Tools & Tactics: Understanding Nonprofit 990s

Last week I had the pleasure of hearing Jessica Prue’s vast knowledge on reviewingcw_eventLogo_02262013 nonprofit financial statements to understand and interpret indicators of fiscal health, including the IRS Form 990, annual reports, balance sheets, and online tools for evaluation. In short, appearances (in dollars) may be misleading.

cw_picJPrue_03Jessica works with the Nonprofit Finance Fund, a community development lender, and is a wealth of information on a topic that few master. Her discussion was part of Catalytic Women’s Tool & Tactics programs, focused on hands-on learning to help us make more effective choices in giving for social impact; members may download the program webcast from our online library. While Guidestar has much of the information she discussed, assuming you have time to review and evaluate, Jessica made a very generous offer forCatalytic Women members to subscribe to their FinancialSCAN at a discount of 20%. This is a terrific resource. (Email us if you’d like more information about the discount, this program, or an introduction to Jessica.)

Jessica is quick to point out the complexities involved. Nonprofit financials are different from corporate financials. (Wondering why? Read on.) And financial data only helps us understand one piece of the pie in assessing the effectiveness of a nonprofit. Specifically, she walked us through some of the primary differences between nonprofit and for-profit finance, and the benefits and drawbacks of using 990 data. Her insights really helped me begin to understand an organization’s sustainability and capacity for growth using financial statements. Lastly, she shared some great tools, besides the publicly available IRS Form 990, that can help a funder analyze data and compare organizations. If you’re interested in financial due diligence in your grantmaking process, or simply wish to learn how to simplify fiscal analysis and hold productive conversations with potential grantees, then you’ll learn a lot from Jessica’s expertise, which is also available in this video.

Before I launch into details, let’s see the world through the eyes of Jessica Prue.

Jessica works with both funders and nonprofits across the Western U.S. as part of the Advisory Services team at the Nonprofit Finance Fund. Grounding her work in rigorous financial analysis, she works with nonprofits across sectors to help management teams understand the implications of strategic decisions such as expansion, facilities projects, hiring new staff, and scaling back programs. This expertise gives her valuable insight into understanding an organization’s financial stability and capacity for program growth. She is also involved in NFF’s national work with Financial SCAN, an online platform for nonprofit financial health analysis. She has experience working with an artisans’ cooperative in Paraguay, a microfinance organization in Bangladesh, and a refugee resettlement agency in Syracuse, New York, and a foundation in Washington DC. Outside of her work at NFF, she serves on the boards of The One Percent Foundation, a foundation I admire greatly that engages next gen philanthropists, and At the Crossroads, a homeless youth organization in San Francisco. For fun, she completed her first Iron(wo)Man triathlon in 2012. This Renaissance Woman has a BS in Applied Economics and Management from Cornell University and a MPA from the Maxwell School at Syracuse University.

So here are highlights on what I learned about nonprofit financials…

  • Reviewing financials is not an end-all. It should be the beginning of a healthy dialogue with a nonprofit that you admire and support.
  • Big budgets and fundraising success don’t mean financial stability. Jessica told a “fundraising success” story that went bad. More money raised doesn’t necessarily mean it can be spent well. Reviewing financials helps us understand: What is the right amount of money for an organization?
  • Audits are the most in-depth financials, but 990s are the most accessible. It’s practical to start there, but understand there are limitations.
  • Some for-profit best practices don’t translate to the nonprofit world. Take economies of scale: more isn’t necessarily better in social service; and growth for a nonprofit doesn’t often generate additional revenue, but rather requires subsidies since clients usually don’t pay for cost of service.
  • Not all nonprofits are required to file the annual 990 tax form (e.g., religious organizations, new groups not yet granted tax-exempt status, state institutions like universities, and organizations with less than $250,000 annual revenue). If filed, 990s are public documents and available for free from Guidestar and the Foundation Center.
  • Understanding all the components of financial health takes a 4-hour workshop at the Nonprofit Financial Fund! Key elements of this 45-minute conversation included operating performance (Do they bring in unrestricted operating revenue that is in excess of expenses?), balance sheets (Does an organization have the ability to handle risk and pursue opportunity? And why is the distinction so important among unrestricted assets, temporarily restricted assets for specific programs, permanently restricted assets held in an endowment, and any property owned).
  • Net worth looks different in the nonprofit sector because of restricted funds. Revenue-less-expenses does not give an accurate reflection because unrestricted, restricted and endowment revenue are all lumped together, yet are not equally accessible. “Temporarily restricted assets” must, by law, be held earmarked for the specific project they support. Beware of Line 19 on the 990, which is not a true reflection of surplus revenue!
  • Rankings of program/admin/fundraising ratios are misleading. Effective organizations need to invest in infrastructure.
  • There are no magic ratios for earned (fee for service) vs. contributed revenue (donations) because the nature of nonprofit service delivery models can vary so dramatically. The more relevant comparison would be looking at an organization’s ratios vis a vis others doing similar work, and over time.
  • Using all the above, we can calculate nonprofit liquidity. Yet an organization with two weeks of cash may not be ready to double in size, but it may be fiscally well-managed. Having two to four weeks of cash is typical of nonprofits operating in low income communities. Nonprofit Finance Fund surveys over 5,000 organizations a year and in the last survey, 60% had less than three months of liquidity! (Typically, only universities with large endowments have over six months’.)

In Jessica’s words, “You should never, ever make a grant based solely on financial health. Doing your due diligence will inform how you can make a grant and what type of grant an organization is ready to absorb.”

Besides Jessica and her organization, I wanted to share a few other resources related to this issue:

  • Make use of GiveSmart’s online donor due diligence tool.
  • Listen to another perspective. To Jessica’s point about being cautious about overhead ratios and how effective nonprofits use financial resources differently than for-profit business, Dan Pallotta also makes the case in his TED .

My biggest takeaway? The best thing we can do as donors is to learn about the nonprofits we support — by trying to understand nonprofit financials in all their messiness and, especially, by having conversations with program staff or leaders of the organization — is to satisfy ourselves that they do effective, valuable work and are well-managed, and then to make unrestricted contributions in support of their work. This is especially true of organizations with less than three months of unrestricted cash on hand: they can most use your unrestricted operating support if you believe in their work and how they do it.

Just my two cents, which you may see if you look really closely at the financials.

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