How Do We Rate Charities?
We rate charities by evaluating two broad areas of financial health, their organizational efficiency and their organizational capacity. We use a set of financial ratios or performance categories to rate each of these two areas, and we issue an overall rating that combines the charity's performance in both areas. Our ratings show givers how efficiently we believe a charity will use their support today, and to what extent the charities are growing their programs and services over time. We provide these ratings so that givers can make intelligent giving decisions, and so that the philanthropic community can more effectively monitor itself.
At its most general level, our rating system is relatively simple. We base our evaluations on the financial information each charity provides in its informational tax returns, or IRS Forms 990. We use that information to analyze a charity's financial performance in seven key performance categories, described below. After analyzing those performance categories, we compare the charity's performance with the performances of similar charities. We then assign the charity a converted score ranging from zero to ten in all seven performance categories, as well as three ratings for the charity's organizational efficiency, organizational capacity, and overall financial health.
A more detailed discussion of our rating system follows. For more information on the scales we use to assign ratings, please visit Our Ratings Tables.
Organizational Efficiency
Analyzing a charity's efficiency reveals how well it functions day to day. Charities that are efficient spend less money to raise more. Their fundraising efforts stay in line with the scope of the programs and services they provide. They keep administrative costs within reasonable limits. They devote the majority of their spending to the programs and services they exist to provide.
Charity Navigator analyzes four performance categories of organizational efficiency: program expenses, administrative expenses, fundraising expenses, and fundraising efficiency. For each charity, we issue a score in each of the four performance categories, as well as a rating that combines a charity's performance in all four categories.
Performance Category 1: Program Expenses
Charities exist to provide programs and services. They fulfill the expectations of givers when they allocate most of their budgets to providing programs. Charities fail givers expectations when their spending on programs is insufficient. To evaluate a charity's program expenses, we divide its program expenses by its total functional expenses. Charity Z spends $2.5 million on program expenses, compared with its overall operating budget of $3.5 million. Thus, Charity Z spends 71.4% on program expenses. We score a charity's program expenses using the conversion scale listed in Our Ratings Tables.
Performance Category 2: Administrative Expenses
As with successful organizations in any sector, effective charities must recruit, develop, and retain talented people. At the same time, they ensure that these administrative expenses remain reasonable and in line with the organization's total functional expenses. Here again, we calculate a charity's administrative expenses by comparing them to its total functional expenses. Charity Z spends $500,000 on administrative expenses, compared with $3.5 million in total functional expenses. Thus, Charity Z spends 14.3% on administrative expenses. Again, we use the scale listed in Our Ratings Tables to score a charity's administrative expenses.
Performance Category 3: Fundraising Expenses
Charities spend money to raise money, but they do not exist to raise money. Givers support charities for their programs and services, not for their ability to raise money. Charities should ensure that fundraising expenses stay in line with the charity's total functional expenses. We evaluate a charity's spending on fundraising by comparing it with the charity's overall spending. That is, we divide a charity's fundraising expenses by its total functional expenses. Charity Z, which spends $500,000 on fundraising and $3.5 million in expenses overall, spends 14.3% on fundraising. We score a charity's fundraising expenses using the corresponding conversion scales listed in Our Ratings Tables.
Performance Category 4: Fundraising Efficiency
Charities spend money to raise money. Effective charities must in part be efficient fundraisers, spending less to raise more. We calculate a charity's fundraising efficiency by determining how much it spends to generate $1 in charitable contributions. In other words, we divide a charity's fundraising expenses by the total contributions it receives as a result. For example, Charity Z, with fundraising expenses of $500,000 and total contributions of $3.4 million, has a fundraising efficiency of $0.147, which means it spends 14.7¢ to raise $1.
After calculating a charity's fundraising efficiency, we convert the results to a numerical score ranging from 0 to 10. Our conversion scales for fundraising efficiency are provided in Our Ratings Tables.
Organizational Efficiency Score Adjustments
Deficit Adjustment
While charities are not created to make a profit, they should not outspend their means. When a charity runs a combined deficit over time, we adjust its efficiency score downward. We do this by comparing its average annual deficit1 to its total functional expenses for the most recent year, and we then deduct that percentage from the charity's program expenses percentage. Charity Z, which spent 71.4% on its programs, ran a deficit of $425,000 in 2003, a $350,000 deficit in 2004, a surplus of $275,000 in 2005, and a deficit of $200,000 in 2006. Over a four-year period, it ran a combined deficit of $700,000, which averages to $175,000, or 5% of $3.5 million in total functional expenses for its most recent year. We deduct that 5% from Charity Z's program expenses score, adjusting it to 66.4%, and now use the revised program expenses to score Charity Z.
Program Expenses less than 33.3% Adjustment
If a charity spends less than a third of its budget on the programs and services it exists to provide, then we automatically give that charity a score of zero for organizational efficiency.
Organizational Capacity
We analyze a charity's capacity to determine how well it has sustained its programs and services over time, and whether it can continue to do so, even if it loses support or faces broad economic downturns. By doing so, we show givers how well that charity is positioned to pursue long-term, systemic change. Charities that show consistent growth and maintain financial stability are more likely to last for years to come. They have the financial flexibility to plan strategically and pursue long-term objectives, rather than facing flurries of fundraising to meet payrolls and other short-term financial obligations. These charities can more ambitiously address our nation's challenges, envisioning and working toward long-term solutions.
Charity Navigator analyzes three categories of organizational capacity: primary revenue growth, program expenses growth, and working capital ratio. We issue a score in each category, as well as a rating that combines a charity's performance in all three categories.
Givers should know that other independent evaluators of charities tend not to measure a charity's capacity. Indeed, charities that maintain large reserves of assets or working capital are occasionally penalized by other evaluators. In our view, a charity's capacity is just as important as its efficiency. By showing growth and stability, charities demonstrate greater fiscal responsibility, not less, for those are the charities that will continue pursuing change in the future and will generate both short- and long-term results for every dollar they receive from givers.
Performance Categories 5 and 6: Primary Revenue Growth and Program Expenses Growth
As do organizations in other sectors, charities must grow over time if they are to sustain their programs and services. For charities, growth means first, increasing their primary revenue, which includes contributions from corporations, foundations, individuals, and government grants; program service revenue, contracts and fees; and revenue from membership dues and fees. Second, growth means growing their programs and services. Organizations that demonstrate consistent annual growth in both primary revenue and program expenses are able to outpace inflation and thus sustain their programs year to year. These organizations also supply givers with confidence by maintaining broad public support for their programs.
Charity Navigator analyzes a charity's average annual growth of primary revenue and program expenses over its three to five most recent fiscal years. In the past, we limited our evaluations to only three years of data, and thus measured growth over a standard 24 month interval2 for all organizations. We did so because charities are required by federal law to make only three years of financial data publicly available.
In an attempt to refine our ratings methodology, we revised this approach in two ways. First, we expanded the standard number of years over which we evaluate an organization from three to four years, thus expanding the standard growth interval from 24 to 36 months. We believe that assessing an organization over a larger window of time offers a less volatile and more relevant picture of its capacity for sustaining its efforts in the future.
Second, we made our ratings more flexible by departing from the standard growth interval when the data makes it necessary to do so. Just like organizations in other sectors, charities engage in certain non-recurring activities that generate unsustainable spikes in their revenues. Such activities can include capital campaigns or endowment drives. Similarly, the start-up period for relatively new organizations represents an unsustainable pattern of growth. When we determine that an organization has engaged in these non-recurring and unsustainable activities in the first of the four years over which we evaluate the organization, we will expand the data we evaluate to five years. If a fifth year is unavailable, we alternatively reduce the data we evaluate to three years.
Once we determine the interval over which we will evaluate an organization, we use the standard formula for computing annualized growth: [(Yn/Y0)(1/n)]-1, where Y0 is the value measured in the first year of the interval analyzed, Yn is the value measured at the end of the interval analyzed, and n is the length of the interval in years. We then evaluate the charity using the corresponding scales listed in Our Ratings Tables.
Performance Category 7: Working Capital Ratio
Charities depend upon their reserves of liquid assets to survive downward economic trends and sustain their existing programs and services. If a charity has insufficient working capital, then it faces the difficult choice of eliminating programs or staff, amassing debts and liabilities, or dissolving. On the other hand, when giving flows, those charities that build working capital develop a greater capability for expanding and improving their programs.
We analyze a charity's working capital ratio by determining how long it could sustain its current programs without generating new revenue. To obtain this ratio, we divide the charity's working capital by its total expenses, including payments to affiliates, for the most recent fiscal year. For example, Charity Z holds $5.4 million in working capital. Its total expenses for the most recent fiscal year are $3.6 million, including a $100,000 payment to an affiliate for its national dues. Thus, it has a working capital ratio of 1.5 years. We score a charity's working capital ratio using the corresponding conversion scales listed in Our Ratings Tables.
As with each of our other six performance categories, we calculate a charity's working capital using the information supplied on the charity's most recently filed Form 990. We include in this calculation only the following assets and liabilities: cash, savings, accounts receivable, grants receivable, pledges receivable, investments in securities, accounts payable, accrued expenses, and grants payable. We acknowledge here that the accounting standards required by the IRS differ in certain fundamental respects from Generally Accepted Accounting Principles (GAAP). Due to those differences, and due to the limitations of the Form 990, our calculation of an organization's working capital may not agree with what it reports in audited financial statements. One example of this difference concerns an organization's investments in securities. We access a schedule of a charity's specific investments, where we determine the nature and term of those investments, we include all liquid investments in securities in our calculation of working capital. Although this standard differs from GAAP, we have applied this standard to all organizations consistently and therefore believe we treat all organizations fairly.
Working Capital Score Adjustment
Charity Navigator understands that after a certain point raising additional funds for the purpose of increasing working capital becomes counterproductive. As a result, we have adjusted the working capital score so that any organization with $250 million or more in working capital receives 10 points.
Assigning Scores and Ratings
After evaluating a charity in each of the seven performance categories described above, we convert the charity's raw score to a numerical score ranging between 0 and 10.
We calculate each charity's efficiency score by summing the scores it receives in our four efficiency categories. Using the table listed in Our Ratings Tables, we assign each charity a rating in organizational efficiency.
Similarly, we calculate each charity's organizational capacity score by summing the scores it receives in our three capacity categories. Using the table listed in Our Ratings Tables, we assign each charity a rating in organizational capacity.
Finally, we calculate an overall score for each charity's financial health by combining its scores in organizational efficiency and organizational capacity. We then assign the charity an overall rating by using the table listed in Our Ratings Tables.
Scoring Uniquely Functioning Causes
Charity Navigator is committed to judging all charities fairly. We work diligently to adjust our ratings to take into account the unique circumstances facing certain types of charities. Those adjustments are embedded in the way we score each performance category. Thus, the rating and score we assign each charity for organizational efficiency, organizational capacity, and overall financial health accounts for the way different kinds of charities function. Consequently, we believe our ratings and scores are fair to all charities.
How do we adjust or normalize our scores in individual performance categories for certain charity types or Causes? Before arbitrarily deciding what is acceptable in each of our performance categories, we continue to study the way non-profits function financially. We adjust our scales whenever our ongoing research gives us a compelling reason to do so. Over time, we have learned that although most kinds of charities function in financially similar ways, charities in certain Causes function in financially unique ways. Because we aim to compare apples to apples and not to oranges, we score those uniquely functioning Causes differently.
For example, due to the nature of their enterprise, food banks require very little working capital to remain sustainable; conversely, community foundations typically maintain several years worth of working capital. In the working capital ratio category, we score charities in these two Causes very differently. Similar adjustments exist for other Causes and in other performance categories. That said, we currently use adjusted scales in only 19 of the 238 separate rating scales (8.0%). Those adjustments can be analyzed in the scales listed in Our Ratings Tables.
Ratings vs. Rankings
Our ratings are not rankings. We do not identify the best performing charity in each of our performance categories. Nor do we assign ratings to charities based on where they fall in a top-to-bottom ranking, so that a charity's score in a category is equal to its rank. We believe that rating charities according to rankings would mislead givers and treat charities unfairly.
Instead of ranking charities, our ratings are qualitative designations. After analyzing how more than 5,000 charities function financially, we define qualitatively distinct ranges of financial performance. For example, with the exception of Community Foundations and Food Banks (see Our Ratings Tables for an explanation), we believe that charities which spend less than $0.10 to raise a dollar all perform in a financially exceptional way. Whether they spend $0.01 or $0.09, we score all of those charities equally assigning a score of 10 in that category.
Similarly, with the exception of charities in eleven Causes (see Our Ratings Tables), we view all charities with a working capital ratio of more than 1 year as performing in an exceptional way. We score all of those charities equally, assigning a 10 in that category, regardless of how much their working capital ratio exceeds 1 year. We simply do not recognize a qualitative difference in the charity with 1.5 years of working capital and the charity with 15 years of working capital, and we thus score them equally.
1 A charity's average annual deficit is limited to the same fiscal years over which we evaluate the organization more generally. If we evaluate an organization based on four years of data, we consider the excess or deficit for those same four years in determining its average annual deficit. If our evaluation is based on three or five years, then we calculate the charity's average annual deficit using data for the same three or five years. Please see our discussion of performance categories 5 and 6 to learn how we determine the number of years to consider in evaluating an organization.
2 This growth interval may seem confusing. When we measure growth based on three years of data, the interval only covers 24 months, from the end of the first year (e.g., 12/31/2004) to the end of the third year (e.g., 12/31/2006). The period of time elapsed between those points is only two years. Similarly, for four years of data, the growth interval is only three years (12/31/2003 to 12/31/2006).
