2 Accounting Issues You Need to Understand

Pay attention. I never thought I would write these words: I wish I had taken accounting in college. I’ve always thought I could focus on strategy and messaging and creative and channels and analytics — the fun stuff — and let other people, you know, count. Little did I know that accounting would play such an important role in our profession. Don’t we spend half our lives calculating percent response, average gift, net yield per thousand, cost per donor and long-term donor value?

However … I regret to inform you that beyond these simple workday calculations, there are now two accounting issues that are about to have a huge impact on our fundraising. Lucky for you, since I didn’t take accounting in college, I’ll spare you the gory details in favor of the 30,000-foot view of two critically important issues for fundraisers: joint cost allocation of fundraising costs and long-term return on investment (ROI) vs. campaign-specific ROI.

Joint cost allocation
Nonprofits have three big buckets in which to categorize expenses: program costs, fundraising costs and administrative costs. Program costs refer to money spent in the delivery of a nonprofit organization’s mission (e.g., feeding the hungry, medical research, rescuing animals, advocacy for veterans). Fundraising costs are the dollars spent raising money for the cause. Administrative costs refer to the cost of managing the organization. When combined, the latter two categories are also known as the organization’s overhead costs.

Brief contextual aside: In the overly simplistic and often misleading view of charity watchdogs and members of the media, program costs are considered good while overhead costs are seen as a necessary evil. They would even say that the lower the overhead (fundraising plus administrative costs as a percentage of income) vs. program costs, the better the charity — and the higher the overhead ratio, the less efficient the charity.

Such a characterization is patently false. Those charities with the greatest impact tend to be those with the best management and the most effective fundraising. Not surprisingly to anyone familiar with either the business or nonprofit worlds, the most successful management and marketing programs cost money. Thus, the way to judge a charity is not on overhead ratios (high or low), but rather on the effectiveness of the organization. The most important metric is the outcome of its programs. Other important metrics can include its growth, the quality of its management and, of course, the importance of its mission to the donor considering where to give.

A bedrock principle of accounting (also recognized by the IRS) is that many expenses need to be subdivided into categories. For example, if a person oversees a nonprofit’s operations but also teaches literacy, her salary needs to be divided between administration and program. The cost of a brochure, video or mailing that advocates for recycling but also invites people to give should be divided between program and fundraising.

The acknowledgment that some expenses fit into more than one bucket is called joint cost allocation. The American Institute of Certified Public Accountants (AICPA) in its Statement of Position 98-2 developed guidelines to help nonprofits determine which expenses fall into which buckets based on the content of the activity, the purpose of the activity and the audience targeted.

Allocating the costs in this way provides donors a much clearer and more accurate understanding of how a nonprofit spends its money. So far so good, right?

But … in a disturbing development, and in total disregard for the IRS and AICPA, some self-anointed charity watchdogs are making headlines by unilaterally proclaiming that they won’t honor joint cost allocation. The result? Needless confusion among the giving public by arbitrarily assigning all the costs of a complex activity to “overhead,” instead of allocating the costs to where they honestly belong.

Clearly charities must not heed the bullying of watchdogs — we need to adhere to the generally accepted accounting principles of the AICPA. At the same time, charities must be alert to the very real danger that the media and the giving public may be hoodwinked into falling for the “new math” of the watchdogs and develop an inaccurate and unfairly negative view of nonprofits.

Nonprofits need to stand together (for example through the Direct Marketing Association Nonprofit Federation) and publicly oppose misleading math and misguided reliance on ratios to evaluate the effectiveness of a nonprofit.

Long-term return on investment
While the most vital metrics to a nonprofit are net revenue (how much is left to accomplish the organization’s mission, after expenses) and impact of the program, another important criterion in evaluating a nonprofit’s fundraising prowess is long-term ROI. That is, the net amount a nonprofit raises for its cause over time divided by the amount it spends to raise the dollars —the operative words being over time. Sadly — and dangerously — some politicians, state regulators, the IRS section G and watchdogs mischaracterize fundraising efforts based on an almost meaningless calculation: short-term ROI. Allow me to illustrate how ludicrous this approach is:

• Take a prospect to lunch this week without coming home with a check? You look like a failure. Get a donation from that donor a week later (without spending an additional dime)? You look like a genius. Neither is a helpful evaluation.
• Spend $1 million on a prospecting effort (mail or phone) that raises $850,000 (acquiring 25,000 new donors) and the media will accuse you of fraud (“All the money went to fundraising costs!”). Cultivate those 25,000 new donors for the next five years at a cost of $900,000 to generate $3.3 million and you’ll win an award.

The point is, a nonprofit must not allow itself to get sucked in to evaluating fundraising results on a campaign-by-campaign, short-term basis.

Sound business practices should not be abandoned simply because there is a “nonprofit” label involved. It’s said that the first pill a pharmaceutical company produces for a new miracle cure can cost $1 billion. The second one (once the research and production costs are taken care of) costs 4 cents. Neither short-term measurement, taken alone, is helpful. If you pay $1,200 in rent on June 1, do you think you paid $1,200 for one day … but received the next 29 days free? Not only is this kind of thinking meaningless, it’s downright misleading.

So it is with fundraising. To communicate an accurate understanding of a fundraising program, we need to calculate revenues and costs over the long haul. A year at minimum. Five years would be an even more helpful and realistic measuring rod.

It’s up to us.

So as I said at the beginning, “Pay attention!” This isn’t a meaningless debate over accounting verbiage; this is a discussion about our business practices. And if we allow overzealous regulators or watchdogs or anyone else define the terms, we’ll find ourselves limited in our ability to raise the much-needed revenue to feed hungry children, save the environment and cure cancer.

It’s up to us to educate donors and regulators about the importance of long-term ROI and how fundraising actually works. Sure, it’s an uphill battle. But who else is going to do it?

Tom Harrison is CEO of Russ Reid and a member of the FundRaising Success Editorial Advisory Board. Reach him at tharrison@russreid.com