Accounting Prof Is First to Research the Spend/Save Decision Facing Charities
Often it is encouraged that donors ask charities what percentage of every dollar spent will be used for overhead and what percentage is actually used on the cause. But how many of us ask when our donation will be spent? Would it make a difference in your giving behavior if an organization that fights world hunger delays spending your money for a number of years? According to the Princeton Survey Research Associates (2001), 63% of surveyed Americans expect charities to spend and not save the bulk of money donated.
Charities face great dilemmas in tough economies such as the one we're in. Although individuals and corporations generally don't stop giving, total donations may decline.
How does an organization that survives off of donations plan for an uncertain future and balance spending and savings to remain successful? Mason School of Business associate professor of accounting, Karen Kitching, and her colleagues are the first to provide evidence on just that dilemma.
"A critical decision charity managers make is how to allocate limited resources, such as donations," says Kitching. "In particular, charities must decide whether to spend or save revenues."
Kitching and her colleagues, Chris Jones of George Washington University, Andrea Roberts of the University of Virginia, and Pam Smith of the University of Texas, San Antonio, sampled 8,200 U.S. charities and found that, on average, the change in overall spending year to year is relatively flat compared to the change in revenues received year to year.
"This indicates that charities smooth spending," says Kitching. "When revenues increase, charities substantially increase savings. In fact, we find when revenues increase, charities, on average, use 31% of the change to increase liquid assets.
"At the same time, many charities appear to anticipate future revenue declines and intentionally save in the prior period for this purpose. We document that even for large declines in revenues, median spending barely declines."
While watchdog agencies advocate that charities save for a rainy day, guidelines are established for excessive saving. For example, the American Institute of Philanthropy (AIP) gives an automatic "F" grade to charities having greater than five years of available resources. The Better Business Bureau's (BBB) Wise Giving Alliance recommends in its best practice guidance that charities save enough to continue to operate for three months in case of an emergency, but limit savings to less than three times the size of the past year's budget.
These are important guidelines to consider. As a donor, you want to see your dollars being spent wisely for the organization, but as a manager in a charity, you must be mindful to have enough funds saved to offset any reductions in donations you may experience. Nevertheless, Kitching and her colleagues find fourteen percent of their sample charities maintain a fund balance of less than three months of prior year's spending and 32 percent have net assets that exceed three times the prior year's spending.
"Understanding the spend-save decision is also important because prior research has found that charities with high savings levels exhibit more agency problems, such as paying higher levels of executive salaries and spending less on programs and more on overhead," says Kitching.
Kitching and her colleagues also reviewed other factors affecting these decisions such as the size and direction of the revenue change, the source of the revenue change, and past savings patterns.
"We document that increases in spending are less when revenue increases are from donors—who are likely to place fewer restrictions requiring the immediate use of funds—than when funds come from the government or program service revenues. We also find smoothing behavior is more prevalent in charities with high levels of accumulated savings and less dependent on current revenues to sustain current operations."
This research is the first to provide direct evidence that charities smooth spending. The results also imply that given greater flexibility, charities will choose not to adjust spending rapidly, suggesting there are costs to altering spending levels.
"Understanding the decision to spend or save revenues provides insights into management behavior and resource allocations," says Kitching "These insights can help donors anticipate the likely use of donations and other revenues."
Kitching's research has caught the eye of the Financial Accounting Standards Board (FASB), which is actively engaged in considering how to improve on the current nonprofit financial statement model. FASB believes one of the important roles of nonprofit financials is to provide information that is useful in understanding how a nonprofit is using its resources and is interested to learn to what extent charities provide management commentary within their annual reports about their saving decisions.
"That's our next project," says Kitching.
Karen Kitching is an associate professor of accounting at George Mason University School of Business. Prior to joining Mason, Dr. Kitching served on the faculties of Georgetown University and the George Washington University, where she earned her PhD. Dr. Kitching currently teaches courses in the undergraduate, MBA, and executive education programs. She is also a member of the executive board in the government and nonprofit section of the American Accounting Association. To learn more about Professor Kitching, click here.