June 24, 2012 | Read Time: 3 minutes
Daniel Borochoff, president of CharityWatch, which grades charities on their financial performance, offers the following tips for spotting red flags when assessing a charity’s finances:
Audit notes
The notes that are attached to audited financial statements sometimes reveal things not found in the Form 990 tax document that charities are required to file, Mr. Borochoff says. They might mention that a charity has made a risky investment or relies on only a few revenue sources or is using a vendor operated by a relative of a charity executive or board member.
Charitable-program costs
When a charity fills out its Form 990, it can count a portion of the money it spends on direct mail or telemarketing as a fundraising cost and a portion as a program expense—as long as the appeal also educates people about issues related to the group’s mission. But watch out for those “joint costs,” Mr. Borochoff says. Sometimes they add up to a huge percentage of a group’s spending, with only a tiny amount going to direct services. CharityWatch gives “F” grades to the worst offenders (though is more lenient toward advocacy groups).
Unreported revenues
If a charity is promoting products or services, check to see if the sales are reported as revenues. If not, they could be benefiting an individual. Mr. Borochoff became suspicious of the Central Asia Institute, a humanitarian group that he and others criticized last year, when he noticed that its Web site was promoting two books co-authored by its founder, Greg Mortenson, as well as his speaking schedule. But he could find no evidence in the charity’s tax records that it was receiving book royalties or speaker’s fees.
Multiple entities
When a charity has financial ties to other organizations, examine how they shift money around. A charity could move money from one bank account to another and record it as a contribution, thus making its fundraising costs look lower than they are, Mr. Borochoff says. To get the full picture, look at the consolidated financial audit covering all of the groups as well as the Schedule R for “related organizations,” attached to the Form 990, he says.
Mr. Borochoff notes that some big nonprofit scandals have involved payments between entities—for example, when William Aramony, the late chief executive of the United Way of America, resigned in 1992 after it emerged he was siphoning money to a United Way subsidiary to pay for lavish personal spending.
Noncash gifts
Charities sometimes inflate the value of donated goods that they receive, allowing them to appear to be delivering more aid at a smaller cost than is accurate, Mr. Borochoff says. They are required to report only vague information about such transactions on the Form 990. He suggests giving more weight to a charity’s cash expenditures when evaluating its finances.
Vague language
Look for specifics when a charity touts its accomplishments, Mr. Borochoff says. Be wary of a group that boasts about its “illustrious history” but gives no details about what it has achieved recently. Also beware if it tallies the number of grants it has given but does not say when they were awarded.
