Don't Judge a Not-For-Profit by Its Profits
Aug 01, 2012
Unlike for-profit businesses, charities do not exist for the purpose of accumulating assets and turning profits to enrich their shareholders. So when judging a charity's financial stability, it is not the case that the charity with the most assets is the one most worthy of your donations. At the same time, many donors want to avoid giving to a charity that is about to go under since their contributions will more likely be used to pay past debts than to forward the charitable programs they are intending to support. CharityWatch encourages donors to consider the following Tips when factoring a charity's financial stability into their giving decisions:
TIP: Financial stability is about reasonableness, not hoarding
Donors should seek out charities that are financially stable, meaning that the charity is able to stay out of debt and fund its current programs. But a charity with three years' worth of assets is not more worthy of your donation than a charity with only one year's worth. This is because a charity that hoards rather than spends the donations it receives is not operating in line with the goals of most donors.
Say a donor—we'll call her Sally—wants to contribute $100 to a charity whose mission is to help sick children. Charity X has $1 million worth of resources saved up, and each year raises $200,000 of contributions while spending only about $100,000. This charity is very financially stable, consistently raising more than it spends. But if Sally contributes to Charity X, it will likely be about ten years before her donation is used to help a sick child. When there are so many sick children who need help today, and not enough resources to assist all of them, it is doubtful that Sally will want to donate to Charity X since it already has far more resources than it is currently able to spend. On the other hand, Charity Y has about one year's worth of assets in reserve, meaning that it will likely use Sally's donation to help a sick child within the next twelve months. Charity Y is probably a better fit for Sally since it is both financially stable and will spend her donation to help a sick child in the near future.
TIP: A net "loss" for the year does not mean a charity is in financial trouble
Donors often misinterpret a negative number on a charity's financial statements to mean that the organization is in financial trouble. A charity may take in $100,000 and spend $110,000 in a particular year, resulting in a $10,000 "loss" for that year. But the next year it may take in $150,000 and only spend $140,000, resulting in a $10,000 "gain" for that year. These fluctuations are normal for a non-profit organization whose purpose is to spend funds on charitable programs, not minimize its expenses every year in order to turn a profit for investors. It would be quite a coincidence for a charity to raise and spend exactly $100,000 in the same year, so donors should not assume that a "gain" or a "loss" in any particular year is automatically a good or bad thing.
Note: Donors can refer to page 1, line 19 of a charity's IRS tax Form 990 to see its gain or loss for the reporting year.
TIP: Look at numbers that do signal financial trouble
If a charity spends far more than it takes in year after year it will eventually go into debt, and in the worst case, be forced to close its doors. When a charity's total liabilities (the debts it owes to outside parties) exceed its assets, this is referred to as a "negative fund balance." When this amount is significant relative to the size of the charity, donors should take caution. A charity that is about to go under may solicit you for its programs, but be forced to instead spend your donation on squaring away past debts, or on administrative costs like legal or accounting fees related to winding down the organization.
Note: Donors can refer to page 1, line 22 of a charity's IRS tax Form 990 to see if it is in the red.
TIP: Don't judge a charity's financial health as if it is a for-profit company
When investing in a for-profit company you want to know if your investment will grow and return a profit to you. You review a company's financial statements for things like revenue growth and working capital to help you decide whether or not to invest. Such ratios do not translate to evaluating nonprofit organizations which do not exist for the purpose of enriching shareholders. For example, the revenues of many relief charities temporarily skyrocketed due to donations given in response to the earthquake in Haiti, Hurricane Katrina, and the Asian Tsunami. The year following each of these disasters, these charities' revenues naturally fell back down to normal, pre-disaster levels. It does not make sense to say that a particular charity is in great financial health one year simply because its revenues grew due to disaster giving, and that its financial health is not as good the following year simply because revenues declined due to the fortunate fact that no large-scale disaster occurred that year.
Note: Some charity raters use automated formulas to award high ratings to charities for financial health when they grow revenue or working capital (a component of net assets). Figures used to compute these ratios are typically taken from a charity's unaudited tax form at face value without sufficient analysis, and without consideration of other assets controlled by a charity that are reported on separate tax forms. CharityWatch believes a charity should not be rewarded for hoarding excessive asset reserves when these funds are often desperately needed by other charities working in similar causes.
TIP: The auditors will tell you if a charity is in serious financial trouble
For donors who are not comfortable reviewing financial statements, there is a no-numbers way to find out if a charity is in financial trouble. Most large charities that solicit donors nationally are required to file audited financial statements in many states, and some groups post their annual audits on their web sites. Check the "Independent Auditor's Report" (IAR) to see if the charity has a "Going Concern" audit. If so, this means the outside accountants who audited the charity believe the organization may not be able to continue its operations for more than one year due to the charity's debts and other factors. In these cases the IAR will refer you to a note within the audit describing the charity's financial instability in more detail, and any plans the charity's management has to address this instability. Other audit notes can signal a charity in financial trouble. They may reveal that officers of a charity are making significant loans to the group to keep it afloat, or that the charity is in trouble with the IRS for using payroll taxes collected from employees to cover its operating expenses.
Note: The IAR is typically found within the first several pages of a charity's annual audit. Visit our links page for a list of state offices that post charity audits online.
TIP: Some charities with little to no savings are still worth supporting
Your local food bank does not have the luxury of saving up funds for a rainy day when it is in the middle of a thunderstorm—the "thunderstorm" in this case being a bad economy in which donations to the charity are declining while demand for its services is increasing. In other words, there are certain charities that need to spend their resources very quickly in order to address urgent needs in their communities and fulfill their missions. Other charities may have low savings because they are working in an unpopular or controversial cause for which raising funds is more difficult. A particular charity's programs may be very unique or benefit a specific community not served by other charities, so consider these factors before deciding against donating to an organization simply because it has little to no savings.