I love when donors and community leaders take an interest in a nonprofit’s financials. That kind of engagement is a tremendously good thing – for the donor, for the organization, and for the broader community. In-depth exploration of a nonprofit’s financial statements can tell a donor so much about an organization’s priorities, sustainability, and efficiency. The larger an organization, the more complicated the financials will likely be, and getting a thorough understanding of the financials and what they mean can be a very involved process. But it’s worth it – particularly if you’re considering a significant investment in the organization.
That said, as excited as I happen to get about it personally, I understand that lots of people don’t share my passion for in-depth financial analysis. (I do proudly own a t-shirt that says, “I heart spreadsheets.”) From my discussions with all types of stakeholders, I feel confident that when people say they’re looking for “the bottom line,” they mean a single number that conveys the organization’s financial performance, confirming that the organization’s operations are sustainable if it were to have that same level of revenue and expense year after year.
Sites like Charity Navigator and GuideStar have made it easier than ever for prospective donors to find financial information about nonprofit organizations. (GuideStar, in particular, has revolutionized philanthropy by collecting and providing access to reliable information in so many areas of a nonprofit’s work – far beyond financial measures.) But because of both sites’ reliance on IRS Form 990, neither is able to provide that single bottom-line number you want. And problematically, on both sites, you can find a number that seems like it is the “bottom line” you’re seeking. On Charity Navigator, it’s listed as “Excess (or Deficit) for the year,” right on the summary page. It’s not as prominent on GuideStar, but if you print the PDF preview of the Financials Report, in the summary of the 990 information, there’s a line called “Net Gain/Loss.”
Both numbers are Total Revenue minus Total Expenses. Which seems logical. It seems like Total Net Income would be that bottom line number we want. But it’s not. For nonprofit organizations, Total Net Income (Total Revenue minus Total Expenses) is very rarely a good indicator of an organization’s financial performance or sustainability. In other words, the number you see on the bottom line isn’t really “the bottom line.” This is not a new or profound insight. I’m not breaking any ground or saying anything controversial. Talk to any experienced nonprofit CFO or third-party auditor and they’ll agree. (Also, none of this is meant as an indictment of Charity Navigator or GuideStar in any way. Both organizations pull their financial data from IRS-990s, which doesn’t provide the source figures they would need to convey a more illustrative “bottom line” number.) Rather than Total Net Income, the most useful single number to convey the bottom line for performance and sustainability is Unrestricted Net Income Before Depreciation. It doesn’t roll trippingly off the tongue, but it does a much better job of telling you how a nonprofit is doing. Here’s why (and how you find the number):
To get the bottom-line number we want, you need a copy of an organization’s Audited Financial Statements. Many organizations have these available on their websites, and any reputable organization will happily send you a PDF copy if you call or email them and ask.
“UNRESTRICTED NET INCOME”
For nonprofit organizations, Unrestricted Net Income (Unrestricted Revenue minus Unrestricted Expenses) gives a far more accurate picture of activities than Total Net Income (Total Revenue minus Total Expenses). In particular, there can be significant differences related to contributed income.
Unrestricted contributions are pretty straightforward; a donor makes a gift and tells the organization it can use it for any purpose that will help it achieve its mission. There are two primary types of restricted contributions. Some contributions are restricted for purpose – a donor asks that the contribution be used to fund a specific program or project. Other contributions have “time restrictions” – a donor makes a promise (pledges) to give a certain amount of money in a future year or over several years. Following IRS guidelines:
- Total Revenue counts all restricted gifts in the year that they are promised, whether or not the money has been received or the restricted purpose has been accomplished.
- Unrestricted Revenue, on the other hand, counts restricted gifts when pledge payments are received or once an organization has released a purpose-restricted gift by doing whatever it promised to do with the funding.
For example, let’s say that, in December of 2015, a loyal donor makes a pledge to contribute $20,000 a year for five consecutive years:
Pledge Pmt Year / Pledge Amount
2016 / $20,000
2017 / $20,000
2018 / $20,000
2019 / $20,000
2020 / $20,000
Total Revenue will show income of $100,000 from that pledge in 2015. All else being equal, if you accept Total Net Income as the bottom-line, it will suggest an additional $100,000 surplus that is not real – that is not reflective of the organization’s performance. Then, for the next five years, Total Revenue from that pledge will be $0. All else being equal, if you accept Total Net Income as the bottom-line, it will suggest a $20,000 a year deficit that is not real – that is not reflective of the organization’s performance. On the other hand, Unrestricted Revenue for that same $100,000 5-year pledge gives us a clear picture of the real situation. In 2015, Unrestricted Revenue will be $0, since none of the gift is being received in or used for 2015 activities. Then, for the next five years, Unrestricted Revenue will be $20,000 a year – perfectly reflecting the organization’s annual activities and performance (and matching the purpose/intent of the contribution).
Let’s say that a different donor contributes $10,000 in cash in 2015 to fund a specific program that will take place in 2016. The problem with Total Revenue is the same. In 2015, Total Revenue will show income of $10,000 from that restricted gift, making it look like the organization raised $10,000 more than it needed or spent. Then, in 2016, Total Revenue will make it look as if the organization failed to raise the $10,000 it needed for that specific program. But, once again, Unrestricted Revenue for that same $10,000 restricted gift will give us a perfect picture. 2015 Unrestricted Revenue will be $0; even though the cash was received in 2015, the restricted purpose wasn’t accomplished yet, so Unrestricted Revenue doesn’t count it. Then, in 2016, Unrestricted Revenue will show income of $10,000, matching the organization’s actual activities and performance (and the donor’s intent).
In some cases, depending on an organization’s activities during a year, Total Net Income and Unrestricted Net Income may be very similar or even identical. But if there is a difference, Unrestricted Net Income is the best starting point for determining a nonprofit’s real “bottom line.”
The other issue that can get in the way of understanding of a nonprofit’s bottom line is non-cash Depreciation, particularly if the organization has undergone a major construction/capital project in the last 40 years or so.
Let’s say that an organization raises $40 million through a capital campaign and builds a brand new facility (theatre, museum, shelter, etc.) to support its mission. The new facility is completed on December 31, 2015. The IRS requires that the cost of the new facility be spread out over its “period of usefulness,” often defined as 40 years. So, starting in 2016, the organization would book $1 million a year in non-cash Depreciation Expense (in addition to annual operating costs associated with the new facility – maintenance, repairs, utilities, overhead, etc.)
There are logical reasons that for-profit organizations are required to book capital expenditures this way. For example, non-cash Depreciation Expense can help for-profits more easily put aside cash for future capital costs (such as a new $40 million building 40 years later, or whatever the for-profit needs in the future). Nonprofit capital projects, however, do not work the same way. Donors are not generally inclined to make large contributions for an organization to put in the bank to use at some future undetermined time for some future undetermined capital project. (Nor should they be, in my opinion.) Nonetheless, a nonprofit in this scenario will be expensing $1 million a year in non-cash depreciation for a project they’ve already paid for and completed. Which means that, if this nonprofit is sustainably accomplishing its mission and performing at peak efficiency, it will misleadingly have a Net Loss of $1 million every year. If you review nonprofit financials, you’ll find that many vibrant, successful, and prudently managed nonprofits have negative Total Net Income (or even Unrestricted Net Income) year after year – due entirely to significant non-cash Depreciation Expense.
“UNRESTRICTED NET INCOME BEFORE DEPRECIATION”
To determine a nonprofit’s real bottom line, Unrestricted Net Income before Depreciation, start with Unrestricted Net Income (sometimes called Unrestricted Change in Net Assets) from the organization’s Statement of Activities in their audited financials – and simply “add back” Depreciation Expense.* (Depreciation Expense will often be called out on the Statement of Activities. And, if it’s not, you can always find in on the IRS-990 – page 10, line 22.)
For example, if an organization has a negative Unrestricted Net Income of ($250,000), and Depreciation Expense of $400,000 – the Unrestricted Net Income before Depreciation would be a positive $150,000. That’s the organization’s real bottom line.
*This approach is intended to provide an easy way to calculate a simple “bottom line” number. The method of subtracting 100% of Depreciation Expenses is not perfect, as there are some (generally smaller) capital expenditures (e.g. computer equipment, office furniture, etc.) that may be more reasonable to think of as part of annual activities. But the level to which depreciation can dramatically overstate expenses far outweighs the potential for understating expenses.
A nonprofit’s financials offer so much more than a single-number bottom line. As the axiom says, “Don’t tell me what you value; show me your budget, and I’ll tell you what you value.” The more you’re thinking about giving, the more I encourage you to spend time with an organization’s leadership to discuss its past financials and forward-looking budget. But if a quick-check-in bottom line number is what you’re looking for, Unrestricted Net Income Before Depreciation is what you want.
Originally published February 21, 2011
Updated March 23, 2016