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How Do We Rate Charities' Financial Health?

 
 

(Note: This page describes our current methodology, CN 2.1. This methodology went into effect on June 1st, 2016. To see our previous methodology, please click here.)

Table of Contents

Financial Efficiency Performance Metrics

Four of the seven financial performance metrics that we analyze are about efficiency: program expense percentage, administrative expense percentage, fundraising expense percentage, and fundraising efficiency.

Performance Metric One: Program Expense Percentage 

Average Program Expense Percentage* = Average Program Expenses* ÷ Average Total Expenses*

(When Calculating Using Form 990) = Average of Part IX line 25B* ÷ Average of Part IX line 25A*

Charities exist to provide programs and services. They fulfill the expectations of givers when they allocate most of their budgets towards their charitable missions. Charities that consistently underspend on their programs and services do not have as strong an impact on their charitable missions.

We calculate the charity’s average program expense percentage over its three most recent fiscal years* and then assign a score using the conversion scale listed in our Financial Score Conversions and Tables.

*Explanation of 3-year averaging.

Performance Metric Two: Administrative Expense Percentage

Average Administrative Expense Percentage* = Average Administrative Expenses* ÷ Average Total Expenses*

(When Calculating Using Form 990) = Average of Part IX line 25C* ÷ Average of Part IX line 25A*

As with successful organizations in any sector, effective charities must recruit, develop, and retain talented people. At the same time, they should ensure that these administrative expenses remain reasonable and in line with the organization's total functional expenses.

We calculate the charity’s average administrative expense percentage over its three most recent fiscal years* and then assign a score using the conversion scale listed in our Financial Score Conversions and Tables.

*Explanation of 3-year averaging.

Performance Metric Three: Fundraising Expense Percentage

Average Fundraising Expense Percentage* = Average Fundraising Expenses* ÷ Average Total Expenses*

(When Calculating Using Form 990) = Average of Part IX line 25D* ÷ Average of Part IX line 25A*

Givers support charities for their programs and services, not for their ability to raise money. Charities should ensure that fundraising expenses stay in line with the charity's total functional expenses. 

We calculate the charity’s average fundraising expense percentage over its three most recent fiscal years* and then assign a score using the conversion scale listed in our Financial Score Conversions and Tables.

*Explanation of 3-year averaging.

Performance Metric Four: Fundraising Efficiency

Average Fundraising Efficiency* = Average Fundraising Expenses* ÷ Average Total Contributions*

(When Calculating Using Form 990) = Average of Part IX line 25D* ÷ Average of Part VIII line 1h*

Financially effective charities must in part be efficient fundraisers, spending less to raise more. We calculate a charity's fundraising efficiency by determining how much it spends to generate $1 in charitable contributions. 

We calculate the charity’s average fundraising expenses and total contributions over its three most recent fiscal years* and then assign a score using the corresponding conversion scales listed in our Financial Score Conversions and Tables

*Explanation of 3-year averaging.

Indirect Cost Allocation Adjustment

The IRS requires charities to allocate their expenses into three categories: Program, Management/General, and Fundraising. Most organizations we evaluate allocate costs directly, the simplest and most transparent technique for fulfilling this requirement. A few use indirect cost allocation for some or all of their accounts, entering all their expenses for those accounts into one category, and then reversing out the expenses that belong to other categories in a single line item. In an effort to treat all evaluated organizations consistently and fairly, we factor out indirect cost allocations where sufficient financial documentation and a reasonable description for the basis used to determine such allocated costs have not been provided to us.

Joint Cost Allocation Adjustment

Consistent with Generally Accepted Accounting Principles (GAAP), some organizations report a portion of their specific joint costs from combined educational campaigns and fundraising solicitations as program costs (those that follow SOP 98-2 or ASC 958-720-45). The IRS requires that these organizations disclose the allocation on the Form 990. In most cases, but not all, charities utilizing this technique allocate a small percentage of their solicitation costs to program expenses from fundraising expenses.

Donors should have the information they need to make informed giving decisions. Observations demonstrate that in many cases it is simply not clear to donors that their donation may be used for educational/awareness campaigns, as opposed to providing direct services. Our main concern is not that organizations are misreporting joint costs (in fact, they are required to identify some of these costs in their joint costs), rather, that the information is not clearly indicated to the donor.

Therefore, in the analysis of an organization that reports Joint Cost Allocations on their tax return, the process includes reviewing the main programs of the organization (as reported in the return), as well as a review of the organization’s website. In those situations where it is clear to potential donors how their money will be used and that joint cost activities have a role in the charity’s mission, we use the joint cost numbers as they are reported on the tax return (specifically, on page 10, Line 26) in our analysis of that charity’s financial performance. In those where it is not clear, we reallocate the portion of joint costs that is reported as program expenses into the fundraising expenses.

If one of the rated charities on our website reports Joint Cost Allocations, here is what they would need to do in order to receive an exception to our JCA adjustment policy:

  • Clearly describe the programs that include the Joint Cost Allocations on the tax return (page 2 of the Core Form)
  • On the organization’s website:
    • Describe the activities that include Joint Costs and be very clear about how a donor can typically expect their donation to be spent.
    • Explain the programs and services the charity offers, whether direct services, educational mailings, awareness campaigns etc.

Here are examples of how charities disclose the information on their website:

  • For nearly 50 years, *redacted* has relied on direct mail to recruit and maintain the large Membership we have. . . Additionally, direct mail is used to maintain our subscriber base in our award winning publications. This is one of our primary mission statements. We communicate by postal mail -- and other channels -- not only to generate income and maintain our membership base, but to educate the public thereby advancing our mission. As a result, in accordance with the Financial Accounting Standards Board (FASB) guidelines, we allocate a portion of our direct mail costs to program services and to fundraising.
  • *redacted* is committed to efficiency and transparency. We communicate with our supporters, donors, and prospective donors by email, postal mail, phone, and other means, both to request contributions to our cause and to educate the public about *redacted* year round ? programs, volunteer opportunities, and ? events in local communities and around the world. These efforts help advance our mission to .... As a result, in accordance with the Financial Accounting Standards Board (FASB) guidelines and Internal Revenue Service (IRS) guidance, *redacted* allocates a portion of our fundraising costs to program services. As a nonprofit organization that is exempt from federal taxation, we ensure our donors’ money is spent as efficiently and effectively as possible.

Financial Capacity Performance Metrics

Three of the seven financial performance metrics that we analyze are about a charity's financial capacity: program expenses growth, working capital ratio, and liabilities to assets ratio.

Performance Metric Five: Program Expense Growth

Program Expense Growth = [ ( Yn / Y0 ) ^ ( 1 / n ) ]  - 1

Yn is the value (Part IX line 25B) in the most recent year of the interval.
Yo is the value (Part IX line 25B) in the oldest year of the interval.

n is the length of the interval in years.

Charities that spend more year over year on their programs and services continue to have a greater impact on their charitable missions. Organizations that demonstrate consistent annual growth in program expenses are able to outpace inflation and thus sustain their programs year to year. These organizations also supply givers with greater confidence by maintaining broad public support for their programs.

Charity Navigator analyzes a charity's average annual growth of program expenses over its four most recent fiscal years, using the standard formula for computing annualized growth. If we determine that an organization has engaged in non-recurring, atypical activities in the first of the four years over which we evaluate the organization, we will expand the data we evaluate to five years. If a fifth year is unavailable, we instead reduce the data we evaluate to three years. We then evaluate the charity using the corresponding scales listed in our Financial Score Conversions and Tables.

Performance Metric Six: Working Capital Ratio


Working Capital Ratio = Working Capital ÷ Average Total Expenses*

(When Calculating Using Form 990) = (Part X line 27 + Part X line 28) ÷ Average of Part IX line 25A*

Charities depend upon their reserves of liquid assets to survive downward economic trends and sustain their existing programs and services. If a charity has insufficient working capital, then it faces the difficult choice of eliminating programs or staff, amassing debts and liabilities, or dissolving. On the other hand, when giving flows, those charities that build working capital develop a greater capability for expanding and improving their programs. We analyze a charity's working capital ratio by determining how long it could sustain its current programs without generating new revenue.

We calculate the charity's working capital for the rated year and its average total expenses over its three most recent fiscal years*. Working capital includes unrestricted and temporarily restricted net assets, and excludes permanently restricted net assets. We then calculate the ratio between working capital and average total expenses and assign a score using the corresponding conversion scales listed in our Financial Score Conversions and Tables.

*Explanation of 3-year averaging.

Performance Metric Seven: Liabilities to Assets Ratio

Liabilities to Assets Ratio = Total Liabilities ÷ Total Assets

(When Calculating Using Form 990) = Part X line 26 ÷ Part X  line 16

Part of our goal in rating the financial performance of charities is to help donors assess the financial capacity and sustainability of a charity.  As do organizations in other sectors, charities must be mindful of their management of their total liabilities in relation to their total assets. This ratio is an indicator of an organization’s solvency and or long term sustainability. It can signal potential issues within an organization, and additionally, it displays how well the charity is managing this balance in comparison to organizations in the same cause area.  This metric helps donors understand if their donations are being used to service debt rather than servicing the charitable mission.  Charities will, of course, have liabilities on their balance sheet, but certain liabilities require a long term commitment of resources and this can impact long term sustainability.     

We calculate a charity's ratio of liabilities to assets by comparing the organization’s total liabilities to total assets in the most recent tax year, and then we assign a score using the conversion scale listed in our Financial Score Conversions and Tables.

Assigning Financial Scores and a Financial Health Rating

After evaluating a charity in each of the seven performance metrics described above, we convert the charity's raw score to a numerical score ranging between 0 and 10. We calculate an overall score for each charity's financial health by combining its scores in each of the seven performance categories and adding 30 points (to convert the scores to a 100 point scale). We then assign the charity a Financial Health rating by using the table listed in our Financial Score Conversions and Tables.

Scoring Uniquely Functioning Causes

Charity Navigator is committed to rating all charities consistently. For more information about how we adjust scores for cause areas that function differently from the norm, please see our Financial Score Conversions and Tables page

*Explanation of 3 year averaging: 42 months is used in order to capture data from a third 990 in the event of a fiscal year change. We use the most recent IRS Form 990 and then include all full year 990s within the 30 months preceding it. This will usually result in three 990s, except in cases of fiscal year changes that are more than six months, if a 990 was not filed, or if an EZ 990 was filed. We do not use partial year 990s in our evaluation.

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