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Thursday, July 7, 2016

CN's Newest Financial Metric


As you have probably noticed, Charity Navigator recently released an updated set of metrics for measuring each charity’s financial health (called CN 2.1). The enhanced methodology was developed after years of reviewing and analyzing feedback, data, and research. Included in the updated methodology is a brand new metric, called LTA, which measures a charity’s ratio of total liabilities to total assets (the higher the ratio, the lower the charity’s score for this metric). Along with our other capacity metrics, LTA is an indicator of an organization’s solvency and long term sustainability.  

In some cases, this metric will help to highlight if donor dollars are being used to service liabilities rather than going toward the charitable mission of the organization.  Liabilities do have some constructive uses but some of them often result in long term commitments of resources. This metric is not an analysis of “good” vs. “bad” liabilities that a charity has on their books.  Per our new methodology and per the data available on Form 990, it is a measure of what the organization owes or has promised to provide in comparison to the assets it has on hand.  Some specific liabilities that a charity reports on their Form 990, such as grants payable or deferred revenue, may be in line with their charitable mission. However, these items are commitments the organization is expected to provide in the future.  And that is informative in terms of their ongoing financial health.  Regardless of the type of liability, there still may be some claim on assets as a result of the liabilities reported.

As do organizations in other sectors, charities must be mindful of the management of their total liabilities in relation to their total assets.  There are two specific recent examples of charities that did not manage this balance well and eventually had to close.  A charity called the Federated Employment Guidance Services filed for Chapter 11 bankruptcy as it was drowning in debt.  Their latest IRS Form 990 showed that they had a total liabilities to total assets ratio of 75%.  The current average for this ratio for all the charities we currently rate is 22%.  Another charity, Hull House, closed down in 2012 after incurring large debt issues. No doubt, these charities had other problems which contributed to their demise. But they also had too many liabilities on their books and not enough asset coverage.

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