Study

Today, you may be subjected to yet another round of specious judgment about the management skills of nonprofit organizations. This is thanks to a newly-released report, “Financial Literacy and Knowledge in the Nonprofit Sector.”

The report is heralded by a press release entitled “Gaps in Financial Knowledge Challenge Mid-Size Nonprofits” but there is no information in the survey results or even in the report that supports the claim that the nonprofits represented have any particular or acute challenges that could not be explained by a bad economy. In fact, about half have more than four months of operating funds in the bank and about a quarter have more than seven months’ worth.

The report is regrettably issued by the Center on Philanthropy at Indiana University, which we have come to trust for its hard work on the annual Giving USA report. This particular study was supported by the Moody Foundation and, as far as we are concerned, its quality and conclusions are not only a disappointment, but pose a serious disservice to nonprofits.

We read the study and then shared it with a few advisors considered to be experts in the field of nonprofit financial management and leadership and, in the end, we all agreed that the study is full of incongruities and unfounded conclusions. It appears, in fact, that the researchers knew precious little about the terminology or practices of nonprofit financial management.

The headliner finding of the study is that “Seventy-six percent of financial managers at mid-size nonprofits said they are knowledgeable about financial principles, but only a third correctly answered all three basic financial literacy questions.” But the data this statement is based on is probably the most glaring “apples and oranges” mismatch in the study.

The study asks respondents to answer “True” or “False” to these three questions as a gauge of financial literacy:

  • If interest rates rise, bond prices will rise.
  • When an investor spreads money between 20 stocks, rather than 2, the risk of losing a lot of money increases.
  • Buying a single company’s stock usually provides a safer return than a stock mutual fund.

These three questions are matter-of-factly presented as the gold standard for assessing financial literacy with no explanation of such a choice.

In the e-mail survey, which drew 526 respondents, a smaller percentage answered the bond question correctly than the other two, men did better than women, larger organizations did better than smaller outfits, and people who took more than five courses in economics and finance did better than people who took none. But so what?

One-third of a respondent’s overall financial literacy score is based on explaining the relationship between interest rates and bond price. People in organizations with less than $1 million got the answer to this question incorrect 24 percent of the time, and responded “don’t know” 28 percent of the time. Presumably, Moody’s did not underwrite the cost of this study to persuade organizations with less than $1 million to get into the bond market.

One does not need to be able to answer the question about the economics of markets in order to create a budget, manage cash, and produce and monitor financial reports. So, for a set of organizations that will never be in the bond market, what does this result tell us? Not much.

The study then asks managers to rate themselves as novices, knowledgeable or experts in financial management principles or concepts, a subjective method which is at such variance from the exactitude of the three questions listed above that it is confounding. The readers (and perhaps the researchers) do not know how those principles and concepts are defined by the respondent. Our own definition, based on a long stint of providing professional development and graduate classes in nonprofit finance, is that the “principles and concepts” would include budgeting, financial analysis, and use of financial reports.

When the study looks at the self-reported knowledge levels in these areas, there is no knowledge gap. In fact, just the opposite:

  • 91.4 percent consider themselves to be knowledgeable or expert in financial management systems and controls.
  • 91.7 percent consider themselves to be knowledgeable or expert in cash flow projections.
  • 95.5 percent consider themselves to be knowledgeable or expert in reporting internal policies to employees.
  • 82.8 percent consider themselves to be knowledgeable and expert in financial scenario planning.

But the researchers compare respondents’ self-assessment with the answers to those three questions first referenced—questions that are only loosely connected to nonprofit financial management (and more relevant to an “Introduction to Markets and Investments” class). This is what yields the judgment of a “disconnect between nonprofit financial managers’ perceptions about their own financial knowledge and actual financial literacy (that) has potentially significant implications for managers and board members, as well as for members of the public who contribute to these organizations and place their trust in them.”

Often, the terms of reference are off the point, vague and exhibit a dearth of understanding about nonprofit finance and nonprofit management in general. For instance, a paragraph in the “Closing Thoughts” section goes on, fairly extensively, about the lack of audit committees at a majority of the organizations included in the study, citing audit committees as a measure of good governance—and in the process, exhibiting a deep lack of familiarity with nonprofit terminology and practices as they occur in organizations of different sizes. In fact, audit committees are still the exception—not the rule—for nonprofits, but that doesn’t equate to substandard governance. The survey doesn’t appear to have asked whether or not the board had a governing group that was involved with oversight of audits, 990’s and internal controls. Many nonprofits accomplish this via a finance committee or an executive committee. In other words, the function is likely there, but the use of the term “audit committee” is likely too narrow to highlight it, especially for smaller nonprofits.

Additionally, the press release asserts that “until recently, nonprofits this size often focused on just breaking even,” making nonprofits sound historically short-sighted. This is not NPQ’s experience and we could find no citation for the assertion.

“Financial Literacy and Knowledge in the Nonprofit Sector” is based on a survey of 526 nonprofit professionals at organizations with budgets ranging from $100,000 to $100 million (though apparently each subcategory of organization studied was more representative of mid-size organizations, defined by the researchers as those with annual budgets ranging from $1 million to $4.99 million). The respondents were those who are “most responsible for financial decision-making at the organization.” More than half of the sample was made up of human services organizations. The survey itself covered the map from financial management knowledge to board practices to reserves. There were no comparisons made to for-profit organizations of a similar size or to the knowledge base of their financial managers, but we would bet that nonprofits would compare very favorably to many businesses of the same size.

The most glaring problem, ultimately, is that the report and the survey on which it is based do not make a connection between the knowledge and practices of financial managers and the health and vitality of the nonprofits and their missions in the community.

It’s quite possible that a better researched and more complete report would come with this title: “Nonprofits Come through Recession with Flying Colors for Wise Financial Management under Stress.”

 

NOTE: The Center on Philanthropy at Indiana University has offered a response to this article, which NPQ has reprinted in its entirety below.

It’s encouraging to see significant interest in nonprofits’ financial knowledge. The economic downturn sparked debate on how nonprofits can build capacity to thrive in difficult times, and the Center on Philanthropy at Indiana University’s new study helps inform and advance that debate.

To date, very few if any studies have attempted to gauge the degree of nonprofit financial managers’ financial knowledge. Our study does that, and also sheds light on current practices, resources and tools. Its goal is to help mid-size nonprofits understand their financial knowledge—both strengths and weaknesses—so they can better prepare for the future.

Unfortunately, The Nonprofit Quarterly’s article misinterprets both the research and the results. Our report does not discredit financial managers’ abilities, as the article implies; rather, it highlights many strengths as well as areas for improvement.

Much of the article’s criticism focuses on three questions that compose one of the study’s financial knowledge indicators. Given the lack of prior nonprofit sector studies on this topic, it was particularly important to use well-designed, proven financial knowledge questions—questions that have been rigorously tested in other fields—to assess nonprofits’ financial knowledge. (This also allows the results to be compared to existing financial knowledge research). The questions we used come from an extensive research literature on financial knowledge, including studies of consumers, small business owners and financial decision makers.

Measuring financial knowledge is complex. These questions aren’t intended to cover all topics that nonprofit managers must know to be financially knowledgeable – but they have been shown to measure key aspects of financial knowledge that are influential for important aspects of financial management, such as managing risk and planning for the future.

Respondents scored highly on two of the three, and that is an important, positive sign. It should also be noted however, that the much lower level of accurate responses on the bond question is important too. It has direct bearing on understanding bonds and other fixed-income borrowing vehicles such as term loans, and on understanding investments. (For example, in a 2009 Grant Thornton study that asked nonprofits how they were responding to the recession, one of the most frequent responses was “rebalancing portfolios,” which requires the type of financial knowledge we tested.) The bond question result, like some others in the study, highlights an opportunity to strengthen nonprofits’ financial know-how in a key area.

Beyond these questions, to ensure the entire study’s relevance to nonprofits we convened a national advisory council of leading scholars and nonprofit consultants who work in, study and teach financial management, accounting and nonprofit management. The advisory council provided feedback on the survey design, methodology and key findings over a 12-month period. Additionally, the survey was first tested with CFOs and business managers at leading nonprofits in several subsectors in Indianapolis to obtain feedback from these hands-on nonprofit professionals about the relevance of the survey questions and the practical implications of the study’s design.

Why is understanding nonprofits’ financial knowledge valuable? Quite simply, financial knowledge has become increasingly important for making sound budgeting and investment decisions, and in planning for the future. In a more complex environment, enhancing financial knowledge within nonprofits has the potential to inform and improve decision making.

While, as the NPQ authors note, nonprofit financial managers certainly need to be able to create a budget, manage cash, and create and monitor financial reports, those are not the only pieces of financial knowledge they need to be successful. It’s surprising anyone would object to the idea that nonprofit financial leaders need the types of basic financial knowledge tested. Along with other researchers, nationally recognized nonprofit management scholar Roger Lohmann has maintained that financial knowledge is an important part of nonprofits’ ability to fulfill their vital missions and serve their communities.

Of course, financial knowledge is just one of many factors that influence nonprofits’ financial outcomes, along with the organization’s environment, the economy, board leadership and many others. Still, it is a key factor—investment and borrowing knowledge and decision making and other aspects of financial knowledge allow nonprofits to survive and thrive in difficult times.

Financial knowledge and financial management measures matter for nonprofits. We encourage more research and more discussion on financial knowledge within the nonprofit sector. This study provides a solid baseline for that debate.

Una Osili

Director of Research

The Center on Philanthropy at Indiana University