Private foundations are tax exempt entities organized primarily to distribute grants to charitable not-for-profit organizations. Wealthy benefactors interested in philanthropy typically endow private foundations. Examples of some well-known private foundations include the Rockefeller Foundation (www.rockfound.org), the Carnegie Corporation (www.carnegie.org), and the Gates Foundation (www.gatesfoundation.org).
These private foundations are one of the primary users of financial information created and reported by charities as they are specifically formed to distribute grants to charities rather than provide charity directly. They often use financial performance measures to determine whether a charitable organization is capable of effectively and efficiently using a grant distribution toward its charitable objectives.
After recently winning the Mega Millions lottery Mr. Prince endowed a $60 million private foundation. The foundation will award grants of $2 million to DePaul and one other university. The grants will be used to provide textbook scholarships to students. The benefactor, who is extremely busy, has decided to form a Grant Committee to determine the grant recipient.
Committee responsibilities
- Review the financial statements for DePaul and two other universities.
- Evaluate their performance using specific not-for-profit financial performance measures.
- Recommend which of the other two universities should receive the $2 million grant by identifying the one with the best performance based on the evaluation.
Learning objective one: The role of not-for-profit accounting
Not-for-profit financial performance measures require analysis of accounting information specifically found in the financial statements. Unlike publicly-traded companies, nonprofit organizations are not required to make their financial statements available to the general public. However, they are required to file an annual tax return (i.e., IRS Form 990). The Form 990 includes financial information about their activities (i.e., income & expenses) and financial position (i.e., assets & liabilities) as well as non-financial disclosures about program service accomplishments, officer compensation, and the activities of the organization.[1] [2]
Find the audited annual financial statements for your two universities and DePaul. The ones for DePaul can be found here: https://financialaffairs.depaul.edu/financialaccounting/listDocs.aspx. Please answer the following questions for all three institutions.
- Review the Statement of Net Position. For the last three years, show the following:
- The major restrictions appearing in the restricted portion of the Statement of Net Position.
- The amount reported for contributions receivable that is unrestricted.
- The amount of unrestricted net assets that is designated by the board.
- The total investment return on investments reported in all three net asset categories along with how much of this amount represented an increase in unrestricted net assets.
- The amount of investments in endowments reported in the permanently restricted net asset class.
- The major depreciable and non-depreciable assets reported.
- The largest non-cash asset on the Statement of Net Position.
- The total amount of cash.
- The amount of cash that donors contributed for the acquisition of buildings and equipment
- Is the Unrestricted Net Position a positive or negative amount??
- Review the Statement of Revenue, Expenses and Change in Net Position. For the last three years, answer the following:
- The largest revenue item in the operating income section; the largest source of total revenue; and the largest source of unrestricted revenue.
- The percent of tuition revenue not on an accrued basis by the end of the fiscal year.
- How (and how much) scholarships and fellowships, for which no service is required, are reported in the statement.
- Whether operating income a positive or negative figure. Why? How much of the net assets released were for operations?
- The five largest expense items in the operating income section. Are these to be expected? Explain why. Give three suggestions on how the school can continue to expand revenue sources and save on spending?
- Review the Statement of Cash Flows. For the last three years, what is the largest adjustment on the statement in adjusting the change in net assets to cash provided by operating activities (also is it positive or negative)? Do you think this adjustment is common for a private university? Why or why not
- How much outstanding bonds payable does the institution have? What is the institution’s bond rating? Has it been improving or deteriorating over the last three years? What are the major comments given by the rating agency for the current bond rating?
- What interest rate did the university use to determine the present value of multiyear pledges?
It is your committee responsibility is to recommend which university should receive the other $2 million grant by identifying the one with the best performance based on your evaluation.
- Complete the ratios included in Table 1 for all three institutions for the last three years in an Excel file.
- Create a chart similar to Table 2, Panel C to show your evaluation of the other two institutions.
- Complete a comprehensive performance evaluation of DePaul and the two universities in a professionally written report. The written report should include background information about the two other universities, as well as clear identification and evaluation of their performance. A final recommendation should be clearly stated at the end of the written report. Each Grant Committee should document their justification for selecting the most deserving university.
Learning objective two: Calculate/evaluate financial performance measures
The main purpose of this project is to calculate and evaluate financial performance measures specific to charitable organizations. Financial performance measures relate to specific dimensions of performance. You should be familiar with the three common dimensions of liquidity, profitability, and solvency from earlier courses and the financial performance measures associated with each of these dimensions as they are used to evaluate for-profit corporations. For example, for-profit organizations measure profitability using return on assets. These financial performance measures are commonly found in financial accounting and financial statement analysis courses and textbooks.
Charitable organizations do not have owners and therefore do not distribute their profits. As such, profitability measures are not always appropriate for charities. However, liquidity and solvency measures are important in a not-for-profit setting. A charitable organization should have adequate liquidity and solvency for operating and sustaining its programs. Charitable organizations also have other types of financial performance measures specific to their organizational form, including financial viability and efficiency.
Although similar in form to for-profit financial measures, you are probably unfamiliar with financial performance measures specific to charitable organizations. Table 1 provides a list of not-for-profit financial performance measures commonly used. Even with these measures, it is still difficult to measure charity performance. In particular, the financial performance measures common to charities provide little or no information about the effectiveness of their charitable programs. For example, a charity may appear to have strong financial performance because it is run in an efficient manner (i.e., total expenses consist primarily of program-related expenses) but may be failing at providing effective services to its beneficiaries. Because profits are less important for charities, other non-financial performance measures may also need to be developed to validly assess the broad objectives of charitable organizations. However, non-financial performance may be difficult or impossible to reliably measure.
An interpretation of the specific performance measures is shown in Table 2. This provides you with the methodology for ranking the universities to be evaluated. Table 2, panel C provides the evaluation results for the financial performance measures pertaining to two sample Human Service charities. In the sample analysis shown in Table 2, panel C, HSO 2 has higher program efficiency in comparison to HSO 1 (85.5 percent versus 81.1 percent). This means HSO 2 is using a higher percentage of its annual total expenses toward its primary mission. However, HSO 1 has lower fundraising efficiency compared to HSO 2 (13.5 percent versus 33.1 percent), which indicates that HSO 1 is more efficient as a fundraiser. The results for the efficiency performance dimension are mixed based on the two financial performance measures.
In the sample analysis, HSO 2 has much lower leverage than HSO 1 (6.9 percent versus 64.3 percent) and higher adequacy of available resources than HSO 1 (73.3 percent versus 19.0 percent). Based on the joint assessment of the leverage and adequacy of available resources measures, HSO 2 has a greater level of financial viability in comparison to HSO 1. HSO 2 has stronger performance measures for three out of the four total financial performance measures assessed in this sample analysis. HSO 2 reports stronger efficiency based on use of the program efficiency measure and is more financially viable in terms of the leverage and adequacy of available resources measures. The $2 million grant should be awarded to HSO 2 based on the overall evaluation of the financial performance measures. Although the financial performance measures indicate that HSO 2 is financial stronger, HSO 2 may not be the “best” choice for receiving the grant. For example, although HSO 2 is more efficient at delivering its programs (i.e., program efficiency is better), the organization is less efficient in its fundraising efforts (i.e., fundraising efficiency is worse). This may lead to the following questions. Which function is more important for a not-for-profit organization, the program function or the fundraising function? Even though HSO 2 is more efficient based on the program efficiency measure, is HSO 1 providing more services per dollar raised through fundraising efforts?
Table 1
Not-For-Profit Financial Performance Dimensions and Measures
- Liquidity
- Current ratio (Current Assets / Current Liabilities)
- Quick ratio (Quick Assets / Current Liabilities)
- Efficiency
- Program efficiency
- Program Expenses / Total Expenses
- Program Expenses / Number of Students Served
- Program Expenses / (Fundraising Expenses + Administrative Expenses)
- Fundraising efficiency
- Contributions / Fundraising Expenses
- Fundraising Expenses / Total Expenses
- Fundraising Expenses / (Contributions + Special Event Revenue)
- Administrative efficiency: Administrative Expenses / Total Expenses
- Program efficiency
- Financial viability
- Leverage
- Total Liabilities / Total Assets
- Total Liabilities / Net Assets
- Adequacy of available resources
- Unrestricted Net Assets / Operating (Total) Expenses
- Revenue, Support, Gains + Interest / Annual Debt Service Expense
- Other
- Revenues / Expenses
- Comparison of Budgeted versus Actual Revenues and Expenses
- Leverage
- Other financial performance dimensions and measures
- Investment performance
- Budgeted Total Return on Investments / Actual Total Return on Investments
- Revenue concentration:
- Percentage of revenues from contributions and grants
- Percentage of revenues from program service revenue
- Percentage of revenues from investment income3
- Investment performance
- Organizational capacity
- Primary revenue growth: [[(Yt=1/Y t=3)(1/ n)] – 1], where PR t=1 is primary revenue (all non- investment revenues) measured in the first year of the interval analyzed, Y t=3 is the primary revenue (all non-investment revenues) measured at the end of the interval analyzed, and n is the length of the interval in years
- Program expense growth: [[(Yt=1/Y t=3)(1/ n)] – 1], where Y t=1 is program expenses measured in the first year of the interval analyzed, Y t=3 is program expenses measured at the end of the interval analyzed, and n is the length of the interval in years
- Working capital ratio: (Current Assets – Current Liabilities) / Total Expenses
Notes: Nonprofits should spend at least 65% of its total expenses on program activities [Program Expenses / Total Expenses], no more than 35% of related contributions on fundraising [Fundraising Expenses / (Contributions + Special Event Revenue)]; and Unrestricted net assets should be no more than 3 times the size of the past year’s expenses or 3 times the size of the current year’s budget, whichever is higher
Table 2 Sample Analysis
Panel A: Financial Performance Dimensions and Measures Used in the Sample Analysis
| Performance Dimension | Specific Performance Measures | Calculation of Specific Performance Measure | Interpretation of Specific Performance Measures |
| I. Efficiency | Program efficiency Fundraising efficiency | Program Expenses / Total Expenses Fundraising Expenses / (Contribution Revenue + Special Event Revenue) | Higher program efficiency indicates the organization is more efficient in delivering its programs Lower fundraising efficiency indicates the organization is more efficient in its fundraising endeavors |
| II. Financial viability | Leverage Adequacy of available resources | Total Liabilities / Total Assets Unrestricted Net Assets / Total Expenses | Lower leverage indicates the organization has less debt burden Higher adequacy of available resources indicates the organization has adequate unrestricted reserves |
Panel B: Location of IRS Form 990 Information Used in the Sample Analysis
| Line Item Name | Specific Location on IRS Form 990 |
| Revenues and Expenses Contribution revenue (direct public support) Special event revenue Program expenses Fundraising expenses Total expenses | Part I, line 8; Part VII line 1h. Part VIII, line 7a. Part IX, line 25 (column B). Part I, line 16; Part IX, line 25 (column D). Part I, line 18; Part IX, line 25 (column A). |
| Assets, Liabilities, and Net Assets Total assets Total liabilities Unrestricted net assets | Part I, line 20; Part X, line 16. Part I, line 21; Part X, line 26. Part X, line 27 |
Table 2
Sample Analysis (continued)
Panel C: Final Evaluation of Financial Dimensions and Measures Used in the Sample Analysis
| Performance Dimensions and Specific Performance Measures | Human Service Organization 1 (HSO1) | Human Service Organization 2 (HSO2) | Conclusion |
| I. Efficiency Program efficiency Fundraising efficiency | 81.1% 13.5% | 85.5% 33.1% | HSO2 > HSO1 HSO1 > HSO2 |
| II. Financial Viability Leverage Adequacy of available resources | 64.3% 19.0% | 6.9% 73.3% | HSO2 > HSO1 HSO2 > HSO1 |
| Last Name | First Name | Group | Nonprofits | ||||
| Lobas | Lottie | 1 | Villanova University and Providence College | ||||
| Lopez | Lizset | 1 | |||||
| Romero | Steven | 1 | |||||
| Mosqueda | Nicolas | 1 | |||||
| Proeh | Alec | 2 | Boston College and College of the Holy Cross | ||||
| Bisbikis | Julia | 2 | |||||
| Ali | Ibrahim | 2 | |||||
| Defilippis | Lino | 2 | |||||
| Garcia | Steve | 3 | Georgetown University and University of Notre Dame | ||||
| Rafter | Hannah | 3 | |||||
| Velazquez | Mathew | 3 | |||||
| Zareba | Jakub | 3 | |||||
| Kujawinski | Bethany | 4 | University of San Francisco and Santa Clara University | ||||
| Machota | Alex | 4 | |||||
| Stayura | Lesya | 4 | |||||
| Burke | Hendrix | 4 | |||||
| Taylor | Katelyn | 5 | St. John’s University and Seton Hall University | ||||
| Yousafzai | Abbas | 5 | |||||
| Chancellor | Aliyah | 5 | |||||
| Perdek | Victoria | 5 | |||||
| Sakiri | Ali | 6 | Marquette University and Creighton University | ||||
| West | Lauren | 6 | |||||
| Khan | Muhammad | 6 | |||||
| Fischer | Elizabeth | 6 | |||||
| Farooq | Hamzah | 7 | Fairfield University and Fordham University | ||||
| Curtov | Hanna | 7 | |||||
| Kerrigan | Michael | 7 | |||||
| Watkins | Holden | 7 | |||||
| Polanco | Angelica | 8 | University of Dayton and Xavier University | ||||
| Butera | Samuel | 8 | |||||
| Gugala | Klaudia | 8 | |||||
| Payne | Kenya | 8 | |||||
| Proeh | Austin | 9 | Seattle University and Gonzaga University | ||||
| Wozniczka | Samantha | 9 | |||||
| Sosa | Romeo | 9 | |||||
| Kiwarkis | Nina | 9 | |||||
| Galeanu | Elena | 9 |
[1] More information about Form 990 is available at https://www.irs.gov/charities-non-profits/form-990-resources-and-tools
[2] Guidestar (www.guidestar.org) provides free access to downloadable IRS Form 990 annual tax returns for most charitable organizations located in the United States.
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