How to Read a Nonprofit Financial Statement

Pay special attention to three figures: percent spent on fundraising, total assets and salaries. Also examine percent spent on management and general expenses and look for unusual activity in the notes.

It is important to compare apples with apples and oranges with oranges. Compare one organization's assets to other organizations in the same field. For example, organizations which run camps for children tend to own more assets than your typical nonprofit because they like to own the buildings, land, and physical structures necessary for operating a camp and like to have endowments which can provide them with a secure financial future and smooth out income fluctuations. New organizations often have higher start up costs than more mature organizations, so one should take this into account in evaluating their management and fundraising expenses. Again, compare new groups with other new groups.

The National Charities Information Bureau (NCIB) requires organizations to spend at least 60% of the annual budget on program activities. A rule of thumb is that fundraising expenses should not exceed 25%. The economist Richard Steinberg argues that donors should completely ignore average fundraising expenses, on the grounds that average fundraising costs do not reflect marginal fundraising costs. However, Steinberg's view is in the minority and ignores the fact that by giving to organizations with low average fundraising expenses, donors can provide incentives to organizations not to waste money competing against each other for greater market share.

NCIB also requires organizations not to keep assets higher than twice annual operating expenses. The justification for this requirement is that contributors generally wish their donations to go to work immediately, funding programs today, not invested for a rainy day tomorrow. Charities always have the option of starting an endowment funded only by gifts that donors have specified for that purpose. Obviously, if an organization invested all of their funds and never spent any on current programs, no one would ever benefit from the donor's generosity.

Comparing apples with apples is equally important when looking at executive salaries. Anyone who has ever worked for a nonprofit will probably tell you that most people working in the field are underpaid. A few top executives of very large organizations do enjoy salaries that are sometimes over $100,000. However, compare their salaries to what managers of for-profit corporations of equal size, with similar responsibilities, make. Some of the highest salaries go to the top managers of health organizations or hospitals; typically, these organizations must offer compensation generous enough to attract talented doctors who can command even higher salaries in the private sector.

However, encouraging slightly lower than private market salaries is a good tradition for the nonprofit sector. Lower salaries insure that the people who fill these positions are there because they care about the organization's mission, and not just for the money. Nonprofits perform services which are difficult for donors to evaluate, so the people responsible for delivering these goods and services must be especially trustworthy. Lower salaries is one way to screen out individuals with less than noble motives.

If you want the judgment of professionals whose job it is to carefully evaluate the financial reports of charitable organizations, consult the American Institute of Philanthropy's Charity Rating Guide (314-454-3040).