Rating the Financial Health of Nonprofit Organizations

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Rating the Financial Health of Nonprofit
Organizations

• Presented by
• John M. Trussel, Ph.D., CPA
• Penn State Harrisburg

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Financial Risk

• The risk that financial problems will not allow
  an organization to continue to achieve its
  objectives
• Several organizations rate financial risk in the
  proprietary sector, such as
• Moodys
• Standard and Poor

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Objective

• To present a financial rating system for
  charitable nonprofit organizations (charities)
• Based on financial data
• Includes broad sector comparisons
• Controls for the size of the organization
• Grant from the Aspen Institute
• Nonprofit Sector Research Fund

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Six Broad Sectors of Charities

• Arts
• Education
• Human Services
• Public Benefit
• Health Care
• Other

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Defining a Financially Troubled Organization

• Possible definitions of a financially troubled
  organization
• One that declared bankruptcy
• One with declines in program services
• One with a negative fund balance
• One with declines in fund balance
• This is the definition used in my research

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The Sample Utilized to Create the Ratings

• National Center for Charitable Statistics
• Part of the Urban Institute
• Statistic of Income database
• Final sample was 7,082 charities
• Screened for outliers
• 1,139 financially troubled (FT)
• 5,943 not financial troubled (NFT)

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The Financial Profile

• The structure of an organizations financial
  statements relative to other organizations
• Based on relative financial variables
• Premise The financial profile of a financially
  troubled charity is different from a charity that
  is not financially troubled.

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The Financial Variables in the Financial Profile

• Debt-to-assets ratio
• Revenue concentration index
• Program cost ratio
• Surplus margin
• Size
• Sector

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Debt-to-Assets Ratio

• Total Liabilities / Total Assets
• 250,000 / 500,000 50
• Percentage of total assets that are financed by
  borrowing
• Measure of ability to pay debts as they come due
• The lower the better

10
Revenue Concentration

• Revenue Source / Total Revenues
• Square each one and then add
• Measure of the adequacy of resources
• Lower is better

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Program Cost Ratio

• Program Costs / Total Revenues
• 300,000 / 400,000 75
• Percentage of revenues spent on administration
• Measure of efficiency of using resources
• Higher is better

12
Surplus Margin

• (Total Revenues - Total Expenses) / Total
  Revenues
• (400,000 - 360,000) / 400,000 10
• Percentage of revenues retained in the fund
  balance
• Measure of the adequacy of resources
• Higher is better

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Results of Testing

• Each of the variables was significantly different
  among two groups of charities
• Financially Troubled charities
• Have more debt
• Are more concentrated in revenue sources
• Spend less on program costs
• Have lower surpluses (net income)
• Are smaller

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Predicting Financial Troubles

• The likelihood of financial troubles (FT)
• Statistical models utilized
• Use the same variables for each charity
• Prediction using the 7,000 charities
• 70 of FT charities predicted correctly
• 61 of Not FT charities predicted correctly
• 63 overall predicted correctly
• Tests on alternative samples are similar

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Financial Health Rating System

• Compute the likelihood of financial troubles for
  each charity
• Financial Risk Index a composite measure
• Combines all of the financial indicators
• Use percentiles for each broad sector
• Top 10 (best financial profile) 10 rating
• Bottom 10 (worst financial profile) 1

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What the Ratings Mean

• A rating of 1 means charitys financial profile
  is similar to a financially troubled one (in that
  sector).
• A rating of 10 means the charitys financial
  profile is dissimilar to a financially troubled
  one (in that sector).
• A rating of 5 means that 50 of the charities
  are better and 50 are worse.

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Software

• FACs Financial Analysis of Charities
• www.lintonshafer.com
• Download a demo and sample report
• Stand alone software
• Only 19 items from Form 990 needed
• Easily analyze multiple organizations
• Index for user-defined types of affiliates
• Output into MS Word document
• Provides sector benchmarks

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Software

• FACsPRO
• Professional edition of FACs
• For use with Microsoft Office 97 or higher
• Provides additional charts and graphs
• Includes common-size financial statements
  (expressed in percentages instead of dollars)
• Needs 45 items from Form 990
• Output into MS Word and MS PowerPoint

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Other Financial Indicators

• Accounts Payable Aging Index
• Accounts payable / (annual expenses / 12)
• Number of months to pay off Accts. Payable
• Asset Management (Turnover)
• Total revenues / Average total assets
• How much revenue is generated from each dollar of
  assets
• Measure of efficiency of operations

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• Financial Profile
• Note This is sample output from the software.
  Slides 19-26 are included in FACs. FACsPRO adds
  Slides 27-32. Actual reports contain narrative,
  too.

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Overall Financial Rating(Scale of 1-10 with 10
being the best)
Compared to organizations in the following sector
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