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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

Accounting uses one software system, development uses another, and the information never agrees! What should you do about this?

5 May

Has this ever happened to you?

Your finance committee meets. The committee members are presented with a packet of information that includes financial reports prepared by your accounting department and reports prepared by your development department. As your committee reviews these reports they notice that the donor grants and contributions from your accounting department do not agree with the revenue numbers from your development department. Questions are asked, the staff tries to explain, and everyone is bewildered.

Shouldn’t the two sets of reports contain the same information? Is one set of reports right and the other wrong? The differences between the two can be confusing and, if inadequately explained, embarrassing.

You may also be wondering: are we wasting time by entering the same information twice, once by accounting and once by development?

All nonprofit organizations have an accounting system. Many, if not most, nonprofits also have a donor database. Can and should these parallel systems talk to each other? This article will discuss the basic issues.

Nonprofits typically receive grants, contributions, donations, pledges, gifts in-kind, sponsorships, etc. These sources of revenue may come from foundations, corporations, individuals, and governments.

Your accounting department will record this revenue in its accounting system. If your organization has a separate donor database, someone in your organization, perhaps in your development department, will also record this revenue information in the donor database. If the same information is being recorded in two different places, why, unless someone makes a data entry mistake, might the two systems report different revenue numbers?

The answer is that accounting rules (called Generally Accepted Accounting Principles or GAAP) require accounting information to be entered one way, but the development department may need the information to be entered in a different way. Therefore when reports generated by the accounting and development departments vary, it is quite possible that neither one is wrong.

Let’s look at some examples to see how this might happen. Suppose a donor sends a check for $10,000 to pay a pledge the donor made in a previous period (such as last month, or two months ago, last year, etc.). The development department enters this $10,000 in the donor database and at the end of the month will produce a report including this $10,000 in their list of contributions.

The accounting department, on the other hand, will apply this $10,000 against a pledge receivable that was recorded in the previous period. If your accounting system is on an accrual basis, it counts revenue when the pledge was made, as opposed to the development department, which might be on a cash basis and logs its donations when the checks actually arrive. Since the revenue from this pledge was already recorded in the accounting system in a previous period, no new revenue results from the receipt of this check. So when the accounting department produces its Statement of Activities, they show no revenue while the development department report shows $10,000. The reports seem to be off by $10,000, yet no one actually made a “mistake.”

Another common example of different treatments of the same transaction can occur with grants.

A grant letter typically spells out the terms, restrictions, and conditions, if any, of the grant. For example, say that a foundation awards your organization a grant for $100,000. The development department will want to carefully track this grant through its donor database and they will print reports showing the receipt of this grant.

The accounting department, however, has to follow GAAP. For example, this $100,000 grant may have a condition attached, such as the need for some uncertain event to occur in the future. This condition may preclude this grant from being recorded in the accounting system until the condition is resolved. This creates the potentially bizarre situation of the development department reports showing $100,000 of revenue while the accounting reports show zero!

So how do we solve this problem? The finance committee must be given information that is clear and unambiguous. Presenting them with reports showing seemingly conflicting information is not satisfactory. What can be done about this?

The answer lies in three parts: Part one is the need for better communication between the accounting and development departments. Specifically, there needs to be a clear set of policies and procedures such that both departments understand how to treat various types of contributions and grants. Furthermore, the donor database and the accounting general ledger, the place where accounting information is stored, should be set up so they are in alignment with each other. For example, if the donor database uses account number 4500 to designate corporate contributions, then the accounting system must also use account number 4500 to designate corporate contributions.

Part two of the answer is that both the accounting system and the donor database must be reconciled to each other at least once per month. With a willing accounting department, and with a willing development department, along with support from the organization’s management and executive director, this communication and alignment is very doable and can be accomplished relatively easily.

Part three is the need to modify report formats, both from the accounting and development systems, to display the information in ways that make clear what is happening to the reader.

Once the issue of conflicting data is addressed, the next issue to address is the potential inefficiency of entering contributions twice; once in the accounting system and once in the donor database. If, for example, your organization receives 100 donor checks per month, is there a way to avoid having two people enter each check in both systems? Can this duplicate entry be avoided?

Of course yes.

The solution involves establishing a disciplined process in which all the contribution details are entered into the donor database, with only summary information posted to the accounting general ledger. For example, assume an organization receives 10 donations on a given day. Each of these donations must be entered in the donor database so that the development department has all the information they need to track the donors, send them thank you letters, follow up with them, etc. Once these contributions are all entered, a summary report can be printed from the donor database showing the total dollars by account distribution. Seven of the checks might have been individual contributions, so they can all be summed into one number. The other three might have been foundation grants, and they can be summed into one total as well. Your accounting department can take this summary report and enter a single journal entry to record the day’s contributions. The double entry problem is effectively eliminated. Note again, though, that a monthly reconciliation must be done to insure the integrity of the information in both systems.

It is clear that an organization can perform quite nicely with two separate systems: one for accounting and one for donor data. However, would an integrated system be more efficient?

By an integrated system I mean a single piece of software that will handle both your organization’s accounting and donor data needs. The theory is that you enter a contribution once and you are done.

The answer is generally yes, an integrated system would be preferable. However, it depends on the system as some are marketed as being integrated when they are really not. It also depends on price and sophistication, as some integrated systems might be unnecessarily expensive and complicated to use.

Integrated systems still require communication between the development and accounting departments. There still needs to be a disciplined set of policies and procedures governing how contributions are recorded. There still needs to be a single chart, or list, of accounts that both departments use. And there needs to be consistency around the use and understanding of financial terms such as knowing when a cash receipt is revenue for the period versus payment on a pledge from a previous period. There still needs to be an accepted understanding of how and when to recognize revenue on conditional grants.

For these reasons, our advice to our clients who have separate accounting and donor systems is to put the brakes on spending more money on an integrated system until they better understand the pros and cons. The essential first step is to get the development and accounting department to communicate about the issues described above. Once all the necessary policies and procedures are in place and things are running smoothly, that is the time when a proper cost-benefit analysis can be done on whether or not to move up to an integrated system.

Comments welcome.

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

NOTE: This article originally appeared in Don Kramer’s “Nonprofit Issues.” I highly recommend Don’s newsletter to anyone in a position of authority and responsibility in the nonprofit world. For more information, visit: http://www.nonprofitissues.com.

Passion and mission: a formidable combination

28 Apr

Mark Bergel is the reason why I decided to devote my life to helping nonprofit organizations almost 20 years ago.  I should say people like Mark are the reason.  You see, I just met Mark for the first time yesterday.

When you meet Mark the first thing you notice is that Mark is passionate about his mission.

Mark is the executive director of an organization called A Wider Circle.  Based in Silver Spring Maryland, A Wider Circle’s mission is to help low-income, and many times no-income, people move out of poverty.  They do this in a number of ways.  They offer for free quality used furniture for low-income families to furnish their homes.  They offer for free professional style clothing, like suits and ties for men, so that their clients can be well dressed and unashamed to go to work.  They provide job training in basic skills needed to get and keep a job.  And more. (Visit their website at: http://awidercircle.org/)

I met Mark yesterday when our firm volunteered for a day of service helping to move and organize A Wider Circle’s household furniture donations.  As our group of volunteers paused for lunch munching pizzas, Mark came and spoke to us about the mission and history of A Wider Circle.

The stories he told us about the work of his organization and the people they help he’s probably told hundreds if not thousands of times before.  Yet his passion and enthusiasm made it seem like we were hearing them for the first time.

I’ve listened to people like Mark scores of times before.  The executive directors of almost all of our clients share Mark’s passion for the missions of their respective organizations.  Our firm, in fact, hosted a panel discussion not long ago of five nonprofit executive director founders to hear their stories of how they started their organizations and why.  Their comments were so moving and inspiring that our staff of accountants broke into spontaneous applause after each one.  (You can read a description of this discussion at http://www.yptc.com/Entrepreneurs.aspx). These people prove that one person can make a difference.

I enjoy accounting.  But what I enjoy even more is helping nonprofits like Mark’s with their accounting so that they can make the world a better place.   The purpose behind what they do is what gives purpose to what we do.  Thank you Mark and to all the passionate executive directors out there!

Comments welcome.

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

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