Balancing the Mission Checkbook

I’m convinced that the reason that people care about the overhead ratio of charities is because we keep telling them that it’s important. I have an announcement to make: I am a donor to quite a few nonprofits, and I don’t care what percentage of their budget is spent for overhead. I think that a lot of donors would agree.

Yet, in another article advising us about charitable giving, 5 Tips on How to Stretch Your Charitable Dollars published in the New York Times online published by the AP and picked up by the New York Times and other newspapers, overhead is (once again) emphasized:

Tip #2: EXAMINE CHARITIES CLOSELY. Do the same due diligence on your donations that you would your investments or your business…
Pay especially close attention to the overhead. Anything above 9 to 14 percent is out of line and signifies that too much money goes to staff or office space and not enough to the beneficiaries, according to Stephanie Risa Stein, managing director of New York-based Philanthropic Capital Advisors LLC.

Here’s my soapbox

I agree that it’s wise to “Do the same due diligence on your donations that you would your investments or your business.” But when I review an investment opportunity, I review based on the expected criteria for a successful business - profitability, market share, and returns. I don’t review their overhead and management costs. So why would overhead be the criteria for a charity?

I’d like to re-write this “tip.”

EXAMINE CHARITIES CLOSELY. Do some due diligence on charities before you donate, just as you would for an investment or business opportunity. Pay especially close attention to how successful the nonprofit has been at achieving its mission. Do they provide information about how effective their programs are and what impact they have on the people and communities that they serve? Do they have a way to measure and communicate progress and/or success?

I put these two types of “due diligence” to the test with five Minnesota nonprofits that I have supported in the past. I looked at the 990s on Guidestar and found that their overhead ratios ranged from 5% to 17%. Then I looked up web sites and annual reports. Here’s what I (a donor) care about:

• St. Stephen’s Human Services provided food and shelter to 6,000 very poor adults and children
• CommonBond Communities houses 7,850 residents in quality affordable housing
• Admission Possible had a 99% success rate in students admitted to college
• Ten Thousand Things presents astounding theater to people in homeless shelters and prisons
• Minnesota Fringe Festival creates connections for audiences and artists that’s the envy of theater communities in many other cities (the 2009 festival starts this Thursday).

Which of these has the “best” overhead ratio?

I don’t care.

I care that they are effective nonprofits that can tell donors what they do and why it matters. Why would a donor rather examine overhead? Before someone jumps on this point, I agree that 90% on fundraising is completely unreasonable, but that kind of organization can’t demonstrate real results anyway. So can we stop using overhead as the primary criteria for donors - please?

One positive comment about this article - Rich Cowles, Executive Director of Charities Review Council is quoted with good advice for donors about budgeting and planning their giving. Nice national recognition of the Council’s good work and solid reputation.

I have a New Years Resolution suggestion that has nothing to do with exercise or diet. Resolve to learn more than you already know about economics, markets, and personal finances.

It’s a matter of self interest for you and for the nonprofits that you serve, now more urgently than ever. Think in hindsight of all the financial choices that have been made about questionable mortgage terms, high home prices, risky investments schemes, and un-diversified retirement portfolios. Could some of the pain have been avoided if consumers, and nonprofit leaders, were more educated about the basics of economics and personal finance? I think so.

In his New York Times article, Contemplating the Boobs We Were, Peter Applebome recounts financial mistakes and asks:

“Are we doomed forever to be the fleeced or is there anything we can learn from this latest round of financial catastrophe? In fact, there are plenty of lessons to be learned. So here’s a revolutionary idea: Maybe it’s time we even start thinking about ways to teach them.”

Freakanomics author Stephen Dubner was even more direct last summer in his blog, asking Are We a Nation of Financial Illiterates? Included in his post, Dubner recites this list of suggested financial basics:

1. Basics of how markets work.
2. Time value of money and the working of interest compounding.
3. The concept of risk and the working of risk diversification and insurance.
4. Basic accounting (very basic).
5. Rights and responsibilities of consumers and institutions.

Read the full post for more detailed descriptions.

I’m sure that if individuals who work at, or serve on boards of, nonprofits were to gain more financial literacy that the nonprofits would also benefit. At Nonprofits Assistance Fund we see many problems that could have been avoided with better understanding of topics such as supply and demand, investment risk, and the difference between cash and income. Resolve to learn more this year, no matter whether you’re starting at Econ 101 or financial analyst level.

If you are a young professional in Minnesota, consider working on a Citizens League Action Group on this topic that is starting soon.

I’m pretty sure that every nonprofit would love to have enough money that some of the funds can be invested for the future. In the past month, though, nonprofits may have seen their investment portfolios buffeted by the markets. If that wasn’t enough of a concern, this week we read about losses for some local nonprofits from investments related to the Petters Company fraud case. News reports this week in both MinnPost and the Star Tribune describe the negative impact on organizations that may lose millions from investments that were made to provide short-term loans to companies for inventory purchases. As Scott Russell said in the MinnPost article, these cases are “a wake-up call for other nonprofits to review their investment policies and portfolios.”  As an outside observer, it’s easy to say that these investments seem like an unlikely fit for a nonprofit organization, but we don’t know what standards or criteria those boards were using to evaluate and select investments. This is a good time, though, to review some fundamental guidelines for investments by nonprofits.

• Time Horizon – Funds that may be needed within a few months must be invested in highly liquid, safe investments. This is the most common type of investment fund for most nonprofits, composed of operating funds and reserves. In order to be assured that the funds will be available as needed, the investment choice must be readily available. The recent financial news has even raised red flags about some short-term investments – see my earlier post It’s 10 AM, do you know where your cash is?.

• Risk Tolerance – One of the fundamentals of investing is the balance of risk versus return. Investments with a higher return almost always also come with higher risk. The key question for nonprofit leaders and boards is to understand how much risk is involved and to decide if they can accept the risk. As an example, if the funds to be invested represent the balance of a large program grant that will be spent over the next year, then the organization can’t afford to risk the loss of any of the funds. A permanent endowment fund, on the other hand, is usually invested in a diverse portfolio that includes more risk in return for a higher long-term return.

• Responsibility – The nonprofit’s board of directors is responsible for overseeing this balance of risk and return for the health of the organization and any legal requirements. In order to fulfill this responsibility the board must act as prudent and loyal stewards of the organization’s assets. The board may decide to employ professional staff or outside advisers to manage the investments if the amount if large enough.  At minimum, the board needs to adopt and follow an investment policy. I highly recommend a booklet from BoardSource, Minding the Money: An Investment Guide for Nonprofit Board Members.

In this economic environment, every nonprofit needs to take a look at their investments and understand any risks that may have been taken for granted. It’s better to spend some time now and avoid surprises later.

Cash is cash, right? Then why are so many nonprofit directors and board members suddenly so concerned about the safety and security of their bank accounts?  All it takes is one alarming story, such as today’s report that some Minnesota private colleges couldn’t access all of their short-term funds. It sounds like the funds will be available, and how would you feel if you couldn’t arrange a transfer of some funds that you consider to be “liquid?”

So how concerned should you be? In general, you shouldn’t panic, but you also can’t make assumptions that all is well just because you haven’t had a problem before. It depends on how your short-term cash accounts are actually invested or deposited. Many nonprofits have balances of funds that are needed for payroll and regular expenses, for reserves, and to hold funds that are restricted or designated for a specific program or purpose. It’s common to have a checking account, other bank accounts, and some money market funds or short-term investments.

However, over the last 20 years the distinction between keeping funds in a bank account and a range of other investment options has gotten pretty fuzzy. We’ve become a little lazy about using terms - like money market account, money market fund, and short-term investments - interchangeably. But they are not the same.  Your first priority is to find out where, in fact, your nonprofit’s cash balances are - do you have a bank account or a mutual fund? If it’s a bank money market account deposit, what is the FDIC insurance coverage? Some banks offer a service to provide additional coverage or work with other banks to enhance the coverage by exchanging funds within a network. If your funds are invested in a money market mutual fund, it’s wise to read the prospectus or other information from the fund manager to learn about the types of investments that are owned by the fund. Money market funds range from ultra-conservative investments in treasury bills to investments with a little more risk. If you have made direct purchases of short-term investments, read up on what you have and how those investments are valued or affected by the current market.

Again, know what you’ve got and then have a discussion with the finance committee about any risks, concerns, or restrictions. Then you can decide whether to make any changes. This might also be the trigger for you to re-visit or create an investment policy and educate yourself and the finance committee on fiduciary duties and nonprofit investment practices. I highly recommend a short book published by BoardSource, Minding the Money: An Investment Guide for Nonprofit Board Members.

I was explaining audits to a group the other day and one person asked if audits were really worth anything. After all, he said, the big financial companies that are in trouble all have “clean” audits. So what’s an audit really worth  -  beyond meeting a legal requirement?  First, you have to understand what an audit is, and what it isn’t. An audited financial report contains standard financial information, supplemental footnotes, and the all-important opinion letter. The letter expresses a professional opinion on the accuracy of the financial information. The opinion is not an assessment of the financial condition or future prospects of the organization.

To answer the person who doubts the value of an audit, it’s helpful to understand how the auditor forms the opinion that the information is accurate.  In the process of conducting the audit, financial information provided by the organization is scrutinized and verified. Verification relies heavily on the auditor’s ability to determine the value of the assets and liabilities. It’s pretty easy to verify the value of the asset called “checking account balance” or even the asset called “foundation grant receivable.” Consider, though, how the auditor values an asset without such a concrete answer. If the organization owns 100 shares of Target Corp. stock, the value can be checked against the market, but what about assets that don’t have a simple or ready market? This includes assets like privately held companies, real estate projects, and investments in hedge funds. All the auditors can do is use whatever information sources are available. Clearly, the values of mortgage-related assets were based on faulty information and assumptions. Auditors use a lot of judgment and research  -  it’s not absolute. Audits are worthwhile and they are worth the paper they’re printed on, but be aware of their limitations and use them with caution.

If you are interested in understanding the crazy assets that got us here  -  CDOs, CMOs, and credit defaults  -  invest $1 for the podcast of This American Life’s radio show on the topic, “The Giant Pool of Money” from May 2008. Jointly produced with NPR News, the 60 minute report explains how the mortgage business changed with subprime loans, new capital sources, and new, indecipherable investments. Well told through stories and understandable questions, it’s illuminating for all.

Right now, about 25% of the nonprofits that we are working with pretty closely are in the midst of a capital campaign, are just finishing their campaign, or have plans to launch one in the next year or so. The meaning of “capital” campaign is evolving, and about one-third of these campaigns include a substantial amount of flexible working capital and infrastructure investment in addition to traditional bricks and mortar. (This is an important trend that I’ve written about before.) Looking at the campaigns and organizations as a whole, it’s clear that the campaigns that are going well were thoughtfully planned out, based on feasibility studies, and focused on donors with whom the nonprofit already had a relationship. The campaigns that have floundered or dragged on were based on some broad assumptions about who “should” support them, plugged numbers to fill out the budget, and the planning happened along the way. These observations lead right to the basics of capital campaigns – lots of planning, being realistic, committing the time and people, and monitoring everything as you progress.

Capital campaigns also demand consideration of external factors, including the competitive impact of other capital campaigns and of economic trends. We in Minnesota can thank the Minnesota Council on Foundations for conducting a survey last month on Capital and Endowment Campaigns in Minnesota, 2007-2008. The survey reports on 62 current and 72 planned campaigns for buildings, endowments, and infrastructure investments. The largest campaigns are for colleges and universities, with human services and health care a distant second and third. Interestingly, the higher ed, health care, and arts organizations expect most of their funds to come from individuals donors, while human service nonprofits expect about half to come from grants. This week’s Chronicle of Philanthropy reports in “Feeling the Squeeze” that some large capital campaigns are running into some resistance from large donors concerned about the economy. The examples in the article, which is only available in its online format to subscribers, indicated that gifts were delayed or stretched out, but that the campaigns continued to be successful in a different environment.

If you are beginning to plan a new fundraising push – whether you call it capital campaign or not – you need to understand the trends, the local landscape, and how many other “asks” will be in the mail.