselves. While there is no substitute for a site visit, Philanthropic Research, Inc. (PRI), is committed to developing and making available to the public information providing answers to these fundamental questions for all IRS-determined public charities. PRI's mission is to help donors form their own judgments about organizations and take responsibility for the allocation of their personal resources to the nonprofit sector, thereby making the process of philanthropy truly a two-way street.


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