MinistryWatch 5 Star Rating System
Introduction to Ratings
Looking at Nonprofits and For Profits
The Ratings Framework
The Efficiency Score
The Model
An Illustration
THE MODEL
The 5 Star Financial Efficiency Ratings system computes an organization's overall financial efficiency as a composite of four separate efficiency measures each corresponding to one of the four fundamental financial decisions made by management. Each of the four efficiency ratings is calculated by subtracting a risk score (based on the financial ratio that measures risk) from a return score (based on the financial ratio that measures return). The relationship between the fundamental financial decisions, the basic elements of organizations, and the risk and return measures used is summarized in the following table:
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Fundamental Financial Decision
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Element in Focus
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Risk Measure
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Return Measure
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Fund
Acquisition
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Donated
Inputs
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Fundraising
Cost Ratio
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Contributions
Reliance Ratio
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Output
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Spending
Ratio
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Program
Output Ratio
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Asset
Leverage
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Throughput
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Liabilities
Ratio
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Operating
Expense Ratio
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Liquidity
Maintenance
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Current Liabilities Ratio
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Supplemental Revenue Ratio
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Efficiency
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All
elements
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Combines risk and return
for each category
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5 Star Financial Efficiency Ratings are computed in the following manner:
- For each fundamental financial decision, calculate the risk ratio and the return ratio for all organizations in a sector (a sector consists of at least 10 organizations with similar mission and/or organizational structure).
- Compute the sector average for the risk ratio and the return ratio.
- Calculate a risk score and a return score for each organization using the following formula:
Organization Ratio / Sector Average Ratio
- For each organization, subtract the risk score from the return score to get an efficiency score.
- For each organization, calculate the percent rank (percentile) of an organization's efficiency score relative to the efficiency scores of its peers.
- Assign an individual financial decision efficiency rating of one to five stars to the organization based on the following distribution:
00.0% - 10.0% 1 Star
10.1% - 32.5% 2
Stars
32.6% -
67.5% 3 Stars
67.6% -
90.0% 4 Stars
90.1% -
100.0% 5 Stars
To compute the overall 5 Star Rating of an organization, perform the following additional steps:
- For each organization, calculate the simple average of the four individual percent ranks (one for each of the four financial decision efficiency ratings) to get an overall efficiency average.
- For each organization, calculate the percent rank of an organization's overall efficiency average relative to the average efficiency averages of its peers.
- Assign a 5 Star Rating of one to five stars based on the distribution used above for the individual financial decision efficiency ratings.
Principles upon which the rating system is based
The 5 Star Financial Efficiency Ratings system was designed as a research tool that would help meet donors' need for good information. This system meets its intended need only insofar as it adheres to ten important principles of good research. Donors alone will ultimately be the judges of its usefulness. These ten principles and their practical definition are as follows:
- Simple - Ratios are easy to calculate
- Intuitive - System is easy to understand
- Value-added - Results improve upon the information currently available
- Objective - Measurements are quantitative and unbiased
- Meaningful - Results condense a large amount of info into an easily interpreted summary
- Useful - Results are easily incorporated into the decision-making process
- Relevant - Results address issues that donors are interested in
- Robust - System is applicable to a large number of nonprofit organizations
- Replicable - Users are able to calculate results themselves using publicly available data.
- Transparent - Explanations of how the results were obtained are provided with results
A final note about ratings systems
It is important to note that Wall Watchers does not consider the 5 Star Financial Efficiency Ratings system to be the final word on nonprofit financial analysis. In fact, it is only the beginning. Wall Watchers believes that as information about nonprofits becomes increasingly available and as the tools for conveying and analyzing that information (e.g. the Internet) become increasingly sophisticated, new ratings models will be produced which look at nonprofits in different ways. The users of these models (primarily donors) will ultimately choose to use the model or models that are most consistent not only with their own information needs, but also with their own ideas about how nonprofits should be utilizing their resources.
Furthermore, the creation of competing ratings models is only part of the evolving nonprofit information marketplace that will ultimately provide for a more efficient allocation of resources and make nonprofits more responsive to donors. An examination of the for-profit capital markets, complete with their investment advisors, ratings organizations, regulatory bodies, and online transaction brokers, provides a good picture of how an information marketplace can facilitate this kind of efficiency. Wall Watchers' ultimate goal with the creation of the 5 Star Financial Efficiency Ratings system is not only to empower donors with a useful tool to help them with their decision-making today, but also to help spur the discussion and innovation that will transform the nonprofit information marketplace of tomorrow.
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