Nonprofit Tip: Use the Statement of Functional Expenses to Evaluate Your Effectiveness– December 05, 2017 by Kaitlin Mansfield

People give to charitable causes that are meaningful to them and that make them feel like they are somehow making a difference. Today’s donors are savvy and often conduct due diligence, researching the credentials and spending habits of charitable organizations using websites such as Give.org or Charity Navigator. However, when they drop that check in the mail or click the “Donate” link on the website, they are trusting that you, the not-for-profit, will ensure their dollars are going to good use.
 
So how can your organization make sure it is operating in the most efficient way to meet the goals of your mission statement and maximize contribution revenue from donors? One quick measure of a not-for-profit’s effectiveness is its statement of functional expenses. Whether presented in an actual statement or in a footnote disclosure, this information provides a quick snapshot of where your organization is incurring its expenses — and therefore, where donors’ money is actually going.
 
The statement presents three categories of expenses: 

  • Program,
  • Administrative and
  • Fundraising. 

There is no hard and fast rule as to what the break-out of these categories should be, but the general rule of thumb is that the higher the percentage of resources being used for program-related activities, the more efficient that organization is operating. Give.org recommends that at least 65% of total expenses should be spent on program activities, but it is not uncommon for that number to be upwards of 80%. In other words, the majority of donors’ funding is going towards the actual mission of the organization, rather than towards administrative expenses.
 
It takes some judgment on the part of management and the board of directors to allocate certain expenses (such as employees’ salaries, rent/utilities, and other general and administrative costs) that are not 100% directly program-related. Salaries should be allocated through the use of timesheets to determine the percentage of hours that each employee spends on any particular activity/program. This salary allocation is typically a good measure to use as the allocation basis for other expenses. It is important to keep the allocation basis consistent from year to year; if the allocation basis changes frequently, it can lead to difficulties in managing resources and budgeting. That being said, if there have been significant changes in the organization’s operations, it may warrant a change in the allocation basis. Therefore, management should make it a habit to analyze these expense allocations on an annual basis.
 
The presentation of financial statements to the audit committee at the conclusion of an audit is the perfect time to ask questions related to functional expense classifications and how they, and your overall organization, are performing.
 
In today’s world of educated and proactive donors, it is incredibly important for charitable organizations to be educated on smart spending and ensuring that contributions are going towards the best use to maximize the generosity of donors.
 
Cohen & Company is not rendering legal, accounting or other professional advice. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts and circumstances.