The following is an excerpt from a longer article published in The Foundation Review in collaboration with GMN. You can read the full article on The Foundation Review website (PDF).
What is one of the worst kept secrets in philanthropy? Grantee budgets are fake. Grant managers and program officers spend hours each docket working with grantees to develop well-crafted budgets designed to move through the decision-making process with as few questions as possible. Why? The most common answers are that we believe the budgets tell us something about an organization and their ability to carry out the work; the budget review process helps us assess a group’s overall comfort with financial management; and financial information helps us prevent or detect fraud and misuse.
It turns out that this exercise in financial review is deeply flawed for funders and grantees alike. Project Streamline reports that under the auspices of financial due diligence, there is wide-spread dissatisfaction with the financial requests being made of grantees and the materials being provided to funders. One nonprofit stated clearly, “We keep two sets of books (or more). Because foundations often require budgets in a particular format or ask to see expenses broken down in specific ways, many nonprofit organizations keep multiple versions of their budgets. The potential for errors is heightened every time a budget is translated into a new format.”
Here is the uncomfortable truth: the budgets that we review are largely created by individuals who have learned exactly what we are looking for and tailor the budgets in their proposals directly to our needs – either our specific institution or the general practices in the philanthropic sector. In other words, the budgets are fake.
So, why are fake funder budgets something we should be concerned with? Grantee time dedicated to preparing and presenting proposals and budgets is time that is not being spent on their core mission.
The Nonprofit Finance Fund (NFF) captures this calculation in what they refer to as the “net grant” which is the total grant amount minus the costs organizations incur to manage the grant itself (e.g., reporting requirements, proposal writing, and funder updates). In other words, if an organization is applying for a $50,000 grant but it costs them $5,000 of staff time to prepare and report on the grant, then the grantee’s “net grant” is $45,000. However, we still expect them to show $50,000 worth of results. Simplifying our applications and our financial requirements are two relatively direct ways to increase the value of our grants even when we can’t increase the size of our grantmaking budgets.
Last year, the Unitarian Universalist Veatch Program at Shelter Rock completely eliminated budgets from our application requirements. We made this breakthrough thanks to the encouragement and leadership of Carol Cantwell of Fun with Financials. Carol worked closely with the Veatch Program to develop the Financial Health Indicators (FHI) tool. The FHI pulls three years’ worth of data directly from the IRS Form 990 and provides the Veatch Program with a more realistic picture of the trends in actual financial performance than a static budget ever could. The IRS Form 990 is especially helpful because all of the organizations complete the same form and the data is more consistent across diverse groups in a way in which the individual budgets are not. The Financial Health Indicators (FHI) tool allows us to see total revenue, total expense, trends in unrestricted net assets and temporarily restricted net assets and if an organization has a diverse base of financial support. The resulting FHI rating is then combined with financial questions and a discussion guide designed for the program officers.
One important side note: one of the most common arguments for why we request a multitude of financial materials is that funders believe they help to prevent misuse and fraud. Unfortunately, there is no real protection against these possibilities. Fraud and mismanagement happen and financial statements (including audits) do not protect a funder against the possibility that funds will not be used correctly or that a grantee will be the victim of fraudulent activity. One study of fraud in nonprofit organizations by Greenlee, Fischer, Gordon and Keating published in the Nonprofit and Voluntary Sector Quarterly found that external auditors found only 12 percent of the cases of fraud. Additionally, the article found that payroll and check-tampering were the most common forms of fraud in the nonprofit sector – neither of which are likely to be detected in the financial information most commonly requested by funders.
The argument to eliminate fake funder budgets is not intended to suggest we do away with financial due diligence. Rather it is an encouragement to speak more directly with our grantees about the role of financial information in their overall organizational plans and to dedicate our institutions to removing busy work and barriers from the grantmaking process. These shifts make our financial review more relevant and our total grants more valuable.