Organizational Health Standard #3: Financial Sustainability (Part 3 of 6)

High performing nonprofits develop careful strategies for creating consistent revenue to sustain operations. Donors do not want to support an organization one year and see its programs collapse the next year from insufficient funding.  Great organizations with bold visions and effective programs understand that sustainable revenue streams are mission-critical.

Finding out if organizations you support will sustain themselves is step 3 in our 6-step process for evaluating nonprofit performance. As a reminder, the 6 steps involve measuring charities against 30 standards for nonprofit performance arranged in the following categories: (1) Leadership, (2) Financial Management, (3) Sustainability, (4) Leverage, (5) Strategy, and (6) Impact.  We explored the first 2 categories of Leadership and Financial Management in my last two articles

Signs of Sustainable Revenue Streams

• To make sure an organization can create consistent revenue to sustain operations, ask these 5 questions:
• Does a single donor account for over 15% of annual expenses?
• Has funding increased during the last 3 years?
• Is the budget % funded by the Board greater than 1%?
• Does the Donor Retention Rate exceed the average of 55%?
• Has the number of annual donors increased in the last 3 years?

The answer to all 5 questions about sustainability would ideally be YES!  A negative response to any of these cursory questions should lead to follow-up questions with the organization’s Chief Development Officer (or CEO for smaller operations).  Why do these questions matter?  Here is what we’ve learned at Excellence in Giving over the past 10 years.

Stable Support Base: Does a single donor account for over 15% of annual expenses?

If one major donor accounts for more than 15% of annual expenses, then the organization’s operational funding is at risk.  I have evaluated charities where 86% of the annual expenses came from 3 major donors.  If 1 or 2 of those major donors cannot or do not support the organization one year, the result is a 25-50% cut in capital to spend.  I have seen it happen.  The cessation of 2 major supporters essentially invalidated the gifts from another 140 donors whose support could no longer sustain the organization’s programs.

The risk of depending on a few donors for the majority of a nonprofit’s support has a clear parallel in the commercial sector where businesses mitigate customer concentration.  Annual revenues cannot fluctuate wildly and still support consistent, quality program delivery.  A stable support base will have the majority of an organization’s funding originating from diverse, small donors.  Compassion International is a perfect example of a stable support base where 66% of annual expenses come from donors of less than $1,000 annually.

Funding Increase: Has funding increased during the last 3 years?

Increased funding does not ensure the organization is doing great work or managing its finances properly.  It only provides the confidence that the nonprofit will be here for a long time doing what they are doing.  Increased funding demonstrates that either more people are buying into the value proposition or the same people are investing bigger dollars in an organization that has impressed them. 

To be sure some nonprofits do have better marketing plans than program services.  So increased funding may speak more to the quality of the fundraising and communication departments than the substance of the programs or long-term outcomes.  It is important to remember that no individual standard of organizational health is adequate for making a judgment on the whole of the organization.  What this one measurement communicates is a history of sustainable revenue that gives confidence to donors that the organization’s work will go on.

Board Support: Is the budget % funded by the Board greater than 1%?

Nonprofit boards play a critical role.  They craft strategy and maintain fiduciary responsibilities.  Boards also raise money and invest in the organization. When a board isn’t contributing toward an organization’s mission, it raises one of two concerns.  First, the board may not have wealth and therefore a network of potential major donors to point toward the organization.  Second, the board (who has the closest view of the organization) may lack confidence in its ability to put money to work well.  Either interpretation makes me apprehensive to invest money.  Make sure organizations you support are also supported by those who know them best.

Donor Retention: Does the donor retention rate exceed the average of 55%?

If an organization loses more than half its donors from year to year, be concerned.  Although a brand new fundraiser or the PR from a headline can attract a number of one-time donors, a sustainable organization will focus on cultivating long-term relationships with supporters.  Too many nonprofits focus all their efforts on donor acquisition and not enough on donor retention.  They end up wasting time and money getting new people in the door each year while last year’s supporters slip out the back door.

In many cases, a substandard donor retention rate means the organization does a poor job of reporting their impact.  I have definitely experienced making grants to organizations that fail to communicate the results.  If you’re concerned, just ask a nonprofit leader if they have a separate line item for donor retention or reporting.  You’ll have your answer in a second if it all goes toward fundraising and donor acquisition.  If you want an organization with good reporting that doesn’t waste money on pursuing one-time donors, make sure the donor retention rate exceeds 55%, preferably even above 65%.

Growing Donor Base: Has the number of annual donors increased in the last 3 years?

If an organization expands its donor base each year, it makes the budgeting process easier and confirms that the communications and development teams are doing something right.  It gives you the confidence as a supporter that you are supporting an organization with momentum that has the potential to fulfill its mission.

Half Way There

Analyzing the above-mentioned health indicators for sustainability gets us past step 3 of the 6-step nonprofit evaluation process. The next post will explore the generally applicable standards I recommend for evaluating “leverage.”  I will define exactly what I mean by “leverage” in that post.  If you are wondering where to find the data needed for this cursory evaluation, Nonprofit Analytics provides it to subscribers in 2-page Analytical Overviews that can be acquired for any U.S.-based 501(c)3.

Remember these 6 steps and 30 standards comprise only a cursory evaluation.  It’s not the level of due diligence appropriate for major gifts.  But we do hope the simple questions related to publicly available data empower donors of all sizes and sophistication to get informed quickly and give more wisely.