Michelle M. Cain, The Daily Record Newswire
Anyone who donates to a nonprofit organization naturally wants to feel their gift will be used in a way that will improve society. But how can a donor evaluate whether or not a charity will ultimately deliver on their promise or mission?
Success in the business world is generally measured by the amount of profit — the bottom line — that is reported in the business’ financial statements. There are other aspects that can mark a successful business: Does it treat its workers fairly? Does it protect the environment? Is its advertising truthful, and are its products or services of good quality?
But failure in these aspects eventually leads to diminished profits, as workers, customers and investors desert that business for more socially responsible companies whose products or services are of better quality.
In the nonprofit world, however, there is no common, easily understood measure of success. In fact, having a large positive bottom line may be an indicator that the organization is not doing as much as it could to fulfill its mission. The true measures of success for most nonprofits are statistics related to its programs, but such data are difficult even for management to obtain and understand, much less outsiders.
For example, an obvious measure of success for an educational institution would be how much students learn from attending classes. But actually measuring this learning is very difficult.
There are three types of data that might be used to measure a nonprofit’s success:
• Inputs describe how much in the way of resources (both financial and nonfinancial, such as volunteer time, materials, equipment, etc.) was used to conduct an activity.
• Outputs measure the activities conducted by the organization, such as the number of classes held, the number of students enrolled or graduated, the number of concerts performed and number of concertgoers attending, the number of members enrolled and the like. The problem with this type of data is that, while it shows the quantity of program services provided, it does not indicate whether any real benefits resulted.
• Outcomes measure how much better off the organization’s clients are as a result of the organization’s activities.
Of these three types of data, only the first is traditionally found in financial statements, although some organizations present certain output data in footnotes, as supplementary schedules or in management reports.
However, true success is measured only by outcomes, and these data are never found in financial statements, if they can be obtained at all.
So, lacking access to most output data and almost all outcome data, donors are often left with input data as the primary means for measuring success for nonprofits. But these data are very flawed when used for this purpose, as they do not necessarily have any direct relationship to true organizational success.
For example, in a hospital, input data show how much money is spent treating patients, but not whether any patients are actually cured of the conditions that brought them to the hospital in the first place. Further, these data are past-oriented, and do not offer any assurance that the gift I make today will be used the same way in the future.
The particular input data that have been widely used to evaluate charities demonstrate how an organization spends its resources. Accounting standards require nonprofits to report their expenses in three categories: program, management and fundraising. The knee-jerk reaction by users of financial statements is to consider program expenses as good and management and fundraising expenses (so-called overhead) as bad.
Various attempts have been made over the years to define acceptable ratios, with desirable program expenses usually somewhere in the range of 60 to 80 percent of total expenses, and/or acceptable fundraising ratios generally no more than 15 to 30 percent of total expenses.
Of course, some expenditure on overhead is necessary for any organization to operate, but too often more attention is paid to this than is warranted. While expense ratios provide valuable information for nonprofit executives charged with making decisions about the organization’s activities, these ratios don’t serve any value as an indicator of organizational success.
Although most people understand that it takes money to raise money, sometimes one sees expressions in a fundraising appeal of an expectation that 100 percent of all contributions raised will go directly toward program expenses. That is clearly unreasonable and indicative of an attempt to mislead the public about how a charity uses contributions.
Some states have passed laws attempting to regulate how much charities that solicit contributions in that state are allowed to spend on overhead. The Internal Revenue Service and federal law have no such requirements. The IRS, however, evaluates tax-exempt organizations on how well they appear to be fulfilling the mission for which they obtained exempt status.
So an extremely low program-expense ratio would naturally raise a question as to whether that mission is likely being fulfilled. Unfortunately, there are some so-called charities out there that spend little, if anything, on programs while paying exorbitant amounts to professional fundraisers and to their own managers. The problem for donors and regulators is to distinguish the bad actors from the well-intentioned charities.
Earlier this year, the presidents of three well known nonprofit organizations — the BBB Wise Giving Alliance, GuideStar and Charity Navigator, whose missions include evaluating charities and making their evaluations available as guidance to donors — issued a joint letter titled, “The Overhead Myth.”
In this call to action, the three organizations urged donors and the public to place less reliance on expense ratios when making giving decisions. They correctly point out that how money is spent is often not a very reliable indicator of the outcomes achieved by the nonprofit.
In fact, they suggest that many nonprofits should probably be spending more on overhead to improve the quality of management, strengthen internal control, gain operating efficiency, and provide for long-term stability.
The last sentence of that letter reads, “The people and communities served by charities don’t need low overhead, they need high performance.”
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Michelle M. Cain, CPA is a partner with Mengel, Metzger, Barr & Co. LLP. She can be reached at Mcain@mmb-co.com.
