November 24, 2014
The Internal Revenue Service is requiring more public disclosure from charities. The industry has data aggregators – GuideStar, Charity Navigator, and the Urban Institute, to name a few – that aid in this process. But a comprehensive analysis of an organization’s finances is the only way to really understand its overall health and viability. And while a verdict of weak or declining health is never welcome, it can be seen as an opportunity to move forward with new strategies, partnerships, collaborations, or even a merger.
Before you can determine your organization's financial health, however, you need to ensure that you are looking at the right measures:
Step 1: Determine what you want to measure. Identify your top measures. Focusing on a handful of top measures makes it easier to take a deeper dive into the data, while too much analysis can compromise stakeholders' ability to focus on the bigger picture.
Step 2: Establish benchmarks and targets. Each area of the social sector is different. To determine a reasonable target range for each of your measures, you need to have a good understanding of your peers and competitors. For example, universities often have significant operating surpluses that they then redirect to their endowment, scholarship, and/or capital funds. Once you've determined the appropriate ranges, establish targets in the top quartile for each measure, and use the bottom quartile as an early warning "time-to-right-the-ship" system.
Step 3: Determine your units of measure. Choosing the right unit – whether it's percentage, a ratio, or time – for each measure will help you tell a story that brings additional donors and stakeholders to the table.
Step 4: Use a consistent period of time. A rolling five-year period is a good length of time for establishing organizational trends. For instance, if four of the last five years resulted in operating deficits and there is no action plan to achieve a surplus, it's likely the deficits will persist. On the other hand, revenues can change significantly from one year to the next. A charity may record revenue in year one but not spend it until year two or three. Looking at year one – or year two or three – in isolation could skew the picture and lead to unwarranted optimism or concerns. Looking at all three years or, even better, a rolling five-year period, will give you a more accurate picture.
Below are some commonly used measures of financial health: