Study: Most Charities Teetering On Financial Peril

The nonprofit sector as a whole is fragile and profoundly undercapitalized, according to a new report that examined tax filing data over a recent five-year period.

Nonprofits account for more than 5 percent of Gross Domestic Product (GDP) and 10 percent of the workforce yet half of them have cash reserves of less than a month and almost a third lost money over three years. More than one in 12 are technically insolvent.

But, the aggregate financial health profile is not evenly distributed, according to “The Financial Health of he United States Nonprofit Sector: Facts and Observations,” a new report by GuideStar that examined the finances of more than 219,000 nonprofits for fiscal year 2010 through 2014.

The report is a collaboration with management consulting firm Oliver Wyman and SeaChange Capital Partners, an investment bank focused on the nonprofit sector. The study is a larger, sector-wide version of one that focused on human services specifically, released last week with the Alliance for Strong Families and Communities (ASFC) and the American Public Human Services Association (APHA).

Analysis was derived from GuideStar’s archive of digitized IRS Form 990 data, so it does not include nonprofits that do not have to file 990s, such as places of worship and organizations with less than $200,000 in revenue or less than $500,000 in assets.

“The scale of the problem is vast,” said John MacIntosh, a partner at SeaChange, and an author of the report. “Just restoring current insolvent nonprofits to solvency would require an injection of $40 to $50 billion,” he said.

Four key dimensions were examined in nonprofit’s financial health:

  • Solvency: Total assets relative to total liabilities;
  • Liquidity: Short-term assets relative to short-term liabilities;
  • Net income margin: The ability to generate surpluses measured by total revenue relative to total expenses over a three-year period; and,
  • Reserves: Financial capacity to withstand negative events and stress scenarios, and self-fund large expenditures. Indicators include months of cash, liquid investments, and operating reserves.

Some 7 to 8 percent of nonprofits have liabilities greater than assets – technically insolvent – and 30 percent face potential liquidity issues because short-term assets are less than short-term liabilities.

Most nonprofits are small, with two-thirds reporting operating budgets of less than $1 million. While 2 percent of nonprofits have budgets of $50 million or more, these account for 80 percent of total spending by the sector. Hospitals, health and human services and educational institutions account for almost half of the organizations in the sector and 80 percent of the $2.4 trillion in expenses.

Religious institutions and environment and animal-related nonprofits are predominantly funded by philanthropy. These nonprofits have less debt and larger reserves. The study suggests that private philanthropy allows them to build prudent reserves in a way that government contracts do not.

Educational institutions, hospitals and health and human services receive the vast majority of funding from government contracts and fee-based services. They use debt more often, operate in a tighter liquidity range and have smaller reserves, and the report suggests that their ability to generate consistent revenues throughout the year may “allow for greater access to credit from banks or debt capital markets.”

In general, larger nonprofits receive very little percentage of their funding via philanthropy.

“This simple analysis should remind trustees, funders and policy makers that it makes little sense to assess the financial health of any given nonprofit relative to the sector as a whole; it is too broad a landscape, encompassing too many different funding models,” according to the report. Analysis is more appropriate when done by size and subsector as large hospitals and educational institutions can dominate any sector-wide analysis.

After setting the stage with its findings, the 30-page report goes on to suggest what trustees, funders, regulators and policy-makers can do to address financial health.

Leadership of nonprofits should compile a “risk management statement,” similar to a mission statement. It indicates the appetite to take on major risks facing the organization and to “trade short-term programmatic impact for long-term sustainability,” according to the report.

“It is important to recognize that even the best risk management strategy does not guarantee survival. Consolidation, mergers and acquisitions, divestments, and orderly wind-downs are part of a healthy, evolving nonprofit sector.”

To download the complete report, visit GuideStar.org