The Overhead Myth and the Bridge to Nowhere

26 Jun

The AICPA (American Institute of Certified Public Accountants) held its annual National Not-for-Profit Industry Conference last week in Washington, DC.  About 2,000 accountants from around the country selected from among approximately 60 sessions during the two-day conference.

In the afternoon of the second day there was a 75 minute session titled “What the Watchdogs are Watching.”  The featured speakers were Ken Berger from Charity Navigator and Art Taylor from BBB Wise Giving.

The timing of this session and the appearance of Berger and Taylor was fortuitous as it came just days after the release of their already infamous joint letter, written with Guidestar, entitled “The Overhead Myth.”  This letter is the latest salvo in the war against so-called overhead ratios to determine the effectiveness of nonprofit organizations.

There is much wrong with overhead ratios that I am not going to get into here.  Readers 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 released.

In terms of full disclosure I should say that Dan Pallotta’s book, “Uncharitable,” is required reading for our staff and a copy is given to every new hire.  The book is also required reading for a class I teach at the Fels Institute of Government at the University of Pennsylvania.

What I found particularly interesting at the AICPA conference was not anything that Berger and Taylor had to say in their session (I don’t think they said anything that was not already in the public domain).  What was striking to me was the dearth of discussion during the rest of the two-day AICPA conference about what the overhead myth implies for the accounting community and the relevance of accounting standards for the nonprofit world.

To be clear, several of the conference sessions I attended during the conference mentioned The Overhead Myth letter.  I would say that the accounting community, or at least the session presenters, was by and large very familiar with the letter’s release.

But while the letter was mentioned and briefly discussed at several sessions, what was missing was any recognition (at least in the sessions I attended) of what the letter implies for the accounting world.

Specifically:  if overhead percentages are, in the words of the overhead myth letter, “a poor measure of a charity’s performance,” what does this imply about the countless hours of work spent by accountants at nonprofits everywhere, every day, developing the functional expense numbers that the ratios are based on?

If the information is a poor measure of a charity’s performance, are we all wasting our time developing poor information?

Are GAAP and IRS rules that require the reporting of functional expense information (i.e. program, fundraising, and management expenses)  irrelevant at best, and, at worst, not only a waste of time, but a misleading means by which to allocate scarce public resources among nonprofit organizations?

To put it another way, if accountants are building a bridge to nowhere, what does this imply about the time, money, and effort spent to build the bridge, and what does it portend for the travelers forced onto the bridge only to find it is leading them astray?

Comments welcome.

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

Let us work together

23 Jun

This blog is right on point about how we should, and should not, attempt to help others.

It is written by Hayley.  She describes herself on her blog as “Medical Student, traveler, seltzer aficionado, reader, loser of pens. My name is Hayley and I created this blog to share my experiences with friends and family back home. I am the 2013-2014 Stanford-NBC Global Health and media fellow so I will be exploring the role of media in international health and development issues as well as sharing my thoughts and experiences.”

Here is the link to her blog:  Let us work together.

Comments welcome.

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

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

Reconciling Fundraising and Accounting Systems

1 Jun

In May of 2013, I participated in a webinar sponsored by the company that makes the fundraising software DonorPerfect. The topic was how to reconcile fundraising and accounting systems when the information does not agree.

To listen to the webinar, click here: WEBINAR: Reconciling Your Fundraising and Accounting Systems

To download the slides, click here: SLIDES: Reconciling Your Fundraising and Accounting Systems

To read my previous blog on this topic, click here: Eric’s previous blog on reconciling fundraising and accounting systems

If you listen to the webinar, you will hear me refer to a report format example and I encouraged the webinar participants to send me an email if they wanted to see this. Now, there is no need to email me as I have included this additional information in the slides which are available above for download. These additional slides are not in the webinar version of the slides, but are in the downloadable version.

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

Video: Unique Elements of Nonprofit Financial Reports

21 Apr

Nonprofit financial reports are different than for-profit financials.  Here is a short video showing these unique elements.

Comments welcome.

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

Executive Directors are Underpaid

30 Mar

Here comes an unsubstantiated assertion:  nonprofit executive directors are underpaid.

I believe I have enough anecdotal evidence to say this based on our work over many years with nonprofits of all types and sizes.  We work closely with the executive directors and we get to know them very well.  Based upon these close working relationships, I can make the following generalizations:

Nonprofit executive directors are smart, knowledgeable people who speak intelligently about the work of their organizations.

They are hardworking and are willing to do whatever it takes to get the work done.

They are very dedicated to the missions of their organizations.

They are resourceful, often accomplishing much with limited resources.

Though they may not have a classical background in finance, they have an intuitive understanding of the finances of their organizations.

They are adroit politically as they must often work with board members who themselves may be less than fully engaged.

They are generally leaders that can inspire staffs and volunteers.

They are people looking to make a difference.

And they are generally underpaid.

What do you think?

Comments welcome.

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

Attention nonprofit board members and executive directors: If your accounting department cannot perform these 7 essential functions, then you need a new accounting department

10 Mar

Show me an organization that cannot do one or more of these 7 basic functions, and I will show you an organization that needs a new accounting department.

At our firm we’ve coined a name for these 7 basic functions: the “Financial Reporting Baseline™” or FRB.

As you read these 7 basic functions, ask yourself if you are getting this minimum level of performance from your accounting department.

(1)    Monthly reporting package:  Your accounting department prepares a monthly financial reporting package consisting of, at the very minimum, a Balance Sheet, a Statement of Activities (commonly called an income statement), and a Cash Flow Statement.

(2)    Timeliness: The monthly financial reporting package is prepared on a “timely” basis.  The definition of timely varies from one organization to the next, but if it takes more than two or three weeks, it is no longer timely.

(3)    Reconciled: Your accounting department reconciles all bank and investment accounts every month.  If this is not done you really do not know how much money you have.

(4)    Restricted funds:  Your accounting department tracks and clearly reports the status of your donor restricted funds.

(5)    Different levels of detail:  Your accounting department is capable of producing financial reports in different levels of detail.  This is sometimes referred to as “vertical” presentations.  Think of your board getting very summary level information, your finance committee getting more detail, and your executive director getting all details.

(6)    Department and program data:  Are you able to easily get your financial information segmented by departments and programs.  We sometimes refer to this as “horizontal” presentations.

(7)    Budgeting:  Does your accounting department budget on both a cash and accrual basis?  The oddities of nonprofit accounting make this particularly important (assuming your organization reports on the accrual basis, which most organizations do).  If you budget only on an accrual basis, you lose information about your cash flows.  If you budget only on a cash basis, your budget may not line up properly with your actual performance which reduces the helpfulness of budget to actual analyses.

These 7 basic FRB functions apply whether your organization has a budget of $500,000, or $500M.  They are in fact so basic that if your accounting department cannot do these things it calls into question the quality of information you are receiving to run your organization.

For a more complete explanation of the FRB, see the article on our website called:  “Don’t Operate Blind: Jump Start Your Accounting Department.”  Find this article, and other articles relating to nonprofit financial management written by me, at:  http://www.yptc.com/NEWSRESOURCES.aspx .

Comments welcome.

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

Why do so many nonprofits have problems with their accounting?

17 Feb

Here is a troubling observation: many nonprofits, certainly more than half, have problems with their accounting and financial reporting. I would further maintain that the real number of underperforming accounting departments in the nonprofit world is closer to 70% or 80%.

These problems manifest themselves in financial reporting that is often inaccurate, late, or not available at all. The for-profit world has its problems too, but not on this scale.

This is an important issue for the nonprofit sector to address. Most of the data that boards and executive directors rely on to run their organizations comes from their accounting departments. Data that is late, erroneous, or nonexistent will have a deleterious effect on decision-making. It hinders an organization’s ability to operate efficiently and effectively and thwarts the organization’s ability to properly execute and deliver on its nonprofit mission. All of this worries the funders of these organizations too.

Why is this problem so pervasive? In our work with hundreds of nonprofit organizations over the years, we see the following patterns repeat themselves over and over.

(1) Nonprofits have a remarkable propensity for hiring people who do not know accounting to do their accounting.

These nonprofits typically do not have sufficient funds to be able to pay a more qualified employee to get the job done. Or they may skimp when it comes to paying up for a qualified person in order to use these scarce resources elsewhere. But you know the saying: you get what you pay for.

There is also, however, a mistaken belief that all you have to do is sit a non-accountant in front of a computer with some accounting software and he or she can learn what they need to know in a few hours or days. The reality is that no matter what accounting software is used, if the user does not know debits and credits, he or she will not be able to properly support your organization as you try to fulfill your mission. Your accounting software, no matter how good, will not correct for bad data input. There is another saying for this: garbage in, garbage out.

(2) Accounting rules for nonprofits are more complicated to understand and to apply than for-profit accounting rules.

Nonprofit accounting rules regarding the recording of restricted funds and for handling multi-year grants are just two examples of rules with an added degree of complexity for a nonprofit organization. Your accountant or bookkeeper either knows these rules or they don’t. If they don’t know them, their ability to produce accurate financial reports is compromised.

(3) There is, in general, greater demand for financial data in a nonprofit environment, so expectations of your accounting department are greater.

All nonprofit organizations have a board of directors. Most also have some combination of finance committees, executive committees, development committees, audit committees, and investment committees. When these committees meet they need reports to look at, and many of these reports are financial reports that come from your accounting department. In addition, data needs to be provided with some regularity to funders, donors, contributors, lenders, and various government agencies. The organization’s internal department and program managers also need financial reports with comparisons to budget and other metrics with which to run their areas.

In addition, many jurisdictions around the country require nonprofits above certain sizes to have an annual audit. Even in jurisdictions without such requirements, many nonprofits have audits done anyway if their boards or outside funders require it, or because they consider it to be a good practice. If your organization receives federal funding above a certain threshold, it is required to submit to still stricter audit oversight.

In addition to all else, your financial information on Federal Form 990 is required to be publicly available.

Consider the implications of this informational demand on a $2 million nonprofit compared with a $2 million for-profit. The nonprofit has to crank out a high volume of accurate, timely information, usually in various formats and levels of detail, while following more complex accounting rules. The $2M for-profit is probably a single owner without all these committees, needs, and demands. He or she simply gets the information they need to run their business.  As a result, the nonprofit has a much greater need for a skilled accountant, or group of accountants, to keep its books.

Moral of the story: Jim Collins, author of “Good to Great,” says you need to get the right people on the bus. More specifically, if you want your accounting and financial reporting to be done right, you must get the right people with the right skills and the right experience.

Comments welcome.

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

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