WHEN COMMON SENSE IS NOT SO COMMON: How misusing accounting data can lead one astray

16 Jun

I’m an accountant. Yet, I would be among the first to admit that standard accounting tools for measuring the performance of nonprofit organizations don’t always make sense.

Here is an example.

Suppose I told you that I have an investment with a 20% rate of return. Would you be interested?

As I write this, with interest rates in the very low single digit zone, I would be happy just to find a solid dividend paying stock yielding 5%, so 20% would certainly get my attention.

A 20% rate of return means that for every $1 that I spend, I get back $1.20 (my original $1 plus an additional $.20). Not a bad return, right?

Suppose I now tell you that I have an investment with a 100% rate of return? I spend $1 and I get back $2 (my original dollar plus an additional dollar). You would probably think this is too good to be true and that I was either lying or simply nuts.

Let’s stretch this point one more time. Imagine that I now tell you that I have an investment that returns 1,000%!!! I spend $1 and I get back $10. This would be so incredibly good that it must be outside the realm of all possibility. Certainly if we could find a person or organization that could achieve this big a return on a large scale we would reward this person or organization with the highest accolades. Such a person or organization would appear on the front page of Time Magazine, Forbes, and, hopefully, the Chronicle of Philanthropy. The CEO would be lauded for their outstanding success.

Yet, in the nonprofit world, this organization would be downgraded.

Consider the rating of organizations done by Charity Navigator, one of the larger charity “watchdogs.”

Charity Navigator attempts to rate the effectiveness of nonprofit organizations using a variety of different metrics. To do this they rely primarily on publicly available information on the Form 990.

I don’t fault Charity Navigator for attempting to rate nonprofits, or for using the 990. However, one needs to apply some common sense to whatever analysis one attempts to do.

One of the measures Charity Navigator uses is a statistic they call “Fundraising Efficiency.” They define this on their website as:

“The amount spent to raise $1 in charitable contributions. To calculate a charity’s fundraising efficiency, we divide its fundraising expenses by the total contributions it receives.”

Once an organization hits a 10% “fundraising efficiency” (they spend $1 to raise $10), Charity Navigator starts deducting points from the organization’s score. Once they hit 20%, more points are deducted, and so on.

So how could a 1,000% rate of return (spend $1 and get back $10) in the for-profit world be so outstanding, while in the nonprofit world an organization has points deducted from their evaluation score?

Has common sense been suspended?

Comments welcome.

Eric Fraint, President and Founder
Your Part-Time Controller, LLC

2 Responses to “WHEN COMMON SENSE IS NOT SO COMMON: How misusing accounting data can lead one astray”

  1. Eric Fraint June 20, 2013 at 7:43 AM #

    Reblogged this on EricYPTC.

    Like

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  1. The Overhead Myth and the Bridge to Nowhere | EricYPTC - June 26, 2013

    […] of my blog already know where I stand on this issue.  By chance, I posted my blog entitled “WHEN COMMON SENSE IS NOT SO COMMON: How misusing accounting data can lead one astray” just one day before The Overhead Myth letter was […]

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