Misgivings

Keating says small nonprofits are much more likely than large ones to account for expenses incorrectly or devote insufficient resources to accounting. They include small-to-midsize health-and-human-services organizations, food banks, environmental groups, and community-building organizations. "They are always operating on the brink in a style that I call 'sustainably broke,'" says Keating. For them, the ends may justify the means: if underreporting of expenses is necessary to get the funding needed to stay open another year and do good work, so be it.

At larger nonprofits, one of the most common problem areas is joint cost allocations, according to Bennett Weiner, chief operating officer of the Better Business Bureau's Wise Giving Alliance, a watchdog group. When nonprofits perform activities that have both fund-raising and program aspects, they can allocate a portion of the activity costs to each function, provided certain conditions are met. For example, a direct-mail campaign might include a solicitation for a donation and an educational aspect, such as a letter advising recipients to beware of certain medical symptoms. Weiner says audits of the campaigns commonly turn up problems with the joint cost allocations, even though there are specific accounting rules that must be followed.

A few years ago, Walter Bristol, CFO of the American Heart Association, thought the AHA needed to be more consistent on how it tracked costs over the three functions of programming, administration, and fund-raising. So Bristol assembled and led a task force to analyze the nonprofit's cost accounting. The task force looked at every activity where costs intersect, such as an event where program activities and fund-raising are involved, and developed guidelines for separating the expenses into the appropriate buckets.

The guidelines are even more important today, says Bristol, now that the AHA is trying to add more program content to fund-raising activities. For example, a fund-raising walk now includes more print materials on quitting smoking, learning CPR, and so on. The additional materials not only help the AHA make a difference, they also help improve efficiency ratios, since a portion of costs can then be allocated to programs. From 2002 to 2005, the AHA cut fund-raising costs as a percentage of spending from 19.7 percent to 14.5 percent and increased efficiency from 73.2 percent to 78.1 percent.

The Wrong Measures?
Such efficiency and fund-raising ratios put the AHA comfortably above thresholds recommended by watchdog organizations. For example, The American Institute of Philanthropy says that an efficiency ratio of more than 60 percent and a fund-raising ratio under 35 are reasonable. The Better Business Bureau's Wise Giving Alliance states in its Standards for Charity Accountability that nonprofits should "spend at least 65 percent of its total expenses on program activities." (The alliance barely passes its own litmus test, with 67 percent of expenses going to programs in the 2005 fiscal year.) The alliance also recommends that nonprofits spend no more than 35 percent of related contributions on fund-raising in any given year.

But some observers in the nonprofit sector say these hard-and-fast thresholds encourage accounting shenanigans. "Many of these organizations are well intentioned, but we are making liars out of them by pressuring them to have low fund-raising costs," says the Center on Philanthropy's Rooney. Others single out nonprofit rankings, such as Charity Navigator's, for blame. (The AHA merits only two stars on Charity Navigator's four-star rating.) In general, critics say the emphasis on administrative and fund-raising costs is misplaced.

"It's a huge problem that nonprofits are discouraged from investing in support services," says Harvard's Keating. She adds that not only are many nonprofits getting the accounting wrong, they are measuring the wrong thing. "There is a sense that the right number is 100 percent on programs and nothing on administration and fund-raising."

Bristol says the AHA's donors get concerned when administrative and fund-raising costs climb above 25 percent. Still, while overhead spending is a key performance ratio that he pays close attention to, he doesn't want it to drive the organization. "It should be the other way around," argues Bristol. "I never want our mission and decision making to be too influenced by it. If we need to put money into fund-raising, then that's what we do. We make sure we report it correctly, and stay focused on our mission."

Still, the pressure to keep costs low leads other nonprofits to underspend on administrative needs, including accounting. In fact, a lack of finance resources and expertise continues to be a problem in the sector; experts say that most nonprofits are not purposely cooking the books, but simply making mistakes. "At lots of organizations, the person I train to do the accounting is the receptionist," says Christine Manor. "They're the only ones that have the time to do it."

Another problem is that the ratios are judged across the board, without much regard for the type of organization under review. A small start-up nonprofit working on an unpopular cause will have a much different spending profile than a national charity that already has name recognition. "I'm not sure it makes sense to lump all these organizations together and judge them the same way," says Gary Kowalczyk, CFO of the Carnegie Institution of Washington, a nonprofit science-research organization based in Washington, D.C. Those nonprofits with endowments, such as Carnegie, which has an endowment of approximately $750 million to draw from, have flexibilities that others do not.

• « previous
• 1
• 2
• 3
• 4
• 5
• next »