Watchdog organizations that patrol not-for-profits have been around for several years. As you probably know, one of their major purposes is to help potential donors evaluate charities’ financial health. But do you know how they evaluate not-for-profits like yours?

Navigating Not-For-Profit Waters

Not-for-profit watchdog Charity Navigator (CN), which describes itself as “the nation’s largest and most-utilized evaluator of charities,” rates more than 5,200 charities and considers itself a source of data and analysis for media, government agencies, not-for-profit managers, grant makers and individual donors. This independent, not-for-profit organization states that it has examined tens of thousands of not-for-profit financial documents since its launch in 2002.

CN lists not-for-profits exempt under Internal Revenue Code Section 501(c)(3) that have more than $500,000 in public support and have filed IRS Form 990 for the past four years. Using Form 990 information, CN claims to apply an objective, numbers-based rating system to assess each charity’s financial health.

What Charity Navigator Examines

CN uses the 990 to analyze a charity’s financial performance in seven performance categories. It concentrates on a charity’s efficiency, emphasizing that efficient not-for-profits spend less money to raise more.

The best not-for-profits, CN maintains, stay in line with the scope of their programs and services, while keeping their administrative costs within reasonable limits. Most spending is devoted to programs and services directly related to their mission. The areas CN examines are:

• Program expenses;
• Administrative expenses;
• Fundraising expenses;
• Fundraising efficiency;
• Primary revenue growth;
• Program expenses growth; and
• Working capital ratio.

From an analysis of a charity’s performance in these categories, CN derives two overall scores:

Organizational Efficiency (day to day) — This considers the percentage of total expenses that the not-for-profit spent on programs, administration and fundraising, plus the amount spent to raise one dollar (its fundraising efficiency).

Organizational Capacity (over time) — This is based on the average annual growth of the charity’s operating revenue, programs and services expense over the past three years and the working capital ratio to total expenses.

CN’s analysis results in a rating from one to four stars: Poor to excellent. No stars are given for an “exceptionally poor” evaluation. More information about CN’s rating system is available at www.charitynavigator.org.

BBB Wise’s Standards

Another watchdog group you should pay attention to is BBB Wise Giving Alliance (BBB Wise), which was formed in 2002 when the National Charities Information Bureau and the Council of Better Business Bureaus’ Foundation merged. The agency sets standards for accountability in charities and evaluates not-for-profits that report against those standards on a voluntary basis. Like CN, the organization educates donors by supplying information on intelligent giving practices.

BBB Wise’s Standards for Charity Accountability’s finance section outlines seven requirements. To meet the standards, your not-for-profit must:

1. Spend at least 65% of its total expenses on program activities (in our experience, many potential donors will look for a percentage closer to 75%-80%);
2. Spend no more than 35% of donations, legacies and other gifts received as a result of fundraising efforts on fundraising;
3. Avoid accumulating funds that could be used for current program activities — unrestricted net assets available for use should not be more than three times the size of the past year’s expenses or three times the size of the current year’s budget, whichever is higher (there may be circumstances where it is appropriate for a charity to accumulate more than this amount in unrestricted net assets);
4. Make available to all, on request, complete annual financial statements prepared in accordance with Generally Accepted Accounting Principles (GAAP), and, if total annual gross income exceeds $250,000, have these statements audited in accordance with GAAP (there may be circumstances where a lower level of reporting by an accounting firm is appropriate);
5. Include in the financial statements a breakdown of expenses (for example, salaries, travel and postage) that shows what portion of these expenses was allocated to program, fundraising and administrative activities;
6. Accurately report its expenses, including any joint cost allocations, in its financial statements; and
7. Have a board-approved annual budget for its current fiscal year, outlining projected expenses for major program activities, fundraising and administration.

As noted above, there may be times when you would deviate from these standards. That may be fine, but you should be prepared to justify that to your prospective donors.

More information on BBB Wise’s standards is available at www.bbb.org, which lists as many as 2,000 national charities. Each charity provides information voluntarily, and has the option to apply for the BBB Wise Giving Alliance Charity Seal, once they meet all of the accountability standards.

Best Face Forward

In an economic downturn, when funders and individual donors spend money more cautiously, the information that appears on not-for-profit watchdogs’ websites is more important than ever. By preparing the best financial information you can in your documents of record, your organization will be in a much better position to compete for available dollars.

For more information on these not-for-profit watchdog organizations, and for assistance evaluating your own organization’s financial health, contact Larry Sophian at 312.670.7444.