This blog offers practical recommendations on the hot topic of the use of ratios to assess non-profit organizations. Part II of this blog will address current research on the relevance (or irrelevance!) of ratios.

The non-profit sector, including rating and certification agencies, has become increasingly focused on two key ratios: (i) the cost of fund-raising (i.e., the amount spent to raise funds, sometimes expressed as cents per dollar raised spent on fund-raising) and (ii) the relative amount of revenue allocated to administrative costs and program costs.

In my experience, virtually all organizations internationally rightly fear comparisons to other organizations on the basis of ratios that reduce complex analyses to a few numbers. Donors, the media, and others have limited ability to integrate into their interpretation of ratios factors such as the impact of differing sectors, financial presentation methods, stages of development, and unique circumstances. Conversely, often organizations manage to ratios – i.e., decision-making is short-term to maintain ratios rather than long-term based on mission effectiveness.

Recommendations. The following are recommendations useful both to organizations and outsiders evaluating ratios:

  • Ratios are only one factor – not a threshold criterion. Non-profit boards often dismiss proposals (e.g. an operations restructuring) if they involve additional personnel or other costs. The question should be value for money: is the administrative expenditure leading to efficient and improved execution of mission and delivery of services to beneficiaries – and in the longer term?
  • Consider internal trends and red flags such as erratic numbers or exceptionally negative (or even positive) numbers. Look carefully at what drives ratios. If administrative costs seem unusually low, was there an unusual event that skewed the ratio (e.g. inability to hire certain positions or inflow of revenue from a natural disaster)? If administrative costs seem unusually high, was there a one-off reason (e.g. decreased donor revenue from the financial crisis coupled with stable fund-raising expenses during the initial assessment period or an essential IT investment)? Or is the organization a start-up that needs a few years of administrative costs to ramp up activity? If so, is there a positive trend after the exceptional period? If there are erratic numbers, why? Is this due to an inconsistent method of calculation, volatility in the numbers, or both?
  • Mission. How does the organization deliver on mission compared to others in the sector? If you are going to compare ratios, and I do not advise this, make sure you are comparing like sectors of activity, sizes, geography, and financial presentation. Better: find a more complete way to communicate your execution of mission, long-term sustainability, and accountability.
  • Sector trends. Monitor sector trends (e.g. humanitarian aid or community foundations) for guidance and red flags in addition to internal trends.
  • Quality of fund-raising practices. Pay attention to the quality of the fund-raising: is there diversity in donor revenue (geographic, levels of giving, areas of interest)? Are fund-raising practices first in class in terms of ethics (e.g. solicitation methods and handling of donor funds)? Is stewardship a priority to maintain relationships and build a solid foundation for future giving (not to mention a reputation for gratitude)?
  • Transparency and thorough explanations of the components of the ratio. Ratios should be accompanied by an explanation of how the numerator and denominator are calculated. Include (i) significant components of the numbers (e.g. the amount of a CEO’s salary allocated to fund-raising cost) and (ii) any matter that would make the ratio misleading (e.g. unusually high income resulting from the Haiti earthquake or a fraud scandal).
  • Avoid comparisons of ratios with other organizations. This will only lead others (donors and competitors) to do so. It’s a losing game for everyone.
  • Clear relationship to financial statements. The Comité de la Charte rightly recommends a direct link between financial ratios and the financial statements (i.e., the numbers in the ratios should be directly traceable to the financial statements). [1]
  • Consistent presentation of ratios. Ratios should be calculated on a consistent basis  (with restatement of at least one but preferably two previous years if the method of calculation changes, together with an explanation of how the method of calculation changed).
  • Rating agencies. Rating agencies do focus on ratios, and their ratings or comments may influence an organization’s reputation. Guidestar offers a reasonable approach focusing on performance of mission, recognizing that this is not always reflected in ratios.[2] Some offer methods of calculation that are unclear (e.g. they don’t specify how to calculate the cost of fund-raising) and/or appear frighteningly official when in fact calculations often should be charity-specific. The follow-on is both potentially misleading comparisons among charities, misleading views of a specific charity, and even a highly public ratings downgrade or upgrade without a legitimate reason. For example, the fact that a charity spends only 10 cents to raise every dollar could indicate failure to spend effectively (e.g. inability to hire for a long-term successful fund-raising department). Again, these are organization-specific questions.

Nonprofit organizations are not a series of numerators and denominators. Don’t reduce them to such. Above all, don’t lose track of the mission. Finally, as always in this blog, use 20/20 foresight: consider how your decisions will look at a future point. 

Comments are welcome!

Copyright 2011 Susan Liautaud. All rights reservedé

[1] The Comit de la Charte, a French national self-regulatory accountability organisation, provides helpful guidance on ratios including this point and the point on consistent presentation, which can be found  at http://www.comitecharte.org/sites/default/files/recommandations_ratios_2007.pdf  (I serve on the board of the Comite de la Charte, but this blog is entirely independent of that role and does not reflect the views of that organization.) The Internal Revenue Service (IRS) Form 990 was recently revamped after a long period of comment solicitation from the non-profit sector and experts. The IRS finally opted not to require ratios due to the misleading comparisons often made. See e.g. ___http://www.irs.gov/pub/irs-tege/background_paper_form__990__redesign.pdf.

[2] See Guidestar: Why Ratios Aren’t the Last Word. http://www2.guidestar.org/rxa/news/articles/2004/why-ratios-arent-the-last-word.aspx.