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Wednesday, June 15, 2011

Evaluating Charities – a Grantmaker’s Perspective


Donations are the life blood of many charities. However, in recent economic times many charities face closure, many endowments have shrunk and many families have cut back on charitable giving. With fewer resources, donors are becoming more selective with their giving and many charities are looking for new ways to secure funding sources. Financial data can be a valuable tool for charities that are trying to demonstrate the effectiveness of their organization or for grantmakers who are deciding where to give.

Public charities rise out of unmet needs and the philanthropic nature of people. Organizations quickly emerge to “help the community,” “make a difference,” “find a cure,” or “solve a problem.” However, the difficulty comes in finding ways to secure limited resources and manage them in an effective and responsible manner to most efficiently carry out charitable purposes. The philanthropic community is learning that no matter how worthy a cause, throwing money at an issue does not often solve it. A growing philosophy among the private foundation community is that one dollar donated to a well-managed, fiscally responsible organization can have a bigger impact on the unmet need in the community than $100 given to another with poor financial controls. If this theory holds true, then donors must find ways to evaluate charities for their financial viability and demonstrated ability to utilize funds to maximize the donors’ charitable goals.

For donors that have already identified organizations that conduct programs aligned with their charitable goals, how do you know if it is financially viable and fiscally responsible? For charities that have large plans for great programs, how do you demonstrate to donors that their funds would be most effective in the hands of your organization? We speculate that this can be accomplished through the analysis and preparation of readily available and accurately prepared financial documents.

By simply using a charity’s tax return and/or financial statements, the following financial benchmarks and ratios can unlock precious information about your favorite charity. All tax exempt organizations must provide their tax return upon request, and you can access the same tax returns without even asking, via the web at www.Guidestar.org. Subject to California’s SB 1262, most California nonprofit organizations must provide their financial statements to individuals upon request, and most charities will post their financial statements on their website or provide them if asked.

Financial indicators, Benchmarks and Ratios

Statement of Functional Expense - This statement can be found in Part IX of the Form 990 and in the financial statements for those non-profit organizations whose main revenue stream is contributions. It breaks out an organization’s expenses between program service, general and administrative, and fundraising. A general standard is that organizations should be spending at least 75% of their funds on program service expenses –or for every $1 you spend, $0.75 goes toward meeting the mission.

Auditors Opinion of the Financial Statements - The first page of a non-profit organization’s financial statements that you should look at is the auditor’s opinion page. Here you will find if, in the independent auditor’s opinion, the financial statements are presented fairly in all material respects. If the opinion states otherwise be careful to find out why. Deficiencies in financial reporting or fraud are good cause to consider whether or not the organization is financially responsible. In the auditor’s opinion you should identify whether the auditor has expressed doubt about the entity’s ability to continue as a “going concern.” This means that there is uncertainty as to whether or not the organization will be able to keep its doors open.

Financial Ratios - Many investors use financial ratios to evaluate the financial health of a for-profit company. As a grantor, you can use financial ratios to evaluate the financial health of a charity.

Below are a few financial ratios that can be easily calculated using the tax return or financial statements and what they mean:

Current Ratio – Helps to assess liquidity
Current Assets/Current Liabilities - You can find this information on the Statement of Financial Position (like a for-profit organization’s balance sheet). Many for-profit analysts say that the minimum safety net requires that current assets be at least twice as large as current liabilities. Therefore, you would hope to see a current ratio around or above 2.

Debt to Equity Ratio – Helps assess long term solvency and stability
Total liabilities/Total Net Assets - You can find this information on the Statement of Financial Position or in Part X of the 990. It compares resources provided by creditors with resources provided by  donors, endowments  and or program services. The higher the ratio, the greater the creditor claims on assets (such as your cash donation). A higher ratio also can mean a higher rate of interest, which means more organization funds used to pay interest expense and less available for programs.

Fundraising Cost to Raise $1 – Calculates the cost for each dollar raised from fundraising
Fundraising Expense/Contribution Revenue - You can find fundraising expense on the Statement of Functional Expenses and contribution revenue on line 1h of Part VIII of the tax return. Generally, this amount should be below $0.35. If it costs the organization $1 of its funds to raise $1 of your Foundation funds it can be argued that your donation did little to further the position of the charity.

Temporarily restricted cash ratio – helps assess whether or not the charity will have enough cash to cover promised actions per the donors intent
(Cash + Marketable Securities + Accounts Receivable) / Temporarily Restricted Net Assets - All of this information can be found on the Statement of Financial Position or Part X of the tax return. This is a great tool for donors. Temporarily Restricted Net Assets generally consist of revenues from foundations, and other donors. The organization has an obligation to utilize those dollars in accordance with donors’ intent and not use those dollars to “float itself” cash until unrestricted cash comes in. Any percentage below 100% means the organization is “floating.”

These keys are the beginnings of a systematic approach to due diligence of a charity. Donors who are just beginning to put these tools in place should seek the advice of a Certified Public Accountant who can assist in helping them build a systematic method for evaluating potential recipients.

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