Charitable Organizations' Strategies and Program-Spending Ratios

By Baber, William R.; Roberts, Andrea Alston et al. | Accounting Horizons, December 2001 | Go to article overview

Charitable Organizations' Strategies and Program-Spending Ratios


Baber, William R., Roberts, Andrea Alston, Visvanathan, Gnanakumar, Accounting Horizons


SYNOPSIS: Analysis in this study demonstrates how differences in strategy can be incorporated into evaluations and comparisons of financial statements of charitable organizations. The ratio of program spending to total spending, a metric commonly used in practice to evaluate charities, is the focus of the analysis. Our approach involves classifying charities according to how they access markets for donated resources and then using regression analysis to predict an organization's program-spending ratio, given the organization's strategic choice, size, and charitable objective. We then compare the predicted ratio to the organization's actual ratio to identify candidates for further review and investigation. In doing so, this paper illustrates how considering strategic choice enhances the analysis of financial statements of charitable organizations and informs assessments of organization effectiveness.

INTRODUCTION

The notion that industry effects and strategic differences among firms need to be considered when evaluating and comparing the financial performance of commercial enterprises is fundamental to contemporary financial statement analysis (Palepu et al. 1996; Stickney and Brown 1999). This study investigates how such factors can be considered when evaluating and comparing the financial profiles of not-for-profit charitable organizations. The focus of the analysis is on the program-spending ratio, defined as the fraction of total expenses committed to activities that advance the charitable objective. We focus on this particular measure because it is used frequently as a basis for making contribution decisions (Weisbrod and Dominguez 1986; Harvey and McCrohan 1988; Posnett and Sandler 1989; Callen 1994; Tinkelman 1996).

Our approach presumes that, just as competing for-profit organizations pursue divergent strategies in product and service markets, not-for-profit charities position themselves differently in the market for charitable resources. In particular, acting both in their private interest and in the collective interest of all parties affected by the charitable enterprise, some organizations commit relatively little to fund-raising activities while other organizations undertake costly fund-raising activities (Steinberg 1986). Similar to interpretations of financial ratios computed for proprietary enterprises, informed interpretations of program-spending ratios as indicators of organization effectiveness involve considering differences in strategic positioning.

To illustrate the relevance of strategy for financial statement analysis, we use publicly available data from filings with the Internal Revenue Service during the period 1992-1998. Our approach consists of four steps:

1. assessing the organization's strategic position;

2. using regression analysis to estimate expected program-spending ratios as a function of strategic position, organization size, and charitable objective;

3. identifying charities worthy of further investigation based on comparisons of expected and actual program-spending ratios;

4. using financial disclosures provided by the organization to assess the extent to which the unexplained program-spending ratio is attributable to organization effectiveness vs. other factors.

We emphasize that the objective is to encourage more informed financial analyses of charitable organizations by regulators, oversight agencies, and potential contributors. We cannot feasibly consider all potentially relevant factors for evaluating financial profiles of charities, and therefore, we make no claim that our specific approach is optimal or comprehensive. Even so, we demonstrate how considering even a small set of factors can provoke more focused investigations that move the evaluator toward definitive conclusions about organization effectiveness.

THE MARKET FOR PHILANTHROPIC CAPITAL

We characterize charities as organizations that broker contributed resources from donors to program activities that advance the organization's philanthropic mission. …

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