A Basic Introduction to Analyzing a Charity
Increasingly, funders are looking for greater transparency and accountability from charities. With billions of dollars going to charities, the need for this is real.As newspaper headlines broadcast charity scandals, funders struggle to ensure that their generosity is well spent.
Funders need help in knowing what methods to use in analyzing charities. In this emerging field of charity analysis, there are no universally recognized measures of meaningful data. However, we have been analyzing charities since September 2006, and would like to share our insights with you.
Ratios That Matter
We would like to introduce funders to the key concepts and ratios used in our analysis of charities. As stock market investors can quickly capture a sense of a good buy opportunity through price-to-earning multiples, debt-to-equity levels, and dividend yields, our hope is to advance meaningful ratios that funders can use in making their giving decisions. Ci's key ratios focus on assessing a charity's need for funding, cost efficiency, and the scope of service.
In each of the following reports on Recommended Charities, the last page contains the charity's numbers and ratios that Ci uses in its analysis. Ci has organized the numbers into three boxes:
1. Program Data — this box presents information that is specific to the charity's operations the number of clients, volunteer hours, and so on.
2. Charity Analysis —This box gives funders insight into a charity.It shows relevant ratios using the financial numbers and makes vital adjustments. This box shows a charity's cost efficiency, the scope of service, and sources of "inputs" (Charity Value).
3. Audited financial statements — These are the basis of transparency and accountability and contain the key aspects of each charity's finances. From a charity's financial statements, these are the financial numbers that Ci uses.
Does a Charity Need Funding?
This is the first question funders looking for impact should ask before making a charitable donation. The answer is simple. The ratio of funding reserves to annual program costs shows whether a charity has funds that exceed its annual needs. Ci calls this ratio "program cost coverage." Compare a charity's program cost coverage ratio to the body-mass index (BMI) used by doctors to measure our weight. The BMI measures a person's weight relative to height; Ci's program cost coverage ratio looks at how much cash a charity holds relative to its annual program spending. The program cost coverage ratio shows whether a charity is fat or thin, rich or in need of funding.
Program Cost Coverage
Some charities fundraise not because they need money, but because they can. This results in a hoarding of scarce dollars. Ci's giving style is results-oriented, so we focus on finding charities where we believe donations can produce the highest impact. To create impact, a donation must go to a charity that actually needs money.
Every charity needs some financial assets as a cushion in case of unexpected events, but if this cushion is too big, donations will sit in an investment account rather than going to the charitable work. Ci looks for charities that have a program cost coverage ratio of between 25%-100%. This range means that donations will be used to deliver charitable works within a year. For charities whose ratio exceeds 100%, donations will likely sit in a bank account for the immediate future. Here, giving "returns" will not have social results but rather offer only treasury-bill returns.
In 2007, every Ci Recommended Charity had a program cost ratio in the ideal 25%-100% range, with two exceptions. These were Pacific Assistance Dogs Society and Cornwall Alternative School. These exceptions require explanation.
Pacific Assistance Dogs (PADS) had a program cost coverage ratio of 299%, which showed it was "fat," with excess cash on hand; but PADS is also in a capital campaign to build a new kennel and training facility. It needed to fundraise and build its capital reserves to do this. Where a charity is actively in a campaign, funders should understand that the program cost coverage ratio will rise above the ideal range.
Cornwall Alternative School's program cost coverage was 8%. If all funding were to stop, Cornwall would have only enough money to cover one month's payroll and program costs. This indicates that Cornwall is not only underfunded; it is emaciated. Funders need to be aware that this level of underfunding presents a higher risk, a financial risk. This charity may not have been able to continue operations. Similar to a company with a weak balance sheet, this charity might have failed. In Cornwall's case this is not due to poor results, since its annual results to help students stay in school are spectacular. Rather, Cornwall's situation exposes the irrational disconnect in the charitable sector between results and a charity's level of funding.
Administrative Costs
Funders focus on administrative costs. This attention to administrative costs draws criticism from charities and academics, who argue that a charity needs a base level of administration to grow, develop, and meet clients' needs. Ci believes that the debate should focus on what is the optimal level of administrative costs, rather than pressing charities to eliminate them entirely. This optimal level will be found through analyzing a charity's results.
In analyzing administrative costs in 2006, Ci found administrative costs were higher than expected. Puzzled by this, we explored administrative costs through management interviews. The charities typically use administrative staff to do all the necessary tasks of running the office, while volunteers run programs and provide services. Yet volunteer time was "off the books" and not recorded in the financial statements. This needs to be addressed, so Ci introduces to funders the concept of Charity Value.
Charity Value
Charities are significantly different from companies in one key respect—a charity receives donations, while companies do not. A charity can receive three types of donations: money, time, and goods. The financial statements record donated money, but typically make no mention of volunteer time or goods donated. Funders need to make adjustments in their analysis to also include donated time and goods. The combination of donated money, time, and goods is what Ci calls "Charity Value."
Charity Value = Donated Money + Donated Time + Donated Goods
In doing charity analysis, it is vital to include the value of donated time and goods. Charities often do not count volunteer hours or donated goods because their accountants do not demand it for reporting purposes. However, from an operational perspective, many charities would grind to a halt without volunteers and donated goods. These "inputs" are just as important as donations, and should be recorded, accounted for, and managed.
Ci values each volunteer hour at $15. This value was suggested by Imagine Canada, and we concur. Initially, this dollar value seemed high, and we considered using the minimum wage instead, However, on further analysis, volunteers are not minimum-wage workers—they are typically trained, experienced professionals. Another consideration is that minimum wage varies between provinces and Ci needs a consistent measurement across Canada. Funders can use whatever dollar value they feel is most appropriate, but volunteer hours need to be counted and given value.
Assessing administrative costs relative to charity value presents a significantly different picture. Take for example, the three following Ci Recommended Charities in 2007:
Fundraising Costs
Ci believes that funders need to pay greater attention to fundraising costs. In 1999 in the US, 18% of every dollar donated went to fundraising costs. Recently in Canada, there have been some large fundraising campaigns with significantly higher fundraising costs, some reportedly as high as 32%. This creates a vicious marketing cycle, necessitating that all charities raise their profile in a crowded market, and spend more on fundraising to attract a scarce resource.
From a charty's perspective, it is rational to spend on fundraising as long as the marginal dollar raised is higher than the marginal dollar cost. For example, it is worth spending $90 on fundraising to receive $100 in donations. For funders, however, an escalation in fundraising costs leads to greater dilution, with less of their donations actually going to charitable work. For each dollar donated, a portion will cover the charity's fundraising costs, with less money getting to charitable work. Fundraising costs dilute the impact of funders' donations.
Similarly, it is important to discover total donations before fundraising costs. Some charities report donations net of fundraising expenses in their income statements, with the details in financial notes. This is an accepted accounting practice, but may understate fundraising costs. A funder should add fundraising expenses to net reported donations. The gross level reflects the true dilutive impact of fundraising costs and more accurately measures what proportion of donations actually go to charitable work.
Ci calculates fundraising costs as a percent of donations, and not as a percent of total revenues or charity value. This is an important distinction.The purpose of fundraising is to raise donations, rather than increase a charity's other sources of revenue, such as interest or investment income.
Worthy Causes…But Affecting How Many People?
Ci uses a charity's scope to inform funders of how many people a charity directly serves in its community, and as such, shows funders how many people will be affected by their donation. A charity's scope reflects the type of service it provides. Each year, Alice Housing works intensively with only seventy women or children escaping domestic abuse. Its scope of service is narrow, directly affecting less than 0.1% of Halifax's population. Conversely, Inner City Home works each year with 3% of Sudbury's population. Neither charity is better or worse than the other, but when funders are solicited for donations, every charity should be able to answer the question "How many clients did you serve in the last year?"
Program Costs: A Final Caution
In the research reports on Recommended Charities, Ci presents funders with the charity's program data. For some charities, this data is relevant; for others, we have serious concerns about whether the correct measurement has been used.
In management interviews, Ci finds charities use two different methods to count program hours: one measures the charity's cost output, while the other measures the charity's service to clients. For example, if a charity provides a program that runs for four hours a week for eight weeks, the cost output method counts this as thirty-two program hours (4 × 8 = 32), with no regard for how many clients benefited from the program. If ten clients attend this program, the service method counts this as 320 program hours (4 × 8 × 10 = 320). Ci prefers the service hour measure, as it reflects the benefit clients receive.
Similarly, food banks are asked to report how many food parcels are distributed in a year. At Calgary Food Bank, a parcel may contain enough food to feed a family for five to seven days. At other food banks, handing out one jar of peanut butter is considered a parcel. The two are not equal, but, using current methods, they are counted equally.
Assessing a charity's program cost efficiency is important. Going forward, Charity Intelligence will search for unit measures that are comparable and meaningful. Today, we lack confidence that the program data presented is a valid measure for assessing program cost efficiency. Ci has presented the information as provided by charities, but advises funders not to rely on it for funding decisions, and particularly not for comparisons between charities.
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None of Ci's findings in this emerging field of charity analysis would be possible without the help of the charities who help us understand their work, share their data, answer our incessant questions, and provide frontline insights. Charity Intelligence is privileged to work with an elite, and we are deeply indebted for the time they have given us.
Ci's analysis methods are simply the product of using our professional expertise to look through a different lens at all the work others have already done in this field. We are grateful to all, and particularly to the Donner Awards program.