Balancing the Mission Checkbook

At the pace we’re all traveling it’s easy to forget what you said last week, much less a few months ago. It’s interesting, then, when we receive a comment on a past post and go back to re-read it. So much is happening and developing in the nonprofit world that I’m taking this week to update three topics.

Transparency

In December 2007 I wrote about Transparency and Financial Information:

I would strongly suggest that nonprofit organizations make the effort to make usable financial information available on their website. The IRS 990 is already a public document, so it seems like the obvious tool for financial disclosure. However, I think we should go past the 990 to share better information, especially since everyone seems to agree that the current version of the IRS 990 is overly complex, confusing, and very difficult to use. A better solution would be having the audited financial statement easily available on the website.

Guidestar recently published The State of Nonprofit Transparency Report, which included these findings:

A high percentage (93 percent) of nonprofits are embracing the Internet to disclose information about their programs and services.

Only 13 percent posted their audited financial statements on their Web sites. The results of our survey show a reluctance to disclose audited financial statements publicly. Although not all nonprofits obtain audits of their financial statements, our survey sample reflects organizations of the size for which an audit is both prudent and a necessary tool for assessing management’s financial capabilities and the organization’s financial health.

Let’s hear it for more audits online!

Mergers and Strategic Collaborations

In June 2008 I suggested Speed Dating for Nonprofits:

No one would say that mergers are the right answer for every nonprofit, but if you do think that joining forces would make sense and help your organization maintain stable services, where do you find your mate? I think I’ve found the answer - speed dating for nonprofits! Speed dating is an organized event to help singles meet a number of people in one evening with the intent of finding one or two for an actual date.

I’m excited that MAP for Nonprofits and the MACC Alliance for Connected Communities have organized a Speed Dating event on May 20^th to explore strategic partnerships.

Low-profit, Limited Liability Corporation (L3C)

And in May 2008 in Where For-Profit and Nonprofit Meet I was excited about the new hybrid Low-profit, Limited Liability Corporation (L3C) that had been adopted in Vermont.

The idea is to create businesses that can attract some private capital, bolster that with more patient philanthropic or socially motivated investment, and result in value to the community (jobs, housing, local revitalization) and a below-market return to investors. This structure is not a fit for every nonprofit, or even for every social enterprise. The L3C is all about raising capital, and when the need for capital is significant, this is worth considering.

This post continues to attract readers and questions. The most common confusion is about the fit for nonprofits that need subsidy (i.e. grants and contributions), rather than capital. The L3C is designed for capital but doesn’t offer any incentive for contributions. For more information, the experts on the L3C are Americans for Community Development. We’ll explain this new hybrid form at the May 14^th meeting of the Social Enterprise Network.

Since the post was written several other states have adopted the model, with others in the legislative process. I’m hoping that Minnesota can get on the bandwagon in the next year.

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.

Wouldn’t every nonprofit, and the nonprofit sector overall, love to be able to increase contributions by 50%? No problem!

I don’t actually have the magic trick to make more dollars come in the door. The big increase in contributions is already in our hands in the form of volunteer labor. It’s a fact. When the value of volunteer labor is included, the total amount of contributions to US nonprofits increases by over 50%.

Here’s the data in a nutshell: The Corporation for National and Community Service just released their annual Volunteering in America study. They report that 61 million Americans volunteered in their communities in 2007, donating 8.1 billion hours of service worth more than $158 billion. The recent Giving USA survey for 2007 reported that cash contributions exceeded $300 billion for the first time. This includes individuals, bequests, corporations, and foundations. The actual value of charitable giving, when donated labor is included, is over $450 billion.

Think about that – 8.1 billion hours is roughly equivalent to 4 million full-time employees. Wow.

Where does this $158 billion calculation come from? Every year, Independent Sector calculates an hourly equivalent for volunteer time. The current value is $19.51 per hour, which is reportedly based on the average hourly earnings of all production and non-supervisory workers on private, non-farm payrolls as determined by the Bureau of Labor Statistics. Independent Sector takes this figure and increases it by 12% to estimate for fringe benefits. (I will leave for another discussion the fact that many employees of nonprofit organizations earn less than this amount.) I encourage every nonprofit with volunteer labor to calculate this value for themselves.

Unfortunately, it’s too easy for this important economic information to be lost because of accounting rules. Most of this economic value is never reported in audited financial statements or IRS 990s. The applicable accounting rule, FASB 116: Accounting for contributions, limits the recognition of the financial value of volunteers to a very narrow definition. Because of this, the actual economic profile of many nonprofits is skewed. When comparing nonprofits to for-profit enterprises, we usually dwell on the role of contributed income and subsidy. The importance of contributed labor is easily lost. I understand why the accounting profession is concerned about accuracy and reliability when recognizing the value of volunteers. However, it’s time to revisit these accounting rules. We’ve been willing to overlook this financial under-reporting for years, but I think the importance and value of volunteers is becoming too significant to ignore for much longer.

End note: There’s a bit of local pride to be found in the new volunteering study. Minnesota ranks #3 by state and the Twin Cities is #1 for large cities in the percentage of the adult population who volunteer. Learn more about how to make the most of volunteers from Hands On Twin Cities.

In the midst of the big fundraising season of the year, I’m wondering about how much nonprofits really want to be open and forthcoming about their financial information. With all the talk about accountability and transparency, I don’t see a lot of evidence of easily available, freely shared financial information from most nonprofits. While I realize that I have a unique (and probably unusual) interest in financial information, I think that it’s important to walk the walk of transparency.

The Panel on the Nonprofit Sector, convened by Independent Sector, just released their report, Principles for Good Governance and Ethical Practice: A Guide for Charities and Foundations. The report lays out 33 practices “that should be considered by every charitable organization as a guide for strengthening its effectiveness and accountability.” Number seven on the list reads:

A charitable organization should make information about its operations, including its governance, finances, programs and activities, widely available to the public. Charitable organizations also should consider making information available on the methods they use to evaluate the outcomes of their work and sharing the results of those evaluations.

In the longer description of ways to implement this practice, the panel suggests an annual report and using websites to make available information such as the IRS 990 and other financial statements.

I would strongly suggest that nonprofit organizations make the effort to make usable financial information available on their website. The IRS 990 is already a public document, so it seems like the obvious tool for financial disclosure. However, I think we should go past the 990 to share better information, especially since everyone seems to agree that the current version of the IRS 990 is overly complex, confusing, and very difficult to use. A better solution would be having the audited financial statement easily available on the website. Many nonprofits already do this, but most do not. I checked the websites of six organizations in Minnesota that I have supported financially in the last few years. Of these six, one had their audit posted, three had a detailed annual report but no audit or 990, and two had no financial information that I could find. Why not post the audited financial report?

I recommend a look at the financial section from the website of The San Diego Lesbian, Gay, Bisexual, Transgender Community Center. In addition to posting their annual report and audit, The Center devotes a page to describing their financial management commitments and policies what a great a model of financial transparency.

In just a few days the comment period will end for the IRS proposed changes to Form 990. Since these proposed changes will impact every nonprofit organization that is required to file a 990 (nonprofits with revenues over $25,000) it will be worthwhile to pay attention to the comments and the IRS’ process for considering and responding to the input received. IRS hopes to have the changes finalized and a new 990 form in place for the 2008 tax year and they have a mountain of comments to digest if they want to stay on schedule. Many commentators, in fact, are urging the IRS to delay the implementation date of all or parts of the new form to allow time for more review and discussion of the impact of this major change. Comments are available for review on the IRS web site. Many state and national organizations have convened their members and constituents to analyze the draft and submit thorough comments, including Independent Sector and the National Council of Nonprofit Associations. Read these comment letters to get a sense of the analysis and feedback to the IRS.

Form 990 has not had a major overhaul in many years. The need for a change is widely accepted, and summarized well in the IRS background paper on the redesign: “The current 990 has not kept pace with changes in the sector and the law. Because of its history of ad hoc revisions, the current form neither adequately describes the filing organization nor provides a basis for comparing an organization with its peers.” The proposed redesigned Form 990 consists of a 10 page core form for all filers, and 15 separate schedules that will be required only of those nonprofits for which the information applies. This format will hopefully be much easier to read and keep related information together instead of scattered on different pages and schedules. It is very different, though, and will require learning a new structure and format.

The core form begins with a summary page with the organization’s mission and activities and several key points about activities, governance, and key financial information. While comments are generally positive about the summary page, there are concerns throughout the proposed form about questions that reach into what might be called best practices. Management and governance practices are developed to respond to an individual organization’s structure, community, financial situation, and activities and any simple yes and no questions can easily be misinterpreted without sufficient context. The comments reflect this concern over and over again, on questions about compensation, conflicts of interest, and audit committees.

The 15 proposed schedules range from supplemental financial information that will be required for most filers to schedules for tax-exempt bonds or foreign activities that would apply to a small percentage. There are several proposed schedules that will require new reporting for many organizations such as non-cash contributions and gaming and fundraising events. Some of these will necessitate additional recordkeeping and could be onerous. Hospitals have commented en masse requesting a delay of the implementation for a new schedule regarding community benefits and charity care.

I suggest you pay attention to this change as it goes through review and any further drafts or discussion. A clearer, more easily understood Form 990 will be good in the end, but will require much effort along the way.

But what if your nonprofit doesn’t have audited financial reports? Does this item listed in the grant proposal form mean that you should rush out and hire an audit firm – or that without an audit you’ll never get a grant? Probably not – but you should understand what an audit is, why the foundation includes this on the checklist, and what alternatives you have. I’ve been asked this question many times by both nonprofit directors and foundation program officers. The short answer is this – no, you don’t have to have an audit for the majority of grant applications. Most foundations do not want to require a small nonprofit to spend $5,000 or more for an audit just to apply for a grant. In some cases, the cost of the audit would actually exceed the amount of the grant! Requirements for nonprofit audits depend on how funds are raised and various state and federal grant requirements, but the threshold for most nonprofits defined by the Attorney General in Minnesota is $350,000 in income. What the foundation really wants – and needs – is financial information that they can rely on. An audit is the ideal, but there are alternatives.

It’s helpful to first understand what a financial audit is – and what it isn’t. An audit report is a financial report prepared according to accounting standards and an accompanying opinion of a CPA that they have reviewed and tested the information and determined that it is accurate. This is called a “clean” opinion. The reason that funders like to see audits is because of this opinion about the accuracy of financial reports. It’s important to understand that the audit is completed using the financial reports prepared by the organization, not by the auditor. (In fact, the auditor cannot prepare the financial reports and then turn around and issue an opinion letter about them.) An audit is not an assessment by a CPA that the nonprofit is in a good financial position. Making that assessment is up to the organization’s staff and board and any outside users of the financial reports.

So without an audit, how can you provide accurate and reliable financial information that is acceptable to a current or potential funder? Go back to the description of what an audit is: a financial report prepared according to accounting standards. Without an audit you won’t have an opinion letter, but you can provide an accurate year end financial report including an income statement and a balance sheet. In order to do this, the financial manager or treasurer will have to prepare a “final” financial report for the year and have it available in a standard accounting format. It’s great if you create a PDF version that can serve as the definitive version. Along with this report, send your IRS 990 form to demonstrate that you have complied with the requirements for reporting and accountability. The 990 should be accurate, the information reported should agree with the financial report, and it should be timely. The executive director and development staff person or volunteer should be able to read and discuss both of these reports at a site visit or phone call.

I recommend an article in the current issue of Nonprofit Quarterly, “Absent the Audit: How Small Nonprofits Can Demonstrate Accountability Without One”, by Jeanne Bell and Steve Zimmerman. The authors suggest that there are three key functions of an audit for a small nonprofit: generating donor and constituent confidence, ensure compliance with accounting standards, and prevent or catch fraud. They propose a number of ways that small nonprofits can fulfill these same functions with a printed annual report, open communication of a summary version of year end results and the annual budget, and a timely, correctly prepared IRS 990. The article also includes some good advice about using a board treasurer or volunteer to help assure accurate reports and the importance of internal controls for any sized nonprofit.