595722

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NVSXXX10.1177/0899764015595722Nonprofit and Voluntary Sector QuarterlyPrentice

Article
Nonprofit and Voluntary Sector Quarterly
1­–26
Why So Many Measures © The Author(s) 2015
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DOI: 10.1177/0899764015595722
Performance? Analyzing nvsq.sagepub.com

and Improving the Use

of Financial Measures in
Nonprofit Research

Christopher R. Prentice1

Abstract
Financial measures provide an empirical basis from which nonprofit researchers and
practicing managers can approximate organizational capacity, financial health, and
performance. These measures are used in nonprofit research to predict organizational
activities and funding opportunities. Yet, little empirical evidence exists to tell us
what these measures assess and whether they capture underlying concepts in the
way we assume. Using Internal Revenue Service (IRS) Form 990 data, this article
explores the following research question: Can accounting measures be organized into
theoretically intuitive and empirically defensible constructs? To answer this question,
a literature review of nonprofit financial health studies and textbooks was conducted,
and dimension reduction techniques were employed. The findings suggest that the
answer to the research question is not as simple as expected, and we should exercise
more caution in how we use financial measures in nonprofit research.

Keywords
nonprofit financial performance, accounting ratios, financial measures

Introduction
Scholars generally agree that nonprofit financial performance is evaluated through a
careful examination of multiple factors, such as liquidity, solvency, margin, and

1University of North Carolina Wilmington, NC, USA

Corresponding Author:
Christopher R. Prentice, University of North Carolina Wilmington, 601 S. College Road, Wilmington,
NC 28403-5607, USA.
Email: prenticecr@uncw.edu

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2 Nonprofit and Voluntary Sector Quarterly 

profitability. These constructs illustrate how much cash a nonprofit has on hand, how
much debt the nonprofit has accrued, how efficient the nonprofit is in the use of its
resources, and how stable the nonprofit is over time. This financial knowledge empow-
ers nonprofit managers to create operating budgets, monitor organizational finances,
measure progress toward predetermined financial targets, and establish financial
reserves sufficient to sustain future operations.
To capture liquidity, solvency, margin, and profitability, nonprofit managers and
researchers use various indicators (e.g., days of cash on hand as a liquidity indicator),
and nonprofit financial management textbooks recommend multiple measures for
each construct. For example, Weikart, Chen, and Sermier (2013) offer three liquidity
measures: the current ratio, the working capital ratio, and the quick ratio. McLaughlin
(2009) and Coe (2011) offer similar liquidity measures and add to the list days’ receiv-
ables and days of cash on hand, respectively. Zietlow, Hankin, and Seidner (2007)
expand the list of liquidity measures and add the cash ratio, the cash reserve ratio, and
the asset ratio. According to Weikart et al. (2013), “Each of these ratios can be used to
determine the extent to which a nonprofit need not worry about its cash flow” (p. 136).
The proliferation of measures raises the questions of why there are so many measures
offered to capture the same construct, and whether for purposes of practice or analysis
each liquidity measure is as suitable as the next.
The basis for the numerous and varied measures is not fully rationalized in the lit-
erature, but the implicit assumption in offering multiple measures is that these con-
structs (liquidity, solvency, margin, and profitability), and financial performance more
generally, are complex and cannot be captured by single measures. McLaughlin (2009)
hints at the need for multiple measures when he states that the current ratio “is actually
a rather crude measure” (p. 76). He goes on to say that “groups needing a more fine-
tuned measure of liquidity” (McLaughlin, 2009, p. 76) should try the quick ratio.
Zietlow et al. (2007) elaborate on the purpose for multiple liquidity measures when
they propose that each ratio “gives a slightly different perspective on the spendable
funds of the organization” (p. 213).
If each ratio provides a different perspective, then multiple measures should be
evaluated in concert with one another to garner a full picture of each construct.
However, this nuance is lost on nonprofit researchers who consistently fail to use
these measures in conjunction with one another, and instead employ the measures
singularly and interchangeably, implicitly assuming that one measure of liquidity is
as good as the next. Two problems arise from this practice. First, construct validity
is undermined when complex constructs, such as liquidity, solvency, margin, and
profitability, are reduced to a single measure. If these constructs are multidimen-
sional, then choosing a single measure as an indicator presents only a partial picture.
Second, because scholars choose, calculate, and employ these measures differently,
nonprofit researchers are failing to test similar constructs, and thus are not contribut-
ing to cumulative research.
This article examines empirically whether financial measures converge and to what
degree these measures are indicators of theoretically intuitive underlying constructs. I

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Prentice 3

Financial
Performance

Liquidity Solvency Margin Profitability

Months of Working Capital / Total Net Assetss Total Assets- Net Income / Net Income / Total Revenue-
Markup
Spending Total Assets / Total Revenue Total Liabilities Total Revenue Total Assets Total Expenses

Figure 1.  Financial performance: Constructs and sample of related indicators.

present the findings from these analyses in two parts: In the first part of the article I
briefly discuss nonprofit financial performance; map our conceptual understanding of
liquidity, solvency, margin, and profitability; and offer an examination of the measures
used in the academic literature to capture these constructs. Then, I investigate the
dimensionality of the constructs and present the results of dimension reduction analy-
ses performed on several measures. The findings demonstrate the disjunction between
the conception of these constructs in the literature and the methods nonprofit research-
ers employ to capture them empirically. Because of this counterintuitive finding, I turn
to another analysis and consider the field more generally.
Thus, in the second part of the article I shift the focus from the four constructs dis-
cussed earlier to a broader analysis of financial measures used in nonprofit research.
After a brief summary of the literature that uncovers 70 financial measures, I present
the results of several statistical tests aimed at deriving a data-driven classification of
the measures. The findings illustrate the uniqueness of these measures and call atten-
tion to the need for nonprofit researchers to exert greater discrimination in the selec-
tion and calculation of financial measures.

Accounting Concepts and Corresponding Measures in

Studies of Financial Health
Nonprofit financial management textbooks suggest monitoring various measures con-
sidered indicators of liquidity, solvency, margin, and profitability, to assess nonprofit
financial performance (Figure 1). This conception is mirrored in nonprofit research,
where multiple studies apply financial ratios as representative indicators of the four
accounting constructs. However, while the textbooks imply that the financial measures
are individual and complementary, the academic literature habitually treats the mea-
sures as redundant and interchangeable. This part of the article reviews nonprofit
financial health studies to identify the most commonly cited indicators of the four
constructs, then examines the relationship among the indicators, and between the indi-
cators and underlying accounting concepts.

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4 Nonprofit and Voluntary Sector Quarterly 

Tuckman and Chang (1991) developed measures for identifying vulnerable non-
profits and in so doing began a line of inquiry that focused attention on the importance
of nonprofit financial health. Subsequent studies (Greenlee & Trussel, 2000; Hager,
2001; Hodge & Piccolo, 2005; Keating, Fischer, Gordon, & Greenlee, 2005; Trussel,
2002) built on their work and incorporated elements of models used in for-profit bank-
ruptcy prediction literature (Altman, 1968; Ohlson, 1980) to produce probabilities of
nonprofit financial vulnerability. The list of predictors generally includes three catego-
ries of variables—accounting variables (e.g., net income divided by total assets), rev-
enue variables (e.g., revenue diversification), and efficiency variables (e.g.,
administrative expenses divided by total expenses)—with accounting variables repre-
senting a large majority.
As illustrated above, accounting variables are intended to represent broader con-
cepts, such as solvency and profitability. Like the measures total assets and total
expenses used to capture organizational size in the literature (Ashley & Faulk, 2010;
McGinnis Johnson, 2013), accounting measures such as net income divided by total
revenue and working capital divided by total assets are employed to capture account-
ing constructs (Keating et al., 2005). Four common accounting constructs are fre-
quently referenced in the literature: liquidity, solvency, margin, and profitability. For
each construct, common financial measures are assumed to measure the construct.

Nonprofit Assets
Unlike for-profit organizations, nonprofit organizations are prohibited due to the non-
distribution constraint from allocating profits to officers of the organization or stake-
holders, and any profit accumulation must remain within the nonprofit (Hansmann,
1980). In the nonprofit sector, “Net assets do not represent cash balances of the orga-
nization; rather, net assets represent a claim of ownership on assets owned by the
organization. Net assets represent those assets reinvested within the NPO rather than
used up” (Calabrese, 2011a, p. 3).
Generally Accepted Accounting Principles (GAAP) require nonprofits to classify
total net assets into three categories: unrestricted net assets, temporarily restricted net
assets, and permanently restricted net assets (Calabrese, 2011a; Financial Accounting
Standards Board [FASB], 1993). However, with the exception of recent studies on
endowments and capital structures (Bowman, 2011a; Bowman, Tuckman, & Young,
2012; Calabrese, 2011a, 2011b), net assets have been lumped together as a singular
category. Unrestricted net assets more closely approximate the actual amount of equity
a nonprofit organization may spend in times of financial distress or use as collateral for
borrowing (Calabrese, 2011b). According to Calabrese (2011a), existing theory sug-
gests that net assets are desirable not only for long-term financing (labeled solvency
here) but also for short-term financing (labeled liquidity here). The reasoning is because
total net assets represent the nonprofit organization’s equity regardless of donor-
imposed restrictions, whereas unrestricted net assets represent the cash balances that
can be used by nonprofit managers to reinvest in the organization to overcome short-
term financial shocks.

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Prentice 5

Solvency
Solvency is measured in nonprofit financial vulnerability literature in three ways: total
net assets divided by total revenue (Tuckman & Chang, 1991), total net assets divided
by total assets (Bowman, 2011a; Keating et al., 2005), and total assets less total liabili-
ties (analogous to Keating et al.’s, 2005, insolvency risk variable). Given the consis-
tency with which these measures are labeled solvency in nonprofit research, I test
whether they capture an underlying solvency construct.

Liquidity
Liquidity “consists of cash or financial resources without donor restrictions, which can
be efficiently converted into cash quickly” (Bowman, 2011b, p. 179) and is the cash
available to continue the organization’s operations in the short run. Two common indi-
cators are used to assess liquidity. The first is working capital divided by total assets
(Greenlee & Tuckman, 2007; Keating et al., 2005); working capital refers to the differ-
ence between current assets and both current liabilities and temporarily restricted net
assets. The second is months of spending (Bowman, 2011a, 2011b), which is “the
number of months an organization could survive after losing all current income and
maintaining its spending on operations at a constant level” (Bowman, 2011b, p. 179).
Months of spending incorporates unrestricted net assets in the numerator, so that only
immediately available funds without donor restriction are considered. I test these
liquidity measures to see if they represent an underlying liquidity construct.

Profitability
Profitability shows how much the organization nets after accounting for expenses and
generally conveys the long-term sustainability of the nonprofit organization. Two vari-
ables representing profitability are common to accounting-based nonprofit research:
net income divided by total assets (Bowman, 2002, 2011a; Keating et al., 2005) and
revenues less expenses (Bowman et al., 2012; Keating et al., 2005). I examine whether
these financial measures, consistent with the assumptions that they represent a firm’s
profitability, converge and capture an underlying profitability construct in the data.

Margin
Margin refers to the efficiency of earnings and represents a nonprofit’s short-term sustain-
ability. The commonly used measure for margin is net income divided by total revenue
(Chabotar, 1989; Coe, 2011; Greenlee & Trussel, 2000; Greenlee & Tuckman, 2007;
Hager, 2001; Hodge & Piccolo, 2005; Keating & Frumkin, 2001; Keating et al., 2005;
Ryan & Irvine, 2012; Trussel, Greenlee, & Brady, 2002; Tuckman & Chang, 1991).
Bowman (2011a) proposes the measure “markup” and contends that it is superior to mar-
gin for use in the nonprofit sector. Markup is “an organization’s annual surplus expressed
as a percentage of spending on operations” (Bowman, 2011b, p. 179). Analogous to the

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6 Nonprofit and Voluntary Sector Quarterly 

Table 1.  Proportion of Sample Meeting Conditions for Selection.

Sample selection n % yes

Total sample size 1,388,480 100
Public charity 1,376,137 99.1
Individual return 1,385,597 99.8
Long form 1,104,666 79.6
Accrual accounting 699,408 50.4
Statement of Financial Accounting Standards 117 1,084,112 78.1
Active: Total expenses > depreciation + interest paid 1,378,447 99.3
Active: Total assets > 0 1,332,137 95.9
No obvious data errors (negative liabilities, negative 1,055,536 76.0
expenses, no program expenses)
Federal Information Processing Standards code 1,383,598 99.6
U.S. states and District of Columbia 1,387,288 99.9
All 549,688 39.6
Fiscal Year 2003 subset 100,788 —

assumptions for the solvency, liquidity, and profitability constructs, I test whether the
margin measures converge to represent an underlying margin construct.
The habitual use of individual measures to represent constructs such as liquidity,
solvency, margin, and profitability in the nonprofit management literature implies
that these constructs are unidimensional. Based on this literature review, I test the
underlying dimensions represented by these measures. If the unidimensionality
assumption is warranted, then the nine measures should coalesce to form the four
accounting constructs discussed above.

Data
Data for this research are the digitized data files from the National Center for Charitable
Statistics (NCCS), which contain Internal Revenue Service (IRS) Form 990 informa-
tion for all filing 501(c)(3) organizations from 1998 to 2003.1 The data were cleaned
following the recommendations of Bowman et al. (2012) and Calabrese (2011b). The
steps taken and the proportion of the sample meeting each criterion are enumerated in
Table 1. To overcome dependencies in the data (i.e., organizations with multiple years
of 990 data in the digitized data files), only 2003 data are selected, resulting in a
sample size of 100,788.

Dimension Reduction—Nine Common Accounting

Measures
If liquidity, solvency, margin, and profitability are unidimensional constructs, then the
nine accounting measures should each load exclusively on the one dimension for
which the literature proposes that it is an indicator. In this section, several factor

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Prentice 7

analyses are performed to examine the relationship of these variables to one another
and to discern the underlying dimensions they represent.

Factor Analysis
An exploratory factor analysis (EFA), using principal component extraction and a
Varimax rotation, was conducted on the cleaned data set consisting of the accounting
measures to determine how well the proposed constructs fit the unidimensional
assumption. The proposed constructs and the nine accounting measures are summa-
rized in the first column in Table 2. Inferring from the use of these measures in the
academic literature, we should expect to see the nine measures load unidimensionally
on their respective components: The first three measures in Table 2 should load on
Component 1, the next two measures on Component 2, the following two measures on
Component 3, and the final two measures on Component 4.
The results of the principal component analysis in Table 2 diverge from this expec-
tation, however. For the nine measures, the principal component analysis returned five
components with an eigenvalue greater than 1.0 (the conventional criterion for deter-
mining dimensionality), rather than the expected four components. Furthermore, the
variables do not load as the literature suggests. The results demonstrate that none of
the measures converge to form underlying dimensions as assumed. For example, the
first three items in Table 2 should load together (as stated above), yet they load on
three separate components.
The items loading on Component 1 both have total revenues in the denominator, so
it is possible revenues are driving this dimension. But one would expect income and
assets to load similarly, and net income divided by total revenue loads positively on
Component 1, while total net assets divided by total revenue loads negatively. Similar
to Component 1, Component 4 items both have total assets in the denominator, per-
haps overwhelming the long-term focus of total net assets and the short-term focus of
working capital. Component 3 items, total assets minus total liabilities and total reve-
nue minus total expenses, are both long-term measures; and Component 2 items,
months of spending and markup, are both short-term measures. It is unclear why net
income divided by total assets loads independently on Component 5 and does not load
with the other measures that have total assets in the denominator (Component 4).

Subsector Analysis
Given the likelihood that subsectors with typically large endowments (e.g., higher
education, hospitals) fundamentally differ from those subsectors with smaller endow-
ments (e.g., human services, religion), a principal component analysis was conducted
on each subsector.2 Even after the subsector effect was removed, the variables contin-
ued to load similarly—which is to say not as the literature suggests. The factor analytic
results conducted on each subsector mirror those in Table 2. While the results across
subsectors show some small variation, subsector has a negligible effect on the dimen-
sionality among the accounting ratios.

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8 Nonprofit and Voluntary Sector Quarterly 

Table 2.  Component Matrix—All Subsectors.

Component
Constructs and corresponding
accounting measures 1 2 3 4 5
Solvency
  Total net assets / total revenue −.945 .002 .004 .001 .000
  Total net assets / total assets −.001 .000 .004 .744 .017
  Total assets − total liabilities −.007 .000 .841 −.002 −.001
Profitability
  Net income / total assets .000 .000 .000 .002 .997
  Total revenue − total expenses .010 .001 .841 .003 .001
Liquidity
  Working capital / total assets .001 .000 −.003 .744 −.015
  Months of spending −.002 .893 .000 .000 .000
Margin
  Net income / total revenue .945 .002 .007 .001 .000
 Markup .001 .893 .000 .000 .000

Note. Extraction method: principal component analysis. Rotation method: Varimax with Kaiser
Normalization.

Index Construction
To test the feasibility of creating an index for each of the accounting constructs (liquid-
ity, solvency, margin, and profitability), a reliability analysis was conducted. The
items composing each construct had extremely low Cronbach’s alpha scores and intra-
class correlations (all scores were at or near 0), implying that the indicators proposed
in the literature should not be combined to create indexes.

Correlation Analysis
To examine the relationships among the nine measures further, I conducted correlation
analysis and tested for multicollinearity. The correlation matrix shows moderate cor-
relations among the variables with only one correlation above .7 and many at or near
0 (Table 3). These modest correlations suggest that each of the financial ratios is mea-
suring different things, despite similarities in their measurement (i.e., same numerator
or denominator).3 This finding challenges the literature-driven conception regarding
the interchangeability of measures.

Implications
By using single measures to capture particular underlying constructs, nonprofit
researchers are portraying accounting constructs unidimensionally. However, these
analyses demonstrate that the assumptions regarding the unidimensionality of the four

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Prentice 9

Table 3.  Correlation Matrix—All Subsectors.

1 2 3 4 5 6 7 8 9
1 Total net assets / total 1.000  
revenue
2 Total net assets / total .001 1.000  
assets
3 Total assets − total .005 .002 1.000  
liabilities
4 Net income / total .000 .004 .000 1.000  
assets
5 Total revenue − total −.003 .002 .413 .001 1.000  
expenses
6 Working capital / .000 .108 −.002 .000 .001 1.000  
total assets
7 Months of spending .004 .000 .000 .000 .000 .000 1.000  
8 Net income / total −.786 .000 .000 .000 .014 .001 .000 1.000  
revenue
9 Markup .000 .000 .000 .000 .001 .000 .595 .001 1.000

accounting constructs lack empirical support. It is likely that these measures failed to
converge into neatly prescribed constructs because the relationship among these mea-
sures is complex and the constructs they represent are multidimensional. This interpre-
tation would support the guidance offered in nonprofit financial management textbooks
that indicators should be evaluated in conjunction with one another.
In sum, these findings suggest that nonprofit researchers should exert more caution
in the discussion and application of these accounting constructs. Construct validity is
undermined when researchers employ measures singularly to represent multidimen-
sional concepts. These findings also raise broader concerns regarding the use of finan-
cial measures in nonprofit research. To explore the implications stemming from these
findings, I broaden the scope of the analysis and conduct additional empirical exami-
nation. Hence, the second part of this article extends the analysis from the four account-
ing constructs to examine the measurement and use of financial measures in nonprofit
literature more generally. Results from the second part of this article demonstrate that
in addition to viewing accounting constructs multidimensionally, researchers should
avoid using financial measures interchangeably.

Financial Measures in Nonprofit Literature

Researchers employ financial measures to stratify their sample (Dumont, 2013), mea-
sure financial performance (Newton, 2013) and organizational performance (Brown,
2005), and predict organizational activities and funding opportunities. Researchers
have used financial measures to predict grantee selection (McGinnis Johnson, 2013),
grant amount (Ashley & Faulk, 2010), advocacy activities (Garrow & Hasenfeld,

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10 Nonprofit and Voluntary Sector Quarterly 

2014), innovations (Jaskyte, 2013), charitable donations (Tinkelman & Mankaney, 2007;
Trussel & Parsons, 2008), individual donations through social media (W. Saxton,
2013), fundraising performance (Scherhag & Boenigk, 2013), executive compensa-
tion (Sedatole, Swaney, Yetman, & Yetman, 2013), governance quality (Newton,
2013), internal accountability (Ryan & Irvine, 2012), adoption of web-based account-
ability practices (G. Saxton & Guo, 2011), compliance with financial reporting stan-
dards (Verbruggen, Chistiaens, & Milis, 2011), and the propensity and intensity of
nonprofit collaboration with local government (McIndoe, 2013).
Financial ratios are used as quantitative surrogates for hard to measure concepts.
For instance, organizational size is a common predictor or control variable in the lit-
erature, and measures of organizational size are used as proxies for capacity. However,
few authors explain why they choose to operationalize size as they do. The studies
cited above variably estimate organizational size as total revenue, total expenses, or
total assets—with some authors adding log or natural log transformation. Researchers
make two assumptions by using organizational size as a proxy for capacity and
employing various measures to estimate organizational size: First, organizational size
empirically captures capacity (financial or otherwise), and second, various measures
of organizational size are empirically equivalent.
The use of financial measures to represent concepts is prevalent, but little attention
is given to what these measures capture and the relationship among them. The result is
a body of nonprofit literature that is overrun with financial measures operationalized
in a variety of ways that are intended to represent a few concepts. This section reviews
the use of financial ratios in the nonprofit finance literature and seeks to organize these
ratios into theoretically intuitive and empirically defensible categories.

Literature Review
The findings from the factor analysis conducted on the nine commonly used account-
ing measures in the first part of this article expose two problems with the traditional
conception of accounting concepts and by extension nonprofit researchers’ and man-
agers’ use of financial measures. First, the assumption that accounting measures are
singular indicators of underlying concepts is accepted a priori knowledge, but this
assumption is not empirically supported. The second problem is the vagueness with
which the literature has defined these accounting constructs and the imprecision with
which various accounting measures have been employed as proxies for these con-
structs. This imprecision has led to studies that refer to solvency or profitability singu-
larly, while measuring them in a multitude of ways. For example, solvency is variably
measured as current assets divided by current liabilities (Zietlow, 2012), change in
unrestricted net assets, change in total net assets, net operating revenue (Bowman,
2011b), total debt service divided by total revenues (Finkler, Purtell, Calabrese, &
Smith, 2013), and total liabilities divided by total assets (Keating et al., 2005; Ohlson,
1980; Weikart et al., 2013).
In the following paragraphs, I present a review of financial measures in nonprofit
literature and look for areas of convergence among the measures that may lead to a

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Prentice 11

better conceptual understanding of what these measures represent. A comprehensive

literature review of dozens of nonprofit financial health articles and six nonprofit
financial management textbooks published over the last two decades resulted in the
identification of 154 financial measures. Once the 154 measures were standardized
(i.e., put in a common language), 70 unique measures remained.
An example of standardization is illustrated in the calculation of the measure, days
cash on hand. Some authors only incorporated cash in the numerator, whereas others
included cash equivalents such as marketable securities. Similarly, while some formu-
las used total expenses in the denominator, others looked at operating expenses and
accounted for depreciation. Thus, the formula for days cash on hand was standardized
as follows:
cash + cash equivalents
.
( total operating expenses − depreciation ) / 365
On the basis of the literature review, I attempted to organize the 70 measures into
theoretically intuitive constructs. Relying predominantly on the authors’ descriptions,
I placed the measures into categories. For example, working capital divided by total
assets was classified as a liquidity ratio, net income divided by total revenue was des-
ignated a margin ratio, and so on. However, it quickly became evident that in addition
to several measures falling into each theoretical construct, some of the same measures
were variously attributed to different constructs. In other words, the analysis not only
suggested multiple solvency measures as expected, but it also showed that some of the
same measures were labeled solvency by one author and liquidity by another. For
instance, Zietlow (2012) categorizes the measure current assets divided by current
liabilities as solvency, while many others (Coe, 2011; Greenlee & Tuckman, 2007;
Keating & Frumkin, 2001; McLaughlin, 2009; Ryan & Irvine, 2012; Weikart et al.,
2013; Zietlow et al., 2007) label the measure liquidity.
Two additional examples illustrate the point further. First, net income divided by
total revenue is variably referred to as margin (Coe, 2011; Hager, 2001; Hodge &
Piccolo, 2005; Keating et al., 2005; Trussel et al., 2002; Tuckman & Chang, 1991),
operating margin (Greenlee & Trussel, 2000), net operating results (Chabotar, 1989),
stability (Trussel & Parsons, 2008), sustainability (Ryan & Irvine, 2012), and profit-
ability (Keating & Frumkin, 2001; McLaughlin, 2009; Zeller, Stanko, & Cleverley,
1996). Second, total liabilities divided by total assets is variably referred to as sol-
vency (Keating et al., 2005; Ohlson, 1980), long-term solvency (Weikart et al., 2013),
equity (Hodge & Piccolo, 2005; Trussel, 2002; Trussel et al., 2002), flexibility (Carroll
& Stater, 2009), leverage (Bacon, 1992; Bowman, 2002; Calabrese, 2011b; Keating &
Frumkin, 2001), debt (Ryan & Irvine, 2012), and uncategorized (Ashley & Faulk,
2010; Greenlee & Tuckman, 2007; Zietlow et al., 2007).
This variability, both in the measurement of the financial measures and in the theo-
retical constructs the measures are purported to represent, illustrates the need for clari-
fication. Hence, the rest of this article is dedicated to pursuing conceptual clarity. In
the following section, the 70 financial measures identified in the literature review are
explored via factor analysis.

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12 Nonprofit and Voluntary Sector Quarterly 

Dimension Reduction—All Accounting Measures

Given the shortcomings of the traditional conceptualization of financial measures, this
section applies inductive reasoning to explore the viability of establishing underlying
constructs from a purely data-driven perspective. Multiple exploratory factor analyses
were performed to uncover latent constructs, and once again, the results affirm the
disjunction between our conceptual understanding of the accounting measures and
empirical data.

Factor Analysis—All 70 Variables

A factor analysis with principal component extraction and a Varimax rotation was
performed on all 70 variables (listed in the Appendix). The output yielded 22 compo-
nents with an eigenvalue greater than 1.0. The number of components precludes any
meaningful interpretation; therefore, attempts were made to reduce the number of
components using decision criteria other than the standard Kaiser Criterion. An exami-
nation of the scree plot suggested, conservatively, 22 components, and if one were
bold in interpreting the “elbow,” 21 components. Cattell’s scree plot test introduces
researcher subjectivity; because it did not improve interpretation in this instance, addi-
tional criteria were explored. Several studies suggest that the Kaiser criterion is among
the least accurate methods for selecting the number of components to retain, with stud-
ies suggesting that the Kaiser criterion consistently overestimates the number of major
components (Costello & Osborne, 2005; Lance, Butts, & Michels, 2006; Rummel,
1970; Velicer & Jackson, 1990). These same studies universally agree that Horn’s
parallel analysis (PA) criterion is much more promising and yields more accurate num-
bers of components. PA is a Monte Carlo–based simulation method that selects com-
ponents after comparing the factor analyzed data with a matrix of data sets with
random numbers representing the same number of cases and variables (Garson, 2012).
The components greater than randomly generated components, based on a specified
threshold, are chosen. To reduce the number of components and ensure selectivity in
the approximation of components, 100 parallel data sets were run with a 99% signifi-
cance level. Despite this rigorous analysis, the PA criterion yielded 21 components.
The high number of components coupled with extensive cross-loadings, despite a
Varimax rotation (which, as an orthogonal rotation, should increase interpretability
and reduce cross-loadings by restricting correlation between the components), frus-
trates interpretation. In an effort to yield more interpretable and theoretically intuitive
results, three decision criteria were applied to the data to reduce the number of compo-
nents. The criteria were applied cumulatively. Those steps are detailed in the following
sections.

Decision Criterion 1—Correlation

Factor analysis uncovers the latent constructs or dimensions underlying a set of vari-
ables by reducing the attribute space among them. Therefore, while not mathematically

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Prentice 13

required, moderate to high correlations among the variables are assumed; otherwise,
the analysis will yield as many components as variables. This assumption is why many
researchers require correlations greater than .30 to include a variable in the analysis
(Garson, 2012).
The first decision criterion applied to the data was the requirement that each vari-
able must have a correlation of .30 or greater with at least one other variable in the
analysis. If a variable did not have a correlation greater than or equal to .30, it was
removed. This decision criterion led to the removal of seven variables.
A principal component analysis with a Varimax rotation was performed on the
remaining 63 variables, and once again the results were not interpretable. The
Kaiser criterion yielded 21 components, the scree plot suggested 20 components,
and a PA (on 100 parallel data sets with a 99% significance level) resulted in 20
components.

Decision Criterion 2—Communality

A variable’s communality, h2,

is the squared multiple correlation for the indicator variable as a dependent variable using
the factors as predictors. Communality measures the percent of variance in a given
variable explained by all the factors jointly and may be interpreted as the ‘reliability’ of
the indicator. (Garson, 2012, p. 36)

Therefore, variables with a low communality (i.e., a small percent of the variable’s
variance is jointly explained by the components) can drive up the number of
components.
The next step then was to remove the measures with a low communality.
Considerable discretion exists regarding what constitutes a low communality, with
some authors suggesting .25 (Garson, 2012) and others suggesting .40 (Rummel,
1970). Given the large number of measures and the desire to substantively reduce the
number of components to a manageable (and interpretable) number, two cutoffs were
employed. First, I removed measures with communality less than .50. A review of the
data showed that all variables had communality greater than or equal to .50, hence a
second more rigorous cutoff of .70 was implemented, which led to the removal of
eight measures.
A principal component analysis with a Varimax rotation was performed on the
remaining 55 variables. As in the foregoing analyses, the results defied interpretation.
The Kaiser criterion yielded 18 components, and the scree plot and PA each recom-
mended 17 components.

Decision Criterion 3—Multicollinearity

While factor analysis relies on moderate to high intercorrelations to reduce variables
to fewer underlying constructs (dimensions), multicollinearity “increases the

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14 Nonprofit and Voluntary Sector Quarterly 

Table 4.  Number of Components by Decision Criterion.

Number of components

All Correlation Communality No

  measures ≥ .30 ≥ .70 multicollinearity
Number of variables 70 63 55 38
Method for determining components
  Kaiser criterion 22 21 18 16
  Scree plot 21 20 17 14
  Parallel analysis 21 20 17 15

standard error of factor loadings, making them less reliable and thereby making
more difficult the process of inferring labels for factors” (Garson, 2012, p. 54).
Therefore, some researchers advocate the elimination of collinear variables (Garson,
2012).
The decision criteria were applied cumulatively. Thus, the 55 remaining variables
were regressed on asset disruption (a common dependent variable in financial vulner-
ability studies) and collinearity statistics were generated. Of the 55 variables, 30 sug-
gested evidence of multicollinearity. Therefore, additional variables would need to be
removed. Removing all 30 measures with evidence of multicollinearity would deci-
mate the sample, so criteria were applied to remove multicollinearity while retaining
as many measures as possible.
This step involved identifying all correlations greater than or equal to .90 and
observing the explanatory power of each variable in predicting asset disruption
(employing explanatory power as a criterion was deemed preferable to the indiscrimi-
nate removal of variables), then removing those variables with high multicollinearity
and low explanatory power. This process was conducted until the collinearity statistics
showed all remaining variables were within the acceptable ranges (tolerance > .20 and
variance inflation factor [VIF] < 5; Garson, 2014). This process resulted in the removal
of 17 additional variables.
The final factor analysis was performed on the remaining 38 measures. Despite
employing all three decision criteria, the results yielded no improvement in interpret-
ability. With “only” 38 measures, the number of recommended components remained
high, and cross-loadings were common for the majority of the measures. Table 4 pro-
vides a summary of the results from the exploratory factor analyses performed after
each decision criterion was applied.

Implications
This research set out to explore whether financial measures can be organized into
theoretically intuitive and empirically defensible constructs. The findings from the
first part of this article suggest that accounting constructs are multidimensional, and

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Prentice 15

nonprofit researchers should consider using multiple measures to capture them. The
findings from the second part of this article demonstrate the difficulty in organizing
empirically dissimilar measures into fewer underlying dimensions, and call attention
to the hazards for research and practice of employing financial measures
interchangeably.

Discussion
Nonprofit scholars agree that liquidity, solvency, margin, and profitability are central
to financial performance and can be observed through several representative financial
measures. However, the literature is inconsistent with regard to what the measures
assess and is unclear on which measures should be employed to capture each con-
struct. Although nonprofit financial management textbooks appear to suggest that
accounting constructs are multidimensional, these exhortations lack empirical sup-
port. Hence, nonprofit managers and researchers are left to choose the appropriate
measures, and without clear guidance, they may choose on the basis of available data,
expediency, or model fit. The result of this variability is a collection of studies sus-
ceptible to attributing more generalizability and salience to their findings than per-
haps warranted.
The conceptual and empirical disjuncture demonstrated in this article yields three
potential interpretations. First, theory is ahead of data. It is possible that our assump-
tions regarding the representativeness of financial measures are correct, but our mea-
surement capacity and available data are falling short. Form 990 data have several
documented weaknesses, including completeness and accuracy of the data, represen-
tativeness of the sample to the population of nonprofits, and misclassification of rev-
enues and expenses. Furthermore, Form 990 data do not distinguish between restricted
and unrestricted cash balances, or specify the purposes for which revenue is raised
(e.g., operating vs. capital campaign). Therefore, organizations could appear liquid,
when in reality their funds are restricted, or organizations could appear to be profitable
when in fact they are deficit spending.4
Second, financial measures may defy classification in nonprofit data. It is con-
ceivable that theoretical coherence is spurious because the measures are representa-
tive of different concepts of interest, and pursuing a theoretically intuitive and
empirically defensible taxonomy of accounting measures is fruitless, even
counterproductive.
The third and most likely interpretation from the results is that the dimension reduc-
tion techniques failed to reduce measures to neat constructs because the constructs are
multidimensional. Correlations among the variables did not uncover conceptually
meaningful relationships, but that does not mean the measures fail as indicators.
Consider organizational performance, which can be evaluated on the basis of pro-
grammatic effectiveness (e.g., number of clients served; Carman, 2009) or organiza-
tional efficiency (e.g., level of input required to generate outputs; Tinkelman &

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16 Nonprofit and Voluntary Sector Quarterly 

Donabedian, 2007). There is no indication that these measures would load on the same
factor, yet both are indicators of organizational performance.5

Conclusion
Despite the prevalence of financial measures in nonprofit literature, scant empirical
research has assessed the dimensionality of these measures in nonprofit data. This gap
in the literature is surprising given the possible implications. If we cannot empirically
substantiate the widely held assumptions regarding financial measures and what they
represent, then we must question our approach to research and our prescriptions for
nonprofit practitioners. Are nonprofit studies that make use of financial measures
building on one another or are they, by using different financial measures to capture
the same concepts, testing different things?
This study did not set out to determine the “correct” liquidity, solvency, margin,
and profitability measures. Rather, this article intended to examine the use of finan-
cial measures in nonprofit research. This analysis takes an important first step in
demonstrating that financial measures are not interchangeable and accounting con-
structs are multidimensional. Future studies should build on the work started here
and reevaluate the conceptual link between constructs and their proposed financial
measures.
The implications from these findings extend well beyond the relatively small pool
of researchers engaged in nonprofit financial research. Nonprofit scholars as well as
practicing managers focusing on volunteerism, cross-sector collaboration, marketing,
and numerous other areas of nonprofit inquiry employ financial measures and trust
that the measures represent an organization’s liquidity, solvency, margin, and profit-
ability. This research illustrates the potential hazards associated with employing
empirically dissimilar financial measures interchangeably and using single measures
to represent important concepts.
Hence, I conclude with three recommendations. First, nonprofit researchers
should focus more attention on construct validity by making financial measures the
element of interest, not concepts such as solvency, margin, profitability, or liquidity.
More caution should be paid to uniformity in the application of accounting ratios in
the literature. Otherwise, researchers are failing to engage in the same conversation,
and we may be failing to build a foundation of knowledge. Second, where a con-
struct is the element of interest, researchers should consider employing multiple
measures for capturing it. One method would be to identify interrelated measures via
dimension reduction or another appropriate technique and combine them into indi-
ces or component scores. Employing multiple measures could present a more multi-
faceted and nuanced picture. Finally, researchers should conduct sensitivity and
robustness tests using different ratios for underlying financial concepts to improve
validity. Regardless of the indicator selected, this analysis calls for more attention to
the choice of financial measures, as well as the interpretation and consequences of
that choice.

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 Appendix
Accounting Measures—Standardized Formulas and 2003 IRS Form 990 Calculation.
Description of Construct
formula in the referenced in the
literature Formula calculation literature Form 990 calculation
Days’ receivables (Accounts receivable × 365) / total operating Liquidity (Line 47cB × 365) / Line 1d + 2 + 3 + 11
revenue
Equity ratio (Total net assets − endowment assets) / (total Long-term capacity (Line 73B − 55aB − 55bB - 56B) / (Line 59B
assets − endowment assets) − 55aB − 55bB - 56B)
Markup 100% × (Change in unrestricted net assets + Short-term 100% × [(Line 67B − 67A) + Line 42A / Line
depreciation / total operating expenses) sustainability 44A − 42A]
Liquidity 12 × (Current assets − [current liabilities + Liquidity 12 × [((Line 45B + 46B + 47cB + 48cB +
temporarily restricted net assets]) / (total 49B + 52B + 53B) − ((Line 60B + 61B) +
assets − depreciation) Line 68B)) / Line 59B − 42A]
Months of spending 12 × (Current assets − [current liabilities + Liquidity 12 × [((Line 45B + 46B + 47cB + 48cB +
temporarily restricted net assets]) / (total 49B + 52B + 53B) − ((Line 60B + 61B) +
expenses − depreciation) Line 68B)) / Line 17 − 42A]
Months of spending 12 × (Unrestricted net assets − [equity in Short-term capacity 12 × [Line 67B − (Line 55cB + 57cB − 64aB
property, plant, and equipment − tax exempt − 64bB) / Line 44A − 42A]
debt and mortgages]) / (total operating
expenses)
Average age of plant Accumulated depreciation/depreciation Fixed asset age Line 55b / Line 42A

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Days’ cash on hand Cash + cash equivalents / ([total operating Liquidity, working Line 45B + (Line 46B + 54B) / ((Line 44A
expenses – depreciation] / 365) capital efficiency − 42A) / 365)
Cash ratio Cash + cash equivalents / current liabilities Liquidity Line 45B + (Line 46B + 54B) / (Line 60B +
61B)
Modified cash ratio Cash + cash equivalents / total assets Liquidity Line 45B + (Line 46B + 54B) / Line 59B

17
(continued)
 18
Appendix (continued)
Description of Construct
formula in the referenced in the
literature Formula calculation literature Form 990 calculation
Cash reserve ratio Cash + cash equivalents / total expenses Liquidity Line 45B + (Line 46B + 54B) / Line 17
Defense interval Cash + cash equivalents + accounts receivable — Line 45B + (Line 46B + 54B) + Line 47cB /
/ average daily operating expenses ((Line 44A − 42A) / 365)
Quick ratio Cash + cash equivalents + accounts receivable Liquidity Line 45B + (Line 46B + 54B) + Line 47cB /
/ current liabilities (Line 60B + … + 64aB)
Total surplus Change in total net assets Surplus, solvency Line 73B − 73A
Return on assets Change in total net assets / total assets Profitability (Line 73B − 73A) / Line 59B
Return on net assets, Change in total net assets / total net assets Return on equity Line 73B − 73A / Line 73B
growth rate in
equity
Net income ratio Change in total net assets / total operating — Line 73B − 73A / Line 1d + 2 + 3 + 11
revenue
Unrestricted surplus Change in unrestricted net assets Surplus, solvency Line 67B − 67A
Profitability Change in unrestricted net assets / total assets Profitability (Line 67B − 67A) / Line 59B
Profit margin Change in unrestricted net assets / total — (Line 67B − 67A) / Line 12
revenue
Liquidity Current assets − (current liabilities + Liquidity ((Line 45B + 46B + 47cB + 48cB + 49B +
temporarily restricted net assets) / total 52B + 53B) − ((Line 60B + 61B) + Line
assets 68B)) / Line 59B

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Net working capital Current assets − current liabilities Liquidity (Line 45B + 46B + 47cB + 48cB + 49B +
52B + 53B) − (Line 60B + 61B)
— Current assets − current liabilities / total — ((Line 45B + 46B + 47cB + 48cB + 49B +
assets 52B + 53B) − (Line 60B + 61B)) / Line 59B

(continued)
 Appendix (continued)
Description of Construct
formula in the referenced in the
literature Formula calculation literature Form 990 calculation
Primary reserve ratio Current assets − current liabilities / total — ((Line 45B + 46B + 47cB + 48cB + 49B +
expenses 52B + 53B) − (Line 60B + 61B)) / Line 17
Quick ratio Current assets − inventories / current Liquidity ((Line 45B + 46B + 47cB + 48cB + 49B +
liabilities 52B + 53B) − Line 52B) / (Line 60B + 61B)
Current ratio Current assets / current liabilities Liquidity, working (Line 45B + 46B + 47cB + 48cB + 49B +
capital efficiency 52B + 53B) / (Line 60B + 61B)
Asset ratio Current assets / total assets Liquidity (Line 45B + 46B + 47cB + 48cB + 49B +
52B + 53B) / Line 59B
Average payment Current liabilities / ([total operating expenses Fixed asset age (Line 60B + 61B) / ((Line 44A − 42A) / 365)
period − depreciation] / 365)
— Current liabilities / current assets Liquidity (Line 60B + 61B) / (Line 45B + 46B + 47cB
+ 48cB + 49B + 52B + 53B)
Depreciation rate Depreciation / gross fixed assets Fixed asset age Line 42A / Line 57a
Asset productivity Earnings before interest / total assets — Line 12 − 4 − 5 / Line 59B
Fixed asset ratio, Gross fixed assets / total assets — Line 57a / Line 59B
financial distress
costs
Endowment Prospectively endowed: If liquid investments Surplus If (Line 54B + Line 56B) ≥ Line 17 then 1,
(i.e., securities, not buildings) are greater otherwise 0

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than or equal to total expenses than 1,
otherwise 0
Return on Investment income / invested financial assets Profitability Line 4 + 5 + 6c + 7 + 8d / Line 45B + 46B +
investments 54B + 55cB + 56B

(continued)

19
 20
Appendix (continued)
Description of Construct
formula in the referenced in the
literature Formula calculation literature Form 990 calculation
Surplus margin, net Net income Surplus Line 18
surplus
Return on assets Net income / total assets Profitability, long- Line 18 / Line 59B
term sustainability
Savings indicator, Net income / total expenses — Line 18 / Line 17
savings ratio
Return on equity Net income / total net assets Equity Line 18 / Line 73B
Operating margin Net income / total operating revenue Margin Line 18 / (Line 1d + 2 + 3 + 11)
ratio
Total margin, net Net income / total revenue Profitability, Line 18 / Line 12
operating results, stability, margin,
surplus margin sustainability
Cash flow to total Net income + depreciation / current liabilities — Line 18 + Line 42A / (Line 60B + 61B) +
debt + mortgages Line 64bB
Cash flow to total Net income + depreciation / total liabilities Capital Line 18 + 42A / Line 66B
debt
Times interest earned Net income + interest expense / interest Debt coverage Line 18 + Line 41A / Line 41A
expense
Nonoperating gains Net nonoperating gains / total revenue Liquidity (Line 4 + 5 + 6c + 7 + 8d + 9c + 10c) / Line

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12
Operating surplus Net operating income Solvency (Line 1d + 2 + 3 + 11) − (Line 44A − 42A)
Debt coverage ratio Net operating income / tax exempt debt + — (Line 1d + 2 + 3 + 11) − (Line 44A − 42A) /
mortgages Line 64aB + 64bB
Return on assets Net operating income / total assets − Long-term (Line 1d + 2 + 3 + 11) − (Line 44A − 42A) /
endowment assets sustainability (Line 59B − 55cB − 56B)

(continued)
 Appendix (continued)
Description of Construct
formula in the referenced in the
literature Formula calculation literature Form 990 calculation
Operating margin Net operating income / total operating Profitability (Line 1d + 2 + 3 + 11) − (Line 44A − 42A) /
revenue (Line 1d + 2 + 3 + 11)
Net operating ratio Net operating income / total revenue — (Line 1d + 2 + 3 + 11) − (Line 44A − 42A)
/ Line 12
Operating margin Net operating income + depreciation / total Profitability (Line 1d + 2 + 3 + 11) − (Line 44A − 42A)
revenue + Line 42A / Line 12
Debt ratio Tax exempt debt + mortgages / total assets — Line 64aB + 64bB / Line 59B
Debt burden ratio Tax exempt debt + mortgages / total expenses — Line 64aB + 64bB / Line 17
Debt-to-equity ratio Tax exempt debt + mortgages / total net — Line 64aB + 64bB / Line 73B
assets
Debt service ratio Tax exempt debt + mortgages / total operating Debt structure Line 64aB + 64bB / Line 1d + 2 + 3 + 11
revenue
Debt service burden Tax exempt debt + mortgages / total revenue Solvency Line 64aB + 64bB / Line 12
Asset growth Total assets (boy) / total assets (boy) — Line 59B / Line 59A
Fixed asset financing Total liabilities / net fixed assets Capital structure Line 66B / Line 57cB
Debt ratio, leverage, Total liabilities / total assets Flexibility, solvency, Line 66B / Line 59B
gearing ratio equity, debt
Debt-to-equity ratio Total liabilities / total net assets Capital structure, Line 66B / Line 73B
long-term

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solvency, long-
term risk
Equity balance Total net assets Equity Line 73B
Liquidity funds Total net assets − permanently restricted — Line 73B − Line 69B − (Line 55cB + 57cB
indicator net assets − equity in property, plant, and − 64aB − 64bB) / Line 17
equipment / total expenses

21
(continued)
 22
Appendix (continued)
Description of Construct
formula in the referenced in the
literature Formula calculation literature Form 990 calculation
Equity financing Total net assets / total assets Capital structure, Line 73B / Line 59B
profitability, long-
term capacity
Net asset reserve Total net assets / total expenses — Line 73B / Line 17
ratio
Adequacy of equity, Total net assets / total revenue Stability, flexibility, Line 73B / Line 12
total margin, equity profitability, equity
ratio
Growth potential Total revenue − (change in total assets + net — Line 12 − ((Line 59B − 59A) + Line 18)
income)
Current asset Total revenue / current assets Working capital Line 12 / (Line 45B + … + 53B)
turnover efficiency
Fixed asset turnover Total revenue / net fixed assets Fixed asset Line 12 / Line 57cB
efficiency
Total asset turnover, Total revenue / total assets Fixed asset Line 12 / Line 59B
capital-turnover efficiency
ratio, return ratio
— Total revenue / total expenses Fiscal performance Line 12 / Line 17
Leverage ratio Unrestricted net assets / total liabilities — Line 67B / Line 66B

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Note. The table presents the 70 formulas identified during the literature review. In addition to the formula calculation and Form 990 calculation, commonly
employed descriptors of the formulas and their corresponding constructs are included. The descriptions and constructs are culled from the literature and are
not this author’s interpretation. “—” represent formulas employed in the literature, based on this author’s review, without a description or reference to a
construct.
Prentice 23

Acknowledgment
I would like to thank the anonymous reviewers for their helpful comments on earlier drafts of
this article.

Declaration of Conflicting Interests

The author(s) declared no potential conflicts of interest with respect to the research, authorship,
and/or publication of this article.

Funding
The author(s) received no financial support for the research, authorship, and/or publication of
this article.

Notes
1. While Form 990 data have several documented weaknesses (Abramson, 1995; Froelich &
Knoepfle, 1996; Froelich, Knoepfle, & Pollak, 2000; Zietlow, 2012), National Center for
Charitable Statistics (NCCS) data are the standard for nonprofit finance research relating to
capital structures (Calabrese, 2011b), endowments (Bowman, 2002; Bowman et al., 2012),
and financial vulnerability (Calabrese, 2011a; Carroll & Stater, 2009; Greenlee & Trussel,
2000; Hager, 2001; Hodge & Piccolo, 2005; Keating, Fischer, Gordon, & Greenlee, 2005;
Trussel, 2002; Trussel, Greenlee, & Brady, 2002; Tuckman & Chang, 1991). As such, it is
the appropriate data for this analysis.
2. National Taxonomy of Exempt Entities Major 12 codes were used to capture subsector.
The 12 categories are as follows: arts, higher education, education, hospitals, environ-
ment, health, human services, international, mutual benefit, public benefit, religion, and
unknown.
3. Collinearity statistics were also generated. Despite concerns that multicollinearity is the
reason for the unexpected results of the factor analysis, tolerance for each of the nine
measures was above .20 and variance inflation factor (VIF) was below 5, the generally
accepted cutoffs (Garson, 2014).
4. Thank you to reviewer Number 1 who offered this critique of Form 990 data and presented
the implications for this analysis.
5. Thank you to reviewer Number 3 who offered this analogy and pointed out the implications
for this analysis.

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Author Biography
Christopher R. Prentice is an assistant professor in the Department of Public and International
Affairs at the University of North Carolina Wilmington, where he teaches public and nonprofit
management. His research focuses on government–nonprofit relations and nonprofit finance.

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