Article

Part IV

The amount and manner of competition among not-for-profits have been changing, and the stakes are getting higher (please see previous installments of this series in the archives section).

Financial, political, and bureaucratic factors have coalesced into a morass that is threatening large and small organizations alike. In short, many nonprofits are finding themselves in a position where they are expected to do more and more, with less and less. Many organizations have cut back their services. Some have ceased to exist.

Solid numbers regarding the dissolution of nonprofits are difficult to come by. The primary source of financial data in the nonprofit sector in the United States has been Form 990. However, if an organization stops filing a Form 990, one cannot assume that it was because it ceased to exist due to the aforementioned pressures. Indeed, some not-for-profits voluntarily close their doors because they have successfully achieved their missions and the need for their services no longer exists. Also, one agency might have merged under the banner of another and disappeared in name only. Furthermore, organizations might dip beneath the dollar threshold at which a Form 990 is required. These continue to function, but are beneath the radar of the federal government.

Still, the anecdotal evidence is clear. Virtually everyone in the field with whom this writer has spoken, regardless of the US State in which they operate, is employed by or knows first hand of an agency that is on the brink of extinction. These observations cross many lines of funding and mission. Even those with strong endowments have suffered (due to the "dot com bust" and a stagnant economy).

As organizations compete for the limited resources, some will survive and some will not. Which will be winners and which will lose? This paper examines some of the existing thinking on this subject, and offers some thoughts that might help develop models that will serve as predictors and warnings.

Efforts to determine which organizations are at risk for failure have been underway in the for-profit sector for many years. This type of research was essential to those who considered whether or not to invest money in a particular business. Attempts to adapt those methods to the non-profit arena lagged far behind the initiation of their use in for-profits. This is, perhaps, because the concept of "investment" in a not-for-profit is in some ways an oxymoron. That is, by definition a 501c(3) entity cannot distribute "profits" to its "investors" in the traditional sense.

This does not mean that it is unimportant to have such models for nonprofits. It just means that the recognition of the need came late, so there is much catching up to do.

Donors want to know that their contributions are not being thrown into a bottomless pit.

Those who purchase bonds issued by nonprofits need to be assured that their investment will pay off.

Government agencies and others who contract with not-for-profits need to know that the organizations can fulfill the terms of the agreements.

Prospective and current employees need to evaluate their degree of job security.

Those who make decisions within nonprofits would benefit from the guidance of accurate models as they engage in risk management. Indeed, as argued by Reiser¹, it is this writer's position that it is important for each and every member of a nonprofit to participate in the oversight role. In doing so they require an understanding of what constitutes undue risk. A sound model of the behaviors and circumstances that create threats to a nonprofit's survival can be a key component of such a comprehensive system of oversight.

So, which analytical models are reliable and useful?

An excellent paper on the matter was done by Keating, Fischer, Gordon and Greenlee². They examined the methods of Altman, Ohlson, and Tuckman & Chang in depth. Of these, "…the Ohlson model performs substantially better than the other models individually or combined…". However, "Despite its superior explanatory power, the Ohlson model actually classifies more firms incorrectly than the naïve model" which is simply a prediction that none of the organizations in the study will become distressed. In its summary, the paper reports:

"While the existing prediction models provide insight into some indicators of future financial vulnerability, they are not very effective in distinguishing the particular firms that will experience distress. Therefore, researchers and practitioners are not encouraged to use any of these models for purposes of default or bankruptcy prediction."

The Ohlson model measured such things as working capital-to-total assets, liabilities-to-current assets, net income-to-total assets, total liabilities-to-total assets, a scaled change in net income, and it also included size and cash flow variables. Ohlson designed his model for use in a for-profit setting. Therefore, Keating, et al modified some variables to make the model more relevant to the not-for-profit environment.

Next, they supplemented the variables from the models they studied with two large categories that might be related to a non-profit's viability: systematic and firm specific. Systematic refers to macroeconomic factors such as regional and industry factors. Firm-specific factors include such things as fundamental accounting based signals, earnings on investments, etc.

Keating et al then attempted to improve upon the above by adding two additional variables: reliance on commercial revenues and endowment sufficiency. They hypothesized that there was a direct relationship between these and the viability of an organization. With these additions, their measurements showed some improvement in the predictive ability of the model. But accuracy and reliability were still insufficient for use in decision-making.

In a paper prepared for a presentation at the 1998 Annual Meetings of the Association for Research on Nonprofit Organizations and Voluntary Actions, Mark A. Hager encouraged the exploration of a different approach³.

Continue to next page>>

____________________________________________

¹Dana Brakman Reiser, Enron.org - Why Sarbanes-Oxley Will Not Ensure Comprehensive Nonprofit Accountability, Brooklyn Law School Public Law and Legal Theory Research Paper Series, Research Paper No. 6; March, 2004

²Keating, Fischer, Gordon, and Greenlee, Assessing Financial Vulnerability in the Nonprofit Sector, July 2004

³Mark A. Hager, Event Structure Analysis as a Tool for understanding Organizational Life Histories, completed under sponsorship of the Nonprofit Sector Research Fund, November 1998