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The Efficacy of Charitable Giving

by Alan Thometz
(Minneapolis, MN)

The Efficacy of Charitable Giving

Abstract

The allocation of scarce charitable dollars is important to donors and to society. This paper proposes a new approach for analyzing and comparing the costs and, more importantly, the projected benefits of not-for-profit programs. The suggested approach involves the development of a new set of accounting principles that would consider imputed income based on the cost savings to society of a successful program. It is hoped that this approach would also facilitate the larger debate of prioritizing societal needs in terms of payback.

Background

One aspect of the financial markets that contributes to the efficient allocation of capital is the requirement that public companies publish their financial statements on a periodic basis. These financial statements are prepared in accordance with generally accepted accounting principles (GAAP). Developed largely by the accounting profession, these principles are widely accepted and uniformly applied. GAAP permits investors to make informed decisions about companies and allows them to compare one company with another. Without these commonly accepted accounting principles, comparisons between companies and the efficient allocation of capital amongst companies would be very difficult.

The Problem

The challenge that donors face in making a decision to contribute to a not-for-profit is that although they are often committed to the overall goals of the organization, they frequently do not know how effectively the programs are executed or if one particular program has a larger societal payback than another. The accounting profession, which also prepares the financial statements of not-for-profits, can tell us what percentage of the dollars contributed were spent on programs, fund-raising, and administration, but these financial statements do not address the efficacy of the programs or allow donors to compare the success of one program with another. In public company terms, we have little information about the return on investment (ROI) or cost vs. benefit of the program. Ironically, it is the expected result of the program that is the donor's primary motivation for making a contribution in the first place.

To summarize, financial reporting for not-for-profits fails to address the primary needs of the donors, which may result in the misallocation of precious charitable contributions. In this time of corporate and government cutbacks, the need for efficient allocation of charitable dollars is greater than ever.

The Idea

The idea is simple---to develop a new set of accounting principles that would be widely accepted and commonly applied in the not-not-profit sector. The proposed accounting principles would focus primarily on the efficacy of the programs. These principles would permit cost/benefit comparisons with other organizations before the donor makes a charitable contribution. These new financial statements would supplement the existing financial statements of a not-for-profit.

The following example helps illustrate the point:

Assume a program that addresses the problem of homelessness is proposed. A projected number of beneficiaries are targeted. Staffing and program costs are determined and a budget is produced. The program is launched. The costs of the program are accounted for as they are incurred and compared to the original budget.

At the time the donor is considering a contribution, it would be very beneficial if the not-for-profit could answer the following questions: What is the projected benefit to society of this program if it is effective? How do we measure the existence and degree of effectiveness? How does this program?s cost vs. its benefits compare with other homelessness programs or with other programs that target, for example, children and family welfare, teen pregnancy, chronic unemployment, the environment, drug addiction, abuse or incarceration?

What is proposed is a collaboration between a major accounting firm and firms, the accounting and economic departments of a university and a major foundation. These organizations would work together to develop a new set of accounting principles that, when adopted, would be uniformly applied to the programs proposed by not-for-profits. A key element of these new accounting principles would be imputed income. The underlying theory for using imputed income is that every dollar saved by society as a result of the success of a not-for-profit?s program should be considered income to that program. For example, if it were determined that the social cost of homelessness were a certain average dollar amount per incident, then any program that prevented homelessness would be credited that amount for each instance of prevention. This ?credit? would not be actual cash, but rather a figure used by the not-for-profit to calculate the effective benefit or profitability of its program. Because not-for-profits would no longer be just cost centers, their true value and contribution to society would be evident.

Although the idea is relatively simple, its execution is not.


The Outcome

Once a common database is developed to reflect the societal costs of various social problems, donors and society as a whole could begin to answer some key questions in a new and more powerful way. Which programs produce the better outcome for society (as measured by the imputed income of the benefits received): resources spent on homelessness, chronic unemployment, abuse or drug addiction? Which programs exact the largest social cost if not addressed, or, conversely, which ones offer the largest social benefit (payback) if addressed?

Such information, although imperfect because of assumptions and projections, would facilitate the debate of social needs as well as the associated costs. The cost vs. benefits approach proposed herein would facilitate the ordering of priorities, sharpen the focus on the most critical social problems and channel the resources to those problems.

What is needed?

Founding members would be the primary drivers of this initiative.

Collaboration between accountants, economists, a major university and one or more large foundations is what is envisioned to launch and develop this new set of accounting principles. These parties, working together and voluntarily contributing their time and resources would develop the new accounting principles. Once these new principles are developed, the group would promote the use and adoption of the principles.



Alan R. Thometz
Investment Banker
Adjunct Professor of Finance
Former Peace Corps volunteer
kacet1@msn.com

June 2004

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Oct 28, 2010
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Thoughts regarding The Efficacy of Charitable Giving by Alan Thomez
by: Tom W.

Defined efficacy- capacity for producing a desired result or effect; effectiveness

I see a valuation of a program in terms of its value created (equity per person) without seeing the complexity of preparing financial statements and all of the related estimates required to prepare financial statements at the segmented program level. Say 10 performance measures can be used in a valuation to point investments to the right program and the right provider. There should be a generally accepted process of determining value much like there is in the projection of a start up or operating business value. Let us remember several examples:

A. The value of early reading skills, counting skills and understanding of positive direction delivered to increase income earning potentials and reduce cost of remediation in schools, city, county and state budgets.

B. The value of emotional and ethical assets and attributes delivered to keep one out of the homeless shelter. Outcome is one has a job that pays to do that in the private sector economy that can be replaced by many jobs in the private sector.

C. The value of a temporary job delivered without attention to assets and attributes to keep one out of the homeless shelter. Outcome is one has a job that pays to do that in the private sector economy but the individual is not likely to replace the job with another without added intervention.

Valuation issues.
1. There is an investment period defined by time, assets and attributes and cost to deliver at full absorption cost to include all functions of the provider.

2. There is a run out period defined by life after the investment and what happens in the real world.
? This has risk factors that reduce gross value to present value.
? Spending to reduce the risk factors in this run out period are not investments?
? That spending reduces the beneficial results.

3. At the end of the defined run out period the organization gets to calculate the value of the assets and attributes as a pro forma realized amount on a present value basis with risk factors and benefits proven. Actual measures of returns and risk against expected measures of returns and risk.

4. The run out period is defined by the higher risk factor where the PV of the expenditure is reasonable and expected as a statement of commitment by the provider organization. At the end of this period the valuation of the benefit per unit can be computed for the year being valued. The difference is plus or minus value against the committed PV expected value.

? Cost to make investment
? Investment is made good or bad
? Estimated benefits by year ?
? Years of benefits
? High value risk factor
? Low value risk factor
? Expected risk factor
? Actual benefits by year
? New projection of benefits
? Actual risk factor used in the valuation
A set of experts could use the above 10 issues (or more).

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