Liam Kay: The reality of ratios

Cost ratios are a terrible way to judge charities, but a better alternative is urgently needed

Liam Kay
Liam Kay

News that The Mail on Sunday is believed to be working on an article using cost ratios to criticise charities will have caused concern and dismay across the voluntary sector.

Broad-brush statistics are rarely a great indicator of performance in any sector, and charities are not the only victims.

Sadly, terms such as "spending on charitable activities" in charity accounts almost invite simplistic comparisons to be made.

But the fact is that cost ratios are simply not a good measure of a charity’s performance.

Despite this, their use in the media to criticise charities’ spending is not new.

In 2015 and 2016, the True and Fair Foundation, a charity set up by the philanthropist and prominent anti-Brexit campaigner Gina Miller, published reports criticising the amount of charitable money that went to the front line.

The reports were widely criticised at the time by umbrella bodies, charities, academics and charity accountants, but attracted front-page coverage in The Daily Telegraph newspaper.

Pesh Framjee, head of not-for-profit at the accountancy firm Crowe, subsequently published his own critique of one of Miller’s reports, which severely cautioned about the use of cost ratios as a measure of a charity’s performance.

That critique highlighted several problems with the rather rudimentary conclusions Miller’s report was drawing, such as failing to include spending on fixed assets in charitable expenditure, ignoring the impact of trading activities and failing to take account of donations in kind.

Various organisations pointed out that investment in increasing income revenue left charities with more money for their cause areas than if they had passively waited for funding to arrive from the public.

Another problem with this approach is that the charity sector is incredibly diverse. It is so difficult to make comparisons between organisations that not only support disparate causes, but also have radically different ways of operating and generating income.

Can an adequate comparison really be made between the cost ratios of a research-driven cancer charity, an international aid charity, a London museum and a drug and alcohol charity working in deprived communities? Between charities dependent on trading income and those that rely on fundraising?

The evidence suggests that cost ratios fall far short.

The back office

But the idea that back-office functions are unimportant or a distraction from the charity’s cause is mistaken.

Effective administration can enable more beneficiaries to be reached, more aid to be delivered, greater numbers of people to gain access to an institution and more people to receive vital treatments.

Spending on staff and buildings is not wasted money if that means an improvement in service delivery.

Cost ratios reinforce the idea that having good finance and HR systems in place are signs of a charity’s weakness, rather than ones of a well-run organisation that has the potential to have a greater impact with its work.

It is telling that Kids Company spent 93 per cent of its money on the cause, as opposed to the back office, before its collapse more than three-and-a-half years ago.

With the past 12 months having been dominated by news of charities’ safeguarding failures, it is also worth pointing out that the same safeguarding functions that were criticised as being underfunded are also part of charities’ back office.

Increased regulation, good financial management, staff security and HR all fall under back-office spending, yet there are few who would argue these areas should not be financed by charities.

But the use of cost ratios as an indicator of charity effectiveness would consign these vital functions to secondary status in the running of a charity, to be pared down at the expense of the front-line work they support.

How to respond?

It is not surprising that the public might want to make comparisons between charities when deciding who to give their hard-earned money to.

But solutions seem to be in short supply, with little agreement on any universal way of making comparisons between charities.

So how should the sector respond?

Jay Kennedy, director of policy at the Directory of Social Change, says charities must find better ways of demonstrating their effectiveness and the difference they make to their beneficiaries.

He says this should avoid "silly ratios that divide apples by oranges to calculate bananas" and needs to be "holistic and thought through".

This means relying on context as well as the numbers in the accounts, and for charities to consider the language they use in explaining to their supporters how they operate.

The British Heart Foundation, for example, tells its supporters that 75p in every £1 goes towards its work combating heart disease.

The rest "was invested to generate our income", the BHF says – a phrase that recognises the importance of the back office and demonstrates that the vast majority of funds go to the front line.

Making changes

Changing language on a charity’s website is easy, but making those changes to the wording within a charity’s financial statements requires a conversation with the Charity Commission and with the accounting bodies that dictate what has to be covered in a charity’s accounts.

It is perhaps something charities should bear in mind when responding to the ongoing consultation on the Statement of Recommended Practice. The commission is also in the middle of a three-year programme to review the charities register, and has included a statement on its Beta website that asks readers to read the ratios included in conjunction with the charity’s financial statements.

Cost ratios are a terrible way to evaluate charities. But the lack of an adequate alternative to them as a means of comparing charities will continue to undermine efforts to educate people on how charities work.

There has to be a proper discussion within the sector about what information is needed to allow the public to evaluate performance and impact.

Until that takes place, you can expect to see more media stories using cost ratios.

Liam Kay is a senior reporter at Third Sector

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