Why cost ratios are not the best way to assess charities

Experts such as Pesh Framjee have taken issue with the True and Fair Foundation's A Hornet's Nest report

Pesh Framjee
Pesh Framjee

There was a storm of criticism from the voluntary sector in December last year when the True and Fair Foundation published A Hornet's Nest, a report about expenditure on charitable activity. It studied the accounts of 5,543 charities with incomes greater than £500,000.

The report said that 292 charities, with a combined income of £2.4bn, spent 10 per cent or less on charitable activities; and 17 charities with incomes above £50m spent 65p in every pound or less on charitable activities, which the foundation contended was unacceptable.

Organisations including the Charity Commission, the National Council for Voluntary Organisations and Acevo said there were errors in the report and it misunderstood charity finance. More detailed repudiations came from the fact-checking charity Full Fact, Cass Business School and the accountancy firm Crowe Clark Whitehill.

The True and Fair Foundation used expenditure figures available in charity accounts under the heading "charitable activities". The 2015 statements of recommended practice for charities say such expenditure should be reported "on an activity basis" to show how a charity's resources further "its charitable aims for the public benefit".

But this heading does not necessarily give a full picture of spending on charitable purposes, and presenting it as a proportion of income can be misleading. In his response to the True and Fair Foundation, Pesh Framjee, a partner at CCW, points out that the report failed to distinguish endowments, which have to be invested, from other income, did not include amounts spent on fixed assets to take forward the charity's mission and ignored the impact of donations in kind and trading activities.

Framjee highlights how the True and Fair Foundation criticises the Lloyds Register Foundation for spending less than 1 per cent of income on charitable activity, based on the £1bn annual income of its associated multinational trading group. The LRF actually has a £19m income and spends £14m on charitable purposes.

But Framjee believes the charity sector's own tendency to use cost ratios - the proportion of each pound donated that goes to the cause - is similar to the approach taken by A Hornet's Nest and, considering the differences in how charities operate, is of limited use in comparing their spending. He also criticises the Charity Commission for using cost ratios on a new "beta" website of its charity register, which the commission has now said it will change in line with user feedback.

"We need to stop talking about good and bad expenditure and focus instead on performance," Framjee says. "Charity trustees and management, considering good practice, must decide on what works for them and should be able to explain what they have chosen to do and why they have chosen to do it, rather than be concerned that their ratios will not look good."

Caron Bradshaw, chief executive of the Charity Finance Group, says a better way to show impact is more explanation. "Charities shouldn't be scared to share the detail of what we're doing and how we're doing it"," she says.

Mark Salway, director of social finance at Cass Business School, says accounts should differentiate between what is spent, what money is spent on and what is brought in as a result. But he says the average set of charity accounts does not achieve this and needs to communicate finances in a way that people understand and relates to the charity's impact.

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