nonprofit management

What Your Form 990 and Financial Statements Tell Major Gift Donors?

Nonprofit Major Gift Funding

We spent our last two articles focusing on Form 990 requirements.  Now we turn our attention to Form 990 and Financial Statements as it relates to potential funding.  We are in a new era of giving where nonprofits are being judged and evaluated on multiple levels.  One way nonprofits are evaluated is based on ratio analysis.  Hence, in this article we will walk you through certain financial ratios that your funders may use to analyze the financial health of your organization.  Keep in mind that financial ratio analysis is not the only useful means to analyze financial health. Moreover, a single ratio does not say much about your organization’s financial standing.  However, some funders and charity evaluators use financial ratios as part of their due diligence review of nonprofit organizations. With that said, let’s discuss how financial ratios are used and calculated.

Financial ratios are used to obtain a more accurate interpretation of an organization’s financial health over time, especially when compared to similarly situated organizations or industry benchmarks.  Financial ratios can be used to measure a nonprofit’s efficiency, growth rates, liquidity, cash reserves among other things.  Financial ratios are also very powerful measurements for analyzing trends (how an organization changes from year to year).   Significant shifts in a key area may cause concern for a potential funder that requires additional explanation or inquiry into the nonprofit’s financial operations. Also, most ratios are best used in two ways: 1) in comparing similar organizations and 2) in analyzing an organization over time.  Ideally, you should track internally certain ratios so that your organization zeros in on areas ripe for improvement.

Ratios are calculated based on financial data generated from financial statements or your Form 990 report. Audited financial statements provide the most comprehensive data about your organization, which is one reason funders request this information.  However, because many nonprofit organizations are not required to be audited some funders request Form 990.  Form 990 also provides relevant financial data that can be used to perform a reasonable analysis of an organization’s financial history.  To calculate a ratio, you take one total and divided it by another total.  For instance, a Quick Ratio equals current assets minus inventory all over current liabilities (Quick Ratio= Current Assets – Inventory/Current Liabilities).

Here are a few ratios and how they can be used:

Dependency Ratio

Largest Type of Income/Total Income

A potential funder who is interested in knowing the depth of your support base may use this ratio.  In this instance, the potential funder is analyzing whether your organization is dependent on a few major sources of income.  Overreliance on a few sources of income causes higher risks for your organization.  Diversification of funding sources reduces overall risks for an organization, and makes an organization more attractive to potential funders.

Self-Sufficiency Ratio

Income Source/Total Expenses

This ratio examines the organization’s ability to sustain itself without certain funding sources such as government funding or grant assistance.  For instance, a funder may examine an organization’s ability to be self-reliant by including on the top line only unrestricted donations, program services fees, and investment income.  By analyzing the trend line, a funder can determine whether you are broadening your donor base and public appeal.

Program Expense Ratio

Program Service Expenses/Total Expenses

This ratio is used by various watch dog organizations to determine how much of a donor’s contribution is being used to support programs versus administrative or fundraising expense.  This ratio is probably one of the most widely debated ratios of those listed here.

Current Ratio

Current Assets/Current Liabilities

This ratio gives insight on an organization’s ability to satisfy its obligations.

Fundraising Efficiency

Contributed Income/Fundraising Expense

This ratio measures how efficient your organization is in raising funds per dollar spent.  Funders may be interested in knowing whether their contributions will be spent efficiently if they decide to fund your organization.

Personnel Expense Ratio   

Personnel Expense/Total Expense

A potential funder who wants to know how labor-intensive your organization is compared to other similar organizations may use this ratio.

There are dozens of other ratios.  Listed here are only a few.  You are encouraged to give us a call at 1-888-206-0066 if you would like to speak to one of our consultants about the needs of your nonprofit organization.  SP Consulting is a division of The Scott Practice, LLC, an Atlanta based law practice. This is not legal or any other type of professional advice and may not be relied upon as substitute. Readers seeking professional advice should contact a professional advisor.

Who is a Disqualified Person in a Nonprofit Organization?

Business Pressure  It is vitally important for leaders managing nonprofit organizations to understand who may be a “disqualified person” within the nonprofit organization to avoid engaging in transactions that may jeopardize the organization’s tax-exempt status. A disqualified person generally is a person who has a close relationship to the nonprofit organization such that they perceivably can exert substantial influence over the affairs of the organization. When identifying persons who may substantially influence the operations of the nonprofit, titles are not as important as actual responsibility. For instance, if an influential volunteer is given wide discretion, control and responsibility over a defined segment of the organization, he or she may be deemed to be a “disqualified person” despite the fact that he or she is a volunteer with segmental responsibility. Substantial contributors may also be classified as “disqualified persons” depending on the amount of influence the contributor holds over the organization. Determining who is a “disqualified person” is vital if the organization engages in any transaction involving persons involved with the organization. This is because there are certain IRS rules that penalize transactions with disqualified persons, especially if such transaction confers an excess benefit on the disqualified person. If the organization anticipates entering into a major financial transaction such as a loan with a potential disqualified person, the organization should seek the guidance of a lawyer or nonprofit tax advisor.

Thinking of Starting a Volunteer Program? Here Are 5 Things To Consider
Couple Working in Homeless Shelter
  1. Know what role your volunteers will have.    Even if your organization has numerous tasks that it just cannot get to, planning is essential to an effective volunteer program. As such, the first step is to think about what suitable tasks and responsibilities are needed that match the organization’s strategic goals.  In other words, is the work suitable for a volunteer and will it advance the organization’s strategic goals.
  2. Know compliance requirements and regulations applicable to your industry and be prepared to share your organization’s written policies and procedures with your volunteers.     If required by law or advised by legal counsel, have volunteers sign written acknowledgements.  Federal grants now require that nonprofit organizations protect personally identifiable information.  Check with a legal professional to find out:
    • If volunteers should adhere to your organization’s confidentiality agreements
    • Whether volunteers should receive training on applicable laws such as HIPPA or other privacy laws
    • Whether volunteers are covered by your organization’s insurance in the event of a claim of liability
    • Does the work require the volunteer to undergo a background check or health assessment
    • Answers to other compliance requirements under either state and federal laws or funding requirements that may impact the volunteer program
  1. Identify staff members with sufficient time to oversee the volunteer program. Don’t assume that HR or a program manager would be the obvious choice for oversight of any portion of the volunteer program.  A proper volunteer program will require time and effort to run properly. 
  2. Develop a framework for recruiting, training, promotion, recognition and retention.    It’s not enough to just seek out helpers and put them to work. An effective volunteer program requires cultivating if you want to retain volunteers.
  3. Select the best channels for recruiting potential volunteers.    The organization continues to brand itself even during the recruitment process.  Therefore, the organization should solicit volunteers that are consistent with the organization’s brand and mission.  Finding volunteers who match the mission and objectives is equally important.  Finally, the type of work involved, general timeframe for completion and any indirect costs to the organization are important considerations.

Nonprofits Be Prepared to Protect PII

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There is a rising effort to protect personally identifiable information (PII).  For instance, the OMB provided new guidance under 2 CFR Chapter Part 200 which requires entities receiving federal grant funds to take reasonable measures to safeguard such information.  The new reforms define PII as information that can be used to distinguish or trace an individual’s identity, either alone or when combined with other personal or identifying information that can be linked to a specific individual.  However, there is no silver bullet with respect to whether any given information is in fact PII. Certain instances will require a case-by-case analysis based on the facts and circumstance of the situation. All in all, these newer requirements on grantees may require grantees to implement tighter controls.

The Grantee Selection Process

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In one of our previous posts, we discussed the issue of fraud and the fact that many large nonprofit organizations are victimized each year by fraudulent acts.  We wish to continue this discussion but from a slightly different perspective.  During research, I came across a statement from Michael Ballin, President of Edna McConnell Clark Foundation.  He stated that their foundation spends “100-200 hours on site with each potential grantee organization, examining the organization’s financial health, leadership and management, and measurement of outcomes.”  He went on to state that investing in the best nonprofits helps strengthen the entire nonprofit filed.  The selection process of the Edna McConnell Clark Foundation suggests that due diligence and accountability can have a positive impact on nonprofit management.  Careful scrutiny during grantee selection has the potential of raising organizational standards and the control environment within nonprofit organizations. This can lead to improved policies, procedures and internal controls that protect against fraud and asset losses.  Likewise, nonprofit organizations who wish to shine during a grant selection process should be positioned to demonstrate control activities used to promote the financial health of the organization.  For example, a nonprofit organization can demonstrate systems to protect patient privacy, prevent cybercrime, or protect system data.  Nonprofit organizations should contact a nonprofit specialist if it desires to improve management practices in this area.  Likewise, private foundations who wish to revamp their grant selection process should contact a nonprofit consultant.