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Building Nonprofit Financial Capacity: The Impact of Revenue

Concentration and Overhead Costs
Grace L. Chikoto and Daniel Gordon Neely
Nonprofit and Voluntary Sector Quarterly published online 5 February 2013
DOI: 10.1177/0899764012474120

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What is This?
474120
ofit and Voluntary Sector QuarterlyChikoto and Neely
NVSXXX10.1177/0899764012474120Nonpr

Nonprofit and Voluntary Sector Quarterly

Building Nonprofit Financial XX(X) 1­–19

© The Author(s) 2013
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DOI: 10.1177/0899764012474120
Revenue Concentration and http://nvsq.sagepub.com

Overhead Costs

Grace L. Chikoto1 and Daniel Gordon Neely1

Abstract
Building on the impressive body of research on issues of nonprofit revenue choice and
mix, this research empirically tests Foster and Fine’s claim that revenue concentration
contributes to the growth of nonprofit organizations. Using National Center for
Charitable Statistics (NCCS) digitized data (1998-2003), the authors test whether
revenue concentration is a viable revenue-generating strategy that can help bolster a
nonprofit’s financial capacity. Overall, study findings refute the mythology of revenue
diversification; the authors find that implementing a revenue concentration strategy
generates a positive growth in one’s financial capacity—in particular, a growth in
one’s total revenue, over time. Contrary to the prevalent charges laid at the door of
high administrative and fundraising efforts by some, the authors find that in order to
support financial capacity growth, nonprofits must make positive investments in favor
of administrative and fundraising support but not in the form of high executive salaries.

Keywords
revenue concentration, financial capacity, nonprofit growth, revenue structure, over-
head, diversification

Introduction
In their inventory of the progress of research on nonprofit revenue sources and revenue
diversification, Chang and Tuckman (2010) observed that this impressive body of
research has been primarily centered on explaining revenue choices, the rewards and
1
University of Wisconsin–Milwaukee, Milwaukee, WI, USA

Corresponding Author:
Grace L. Chikoto, University of Wisconsin–Milwaukee, Mitchell Hall 225, P.O. Box 413, Milwaukee, WI
53201, USA
Email: chikoto@uwm.edu

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2 Nonprofit and Voluntary Sector Quarterly XX(X)

risks associated with revenue diversification, and the association between revenue
diversification and nonprofit financial stability. The authors’ proposed agenda for future
research continues to be directed at only one of two dimensions of financial health
(Bowman, 2011)—achieving financial stability, which is a type of organizational sur-
vival generated from reduced volatility in revenue streams (Carroll & Stater, 2009;
Tuckman & Chang, 1991; Yan, Denison, & Butler, 2009). This continued focus is no
surprise, as it reflects a widespread negligence toward the second dimension of non-
profit financial health—financial capacity (Miller, 2001, 2003), that is, the “resources
that give an organization the wherewithal to seize opportunities and react to unexpected
threats” (Bowman, 2011, p. 38). Focusing on this second dimension, this research inves-
tigates whether revenue concentration is a strategy for building financial capacity.
A lot of attention has been on the potency of the revenue diversification strategy.
This research however, examines whether the inverse of that—revenue concentration—
has some utility in bolstering nonprofits’ financial capacity, as suggested by Foster and
Fine. In their study of 144 nonprofits that had reached US$50 million in annual revenue
between 1970 and 2003, the authors attributed the growth in revenue of 110 of these
nonprofits to the organizations’ decision to “raise the bulk of their money from a single
type of funder such as corporations or governments—and not . . ., by going after
diverse sources of funding” (p. 46). Of these 110 nonprofits, 90% demonstrated reli-
ance on “a single dominant funding stream such as government, individual donations,
or corporate gifts” (Foster & Fine, 2007, p. 49), with almost 90% of the organizations’
total revenue being generated from a single dominant funding stream.
Although limited, the focus on the efficacy of the revenue concentration strategy is
not new. For instance, Gronbjerg (1992) observed that nonprofits may sometimes opt
to develop and rely on one to a few stable sources of funding in order to establish
program and funding continuity. However, to our knowledge, until Foster and Fine’s
(2007) research, no connection had been drawn between revenue concentration, as a
revenue-generating strategy, for the specific purpose of growing one’s financial capac-
ity. In fact, Foster and Fine claim that revenue concentration is the strategy of choice
if nonprofit organizations want to grow and achieve sustainability or longevity. Along
these lines, Faulk’s (2010) preliminary analysis of 3,642 U.S. nonprofit theatres also
found evidence giving some credence of the potency of revenue concentration in bol-
stering one’s financial capacity.
In addition, prior literature also finds that organizations that appear relatively inef-
ficient (i.e., a higher proportion of total spending allocated to administrative expenses,
and/or fundraising expenses, resulting in a lower program expense ratio) receive less
donor support (Greenlee & Brown, 1999; Jacobs & Marudas, 2009; Szper & Prakash,
2011; Tinkelman & Mankaney, 2007). On the other hand, administrative expenses can
provide organizations with resource flexibility necessary to take advantage of capacity-
building opportunities. In this research, we also consider whether investing in adminis-
trative and fundraising activities is associated with financial capacity building.
To this end, we rely on the 1998 to 20031 digitized data from the National Center
for Charitable Statistics (NCCS). These data were drawn from the annual Form 990
filings submitted to the Internal Revenue Service by nonprofit organizations with

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Chikoto and Neely 3

revenues exceeding US$25,000 annually. The digitized data set has the advantage of
differentiating government grants from private contributions, in addition to further
distinguishing between direct and indirect private contributions. Such nuances allow
us to construct different measures of revenue concentration. This data set also contains
additional variables that would not be found in the NCCS core files, one of which is
instrumental in the construction of one of our measures of financial capacity—total
unrestricted end-of-year fund balance (Line 67 on the IRS 990 Form). There are, how-
ever, inherent weaknesses to this data set as has been adequately documented in the
literature (see, Gordon, Greenlee, & Nitterhouse, 1999; Keating & Frumkin, 2003).

Nonprofit Financial Capacity

The current economic crisis has resulted in financial distress for social service non-
profit organizations due to declines in charitable donations and as their state and local
government clients continue to scale back in response to their own fiscal challenges
(Bridgeland & Reed, 2009). To add insult to injury, the demand for social services
continues to rise. For instance, more than 70% of nonprofits in Michigan have seen
an increase in service demand, with the state of Arizona seeing a more than 100% rise
in the number of people seeking social services between 2007 and 2008 alone
(Bridgeland & Reed, 2009). For these reasons, nonprofits are even more compelled to
reevaluate their financial capacity along with devising revenue-generating strategies
geared toward strengthening their financial capacity and, in the long term, bolster
their financial sustainability. As noted in the literature, financially vulnerable nonprof-
its are likely to cut back on their services offerings (Greenlee & Trussel, 2000;
Tuckman & Chang, 1991) or, in some cases, close altogether.
As noted earlier, financial capacity can be described as consisting of “resources
that give an organization the wherewithal to seize opportunities and react to unex-
pected threats” (Bowman, 2011, p. 38). Financial capacity has also been conceptual-
ized as organizational slack,2 a view held prevalent in the private sector (e.g., Antle &
Eppen, 1985; Bourgeois, 1981; Cyert & March, 1963). In the nonprofit context,
Bowman views organizational slack in terms of returns on or percentage change in net
assets (or total fund balance). In light of these two depictions and consistent with
Foster and Fine (2007), as well as prior literature (e.g., Saxton & Guo, 2011), we first
measure financial capacity in terms of total revenue (a measure of organizational size).
Following Bowman’s conceptualization of capacity as organizational slack, we also
include total fund balance as a measure of financial capacity. Due to the fact that fund
balances may be restricted (and thus not available as a general organization resource)
we further measure financial capacity as the total unrestricted fund balance.

The Role of Revenue Diversification

Donor preferences and priorities change, and government support waxes and wanes
(Hager, 2001). As a result, revenue diversification has been offered as a strategy for
maximizing one’s resource independence (Chang & Tuckman, 1994; Pfeffer &

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4 Nonprofit and Voluntary Sector Quarterly XX(X)

Salancik, 2003). A long-held belief is that nonprofits that reduce the volatility of their
revenue streams with revenue stability resulting from a diversified revenue portfolio
increase their organizations’ chances at survival (Carroll & Stater, 2009; Jegers, 1997;
Kingma, 1993; White, 1983; Markowitz, 1952). As a result, various theoretical mod-
els of nonprofit financial health (e.g., Chang & Tuckman, 1994; Frumklin & Keating,
2002; Greenlee & Bukovnsky, 1998; Greenlee & Trussel, 2000; Greenlee & Tuckman,
2006; Trussel, 2002; Tuckman & Chang, 1991) consider revenue diversification as
one of the key indicators of financial stability and of an organization’s agility in recov-
ering from financial shocks.
In spite of this overwhelming endorsement of revenue diversification as an effec-
tive strategy for bolstering nonprofit organizations’ stability, others also extend alter-
native explanations for having diversified revenue streams. For instance, revenue
diversification has also been positively associated with community buy-in and orga-
nizational legitimacy (Bielefeld, 1992; Galaskiewicz, 1990; Galaskiewicz &
Bielefeld, 1998), whereby nonprofits consciously seek to widely diversify their fund-
ing sources in order to establish more relationships in the community. Such social
networking signals the organization’s dependence on community support.
Furthermore, recognizing the influence of the variant nature of the services non-
profits provide, Young suggests that the extent to which a nonprofit’s revenue
streams are diversified/concentrated may actually be a function of the nature of ser-
vices it provides, that is, the types of benefits the services confer to a particular col-
lection of beneficiaries. For example, although public benefits emanate from
collective goods that exude a nonexcludability quality to them, and therefore accrue
to society in general (e.g., educated youth, an inoculated population), private bene-
fits accrue specifically to only those individual consumers who signal by their will-
ingness to pay for the services provided (see Young, 2006). As a result, particular
service fields are predisposed toward particular revenue mixes (see Fischer, Wilsker,
& Young, 2010).
Without discrediting the importance of revenue diversification or of investing in
secondary funding sources, Foster and Fine also remind us that there has to be a natural
congruence of missions and beneficiaries with the primary funding source. In addition,
concentrating one’s funding sources can also result in lower overhead costs as well as
stimulate capacity growth (Foster & Fine, 2007). Overall, this finding suggests that the
decision to diversify/concentrate one’s revenue streams can be a product of conscious
strategizing on the one hand and a product of path dependence on the other, one that is
driven by the nature of benefits (services) a nonprofit confers through its activities.

The Role of Overhead Costs

In addition to evaluating the impact of revenue concentration on nonprofit growth, we
also examine the relationship between organizational efficiency—an arena that is cur-
rently being championed by nonprofit watchdogs of the likes of Charity Navigator
and the Better Business Bureau—and financial capacity growth. Generally, nonprofit

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Chikoto and Neely 5

watchdogs view high overhead costs and nonprogrammatic expenses as indicators of

inefficiency and waste. Such inefficiencies have been linked to reductions in donor
confidence and support (Greenlee & Brown, 1999; Jacobs & Marudas, 2009;
Tinkelman & Mankaney, 2007), which in turn reduce an organization’s overall finan-
cial capacity. For instance, investing in fundraising efforts has been observed to yield
increases in financial capacity in the short run; however, when donors perceived prior
fundraising expenses to have been too high, negative lagged effects resulted (Weisbrod
& Dominguez, 1986).
Yet others contend that having access to high administrative costs provides organiza-
tions with some financial flexibility it can use as leverage in turbulent economic times
(Tuckman & Chang, 1991). However, organizational capacity is reduced when nonprof-
its limit their fundraising and administrative oversight expenses (Bowman, 2006;
Silvergleid, 2003). Furthermore, relying on more concentrated revenue bases may actu-
ally result in lower administrative and fundraising costs (e.g., Foster & Fine, 2007;
Frumkin & Keating, 2002). In a nutshell, whether overhead costs are associated with
higher or lower rates of financial capacity building remains an important empirical ques-
tion, in addition to evaluating the effects of the revenue concentration strategy.

Data and Methods

Using the NCCS digitized data from 1998 to 2003, we empirically test whether rev-
enue concentration leads to nonprofit growth (measured as financial capacity growth).
These data allow us to capture a 5-year revenue growth period. Bowman (2011) clas-
sifies a 12-month period as a short-term period, one that reflects on an organization’s
“resilience to occasional economic shocks while making progress toward meeting its
long-term objective” (p. 42). Although not explicit, a long-term period can be consid-
ered anything beyond 12 months.
To that effect, unlike Foster and Fine (2007), who focus on a much longer growth
period of 33 years (1970 to 2003) and rely on a much smaller sample (n = 144), this
research focuses on a 5-year growth period. And unlike their case study approach, we
employ ordinary least squares (OLS)3 analysis using a very rich multiple-year data set
containing a national sample of nonprofit organizations (n ranging from 50,000 to
108,000). In addition, we also employ multiple measures of financial capacity growth
(measured as 5-year percentage growths in total revenues, end-of-year total fund bal-
ances, and unrestricted end-of-year fund balances), instead of relying on merely “hav-
ing more revenue” as an indicator of nonprofit growth. Finally, we also employ
multiple measures of revenue concentration (following Calabrese, 2011; Carroll &
Stater, 2009; Yan et al., 2009).

Dependent Variables: Financial Capacity Growth

When nonprofits raise surplus revenue, they contribute to building their growth
potential for service expansion and other organizational investments (Carroll &

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6 Nonprofit and Voluntary Sector Quarterly XX(X)

Stater, 2009; James, 1983; Miller, 2001, 2003; Tuckman & Chang, 1991). Surplus
revenues provide nonprofits “the wherewithal to seize opportunities and react to
unexpected threats” (Bowman, 2011, p. 38). We therefore model financial capacity
in the following three ways:
Percentage growth in total revenue. This measure is consistent with Foster and Fine’s
and Yan et al.’s (2009) measures of nonprofit growth, measured in total revenue and
the log of total revenue, respectively. We model nonprofit growth as the log of 5-year
percentage growth in total revenues (Line 12 on the IRS 990 Form). Although total
revenue as a “metric of growth” is limited, revenue remains a “central constraint that
prevents many nonprofits from growing” (Foster & Fine, 2007, p. 49).
And consistent with Bowman’s (2011) conceptualizing nonprofit financial capacity
as organizational slack, we also model financial capacity in terms of percentage
growths in Total End-of-Year Net Assets or Fund Balances and Total End-of-Year
Unrestricted Fund Balances as follows:
Percentage growth in total fund balance or accumulated surplus. Here we calculated the
log of 5-year percentage growth in the end-of-year total fund balance (Line 73 on the
IRS 990 Form). This includes unrestricted, temporarily, and permanently restricted
funds, which, based on the 990 Form, includes excess income (Line 18), the beginning-
of-year net fund balances (Line 19), and other changes in net assets (e.g., foreign
gains, actuarial gains on annuity obligations, interest and dividends on gift annuity
investments, increases in trust held by third party).
Percentage growth in total unrestricted fund balance or accumulated surplus. The rich-
ness of our data set also allowed us to model nonprofit growth in terms of unrestricted
net assets calculated as the log of 5-year percentage growth in the end-of-year total
unrestricted fund balance (Line 67 on the IRS 990 Form). Unlike the total fund bal-
ances, unrestricted net assets or fund balances capture only the funds available to
nonprofits without restrictions (excludes restricted gifts and grants) and are within the
control of the nonprofits. Unrestricted fund balances are an important source of a non-
profit’s internal financing (Bowman, Tuckman, & Young, 2011; Calabrese, 2011).

Independent Variables
Revenue concentration. Revenue concentration (or its inverse) has also been mea-
sured in several ways. Depending on the nature of the 990 data used, researchers often
relied on three revenue streams—contributions, government grants, and program rev-
enue (e.g., Carroll & Stater, 2009), whereas others expanded the revenue streams into
four major categories—government grants, contributions, program revenue, and
investment income (e.g., Yan et al., 2009). Using the Herfindahl–Hirschman Index
(HHI),4 we therefore model revenue concentration in three ways: as measured by Car-
roll and Stater5 (HHIC-S) and by Yan et al.6 (HHIYan), and similar to Calabrese (2011),
we also include a comprehensive and finer measure7 (HHIComp) that takes advantage of
the richness of the digitized data. The HHI ranges from “0” (which denotes perfect
diversification) to “1” (which denotes perfect concentration).

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Chikoto and Neely 7

Overhead costs. We measure the resources allocated to overhead costs (i.e., organiza-
tional efficiency) in two ways, as administrative efficiency—modeled as a ratio of admin-
istrative costs to total expenses (Line 14 divided by total expenses in Line 17 on the IRS
990 Form), and as fundraising efficiency—modeled as a ratio of fundraising expenses to
total expenses (Line 15 divided by total expenses in Line 17 on the IRS 990 Form).

Control Variables
Our control variables reflect findings from previous research. In explaining nonprofit
capital structure, previous research has also controlled for executive compensation as
an important variable (Yan et al., 2009). The rationale is higher-paid executives are
likely to have more professional training (Yan et al., 2009), they may possess skill
sets, expertise, and innovative revenue-generating strategies and other ideas that can
be implemented to improve their organizations’ financial capacity. On the other hand,
similar to the negative lagged effect noted with fundraising costs (Weisbrod &
Dominguez, 1986), high executive compensation could also be viewed as wasteful
and inefficient, which may result in similar negative effects on a nonprofit’s financial
capacity. We measure executive compensation as a percentage of total expenses (Line
25a as a percentage of total expenses in Line 17 on the IRS 990 Form).
Finally, following previous research on nonprofit financial health (e.g., Carroll &
Stater, 2009; Chang & Tuckman, 1994; Faulk, 2010; Fischer et al., 2010; Greenlee &
Trussel, 2000; Hager, 2001; Keating, Fischer, Gordon, & Greenlee, 2005; Tuckman &
Chang, 1991; Yan et al., 2009), we also control for organizational demographics such
as industry type (National Taxonomy of Exempt Entities [NTEE]), location (state),
and organizational size (measured as a natural log of total revenues, total fund bal-
ance, or total unrestricted fund balance).
Table 1 below shows the descriptive statistics for the variables included in our
models. Note here that the median revenue growth over the 5-year period was rela-
tively tame (15%). The median total fund balance increased by 22% over the 5-year
period, and the median unrestricted fund balance declined by 9% for the sample. A
review of our three measures of revenue concentration reveals a consistently high
concentration of revenue on average for the sample. Our most comprehensive measure
(HHIComp) shows the lowest average concentration index (0.71), whereas the Carroll
and Stater’s (2009) measure (HHIC-S) has the highest average concentration index
(0.82). The sample also reports an average administrative expense ratio of 14%, aver-
age fundraising expense ratio of 3%, and average compensation ratio of 5%. The size
of the sample organizations is quite skewed toward larger organizations; therefore we
log the dependent variable and size controls in this analysis.

Results and Analysis

In what follows, we present our regression results for the three dependent variables:
log of 5-year total revenue growth, log of 5-year fund balance growth, and log of

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8 Nonprofit and Voluntary Sector Quarterly XX(X)

Table 1. Descriptive Statistics

Variables M Median SD Min. Max. N

Dependent variables
  5-year total revenue growth 7.61 0.15 185.28 –1 39,208 200,658
  5-year fund balance growth 115.12 0.22 14,034 –1 4,573,157 198,965
  5-year unrestricted fund 29.19 –0.09 2,893 –1 849,790 106,587
balance growth
Independent variables
  Revenue concentration (1998)
  HHIComp 0.71 0.73 0.24 0.12 1 190,948
  HHIC-S 0.82 0.91 0.19 0.33 1 200,338
  HHIYan 0.79 0.85 0.21 0.25 1 190,918
  Administrative expenses 0.14 0.07 0.20 0 21.77 199,683
ratio (1998)
  Fundraising expenses ratio 0.03 0.00 0.10 0 13.55 199,683
(1998)
  Compensation ratio (1998) 0.05 0.00 0.16 0 51.88 199,683
  Total revenue (1998) in 3.3 0.173 4.55 0 12,400 200,976
millions
  Total fund balance (1998) in 3.65 0.133 74.3 0 15,900 200,976
millions
  Total unrestricted fund 2.44 0.011 49.7 0 13,400 200,976
balance (1998) in millions

5-year unrestricted fund balance growth. Shown in Table 2 are summary regression
results for the Carroll and Stater’s (2009) measure of revenue concentration (HHIC-S);
the Yan et al.’s (2009) absolute measure of revenue concentration (HHIYan); and the
comprehensive revenue concentration index (HHIComp; see Tables 3A, 3B, and 3C in
the Appendices for detailed regression results for each of these models).
Our first key finding is consistent with Fine and Foster (2007). Table 2 shows that the
more concentrated a nonprofit’s revenue streams are, the higher its 5-year growth in total
revenue, across all three models (24%, 27%, and 51% growths, respectively). These results
are statistically significant at the 1% level, and this relationship also remains consistent and
statistically significant when we exclude hospitals from the analysis (showing 14%, 22%,
and 50% growths in total revenue over a 5-year period, respectively).
However, when financial capacity is measured in terms of restricted and unre-
stricted fund balances, the results tell a more nuanced story, across all three models
(see Table 2 and Tables 3A, 3B, and 3C in the Appendices). The regressions show
mixed results with respect to the retention of increased levels of restricted and unre-
stricted fund balances over time. However, at close observation, the levels of fund
balances retained appear to increase as the comprehensiveness of the revenue concen-
tration index increases. As the revenue concentration index becomes more concen-
trated (Table 3A to Table 3B to Table 3C) the results yield an increasingly positive

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Chikoto and Neely 9

Table 2. Summary Key Regression Results—Determinants of Growth in Nonprofit Financial

Capacity
(1) Log of 5-year total (2) Log of 5-year fund (3) Log of 5-year unrestricted
revenue growth balance growth fund balance growth

Excluding Excluding Excluding

Across all three models Full sample hospitals Full sample hospitals Full sample hospitals

HHIC-S (1998) 0.24c (0.03) 0.14c (0.03) –0.43c (0.03) –0.63c (0.03) –0.16c (0.04) –0.39c (0.05)
HHIYan (1998) 0.27c (0.03) 0.22c (0.03) –0.17c (0.03) –.034c (0.03) 0.17c (0.04) 0.03 (0.04)
HHIComp (1998) 0.51c (0.02) 0.50c (0.03) 0.17c (0.03) –0.00 (0.03) 0.37c (0.04) 0.23c (0.04)
In the HHIC-S model
  Administrative expenses 0.09c (0.02) 0.10c (0.03) 0.06c (0.03) 0.09c (0.03) 0.06b (0.03) 0.08c (0.03)
ratio (1998)
  Fundraising expenses 0.22c (0.05) 0.20c (0.07) 0.55c (0.06) 0.52c (0.07) 0.76c (0.08) 0.80c (0.10)
ratio (1998)
  Compensation expense –0.06b (0.03) –0.04c (0.02) –0.03 (0.05) –0.04 (0.05) –0.10 (0.07) –0.15c (0.08)
ratio (1998)
In the HHIYan model
  Administrative expenses 0.13c (0.02) 0.15c (0.03) 0.07c (0.03) 0.10c (0.03) 0.07b (0.03) 0.09c (0.03)
ratio (1998)
  Fundraising expenses 0.30c (0.05) 0.23c (0.08) 0.60c (0.06) 0.56c (0.07) 0.79c (0.08) 0.83c (0.10)
ratio (1998)
  Compensation expense –0.05b (0.02) –0.04b (0.02) –0.01 (0.05) –0.03 (0.05) –0.09 (0.07) –0.14a (0.08)
ratio (1998)
In the HHIComp model
  Administrative expenses 0.16c (0.02) 0.16c (0.03) 0.08c (0.03) 0.11c (0.03) 0.10c (0.03) 0.11c (0.04)
ratio (1998)
  Fundraising expenses 0.37c (0.05) 0.24c (0.09) 0.61c (0.06) 0.56c (0.07) 0.83c (0.08) 0.84c (0.10)
ratio (1998)
  Compensation expense –0.06b (0.02) –0.04b (0.02) –0.00 (0.05) –0.03 (0.05) –0.07 (0.07) –0.13a (0.08)
ratio (1998)

Note: Standard errors are in parentheses.

a
Significant at 10%.
b
Significant at 5%.
c
Significant at 1%.

change in the levels of restricted (–43%, –17%, and 17% changes) and unrestricted
fund balances (–16%, 17%, and 37% changes).
The second key finding in this research is that whereas charity watchdogs recom-
mend expending less resources on administrative support and fundraising as an indica-
tion of organizational legitimacy, our results show a positive and statistically significant
association between growth in nonprofit financial capacity (whether measures as total
revenue or restricted or unrestricted fund balances) and administrative support and
fundraising expenses. Spending more on administrative support is associated with an
expected 13% growth in total revenue over a 5-year period (15% when we exclude
hospitals) and an expected 7% growth in both restricted and unrestricted net assets
over the 5-year period.
Even in the face of alleged gross underreporting of fundraising expenses among
some nonprofits (Hager, 2003; Hager, Rooney, & Pollak, 2002), our results show that
spending more on fundraising is associated with even larger dividends for nonprofits’

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10 Nonprofit and Voluntary Sector Quarterly XX(X)

financial capacity. This result is consistent with prior research on the impact fundrais-
ing has on increasing donations (see Sloan, 2009). The coefficients ranged from an
expected 20% to 84% growth in financial capacity (statistically significant at the 1%
level), with higher dividends for unrestricted fund balances.
Although high executive salaries have been regarded as indicative of investments
in professional and highly trained personnel—an investment that could yield positive
dividends for a nonprofit organization (Yan, Denison, & Butler, 2009), our findings
suggest otherwise when it comes to building one’s financial capacity. Although the
magnitude of the change is low, these results suggest that high compensation ratios
actually limit an organization’s potential for financial capacity growth. Spending more
on executive compensation reduced nonprofits’ total revenue growth by approximately
4% to 6% and unrestricted net assets by 15%, 14%, and 13%, respectively (when we
exclude hospitals). These results are also statistically significant.
Whereas these results suggest that revenue concentration can be expected to
increase nonprofits’ financial capacity, our results also indicate that increasingly
becoming more concentrated over time may be unwise. For example, the change in the
revenue concentration index between 1998 and 2003 was negatively associated with
financial growth, and this remained consistent and statistically significant at the 1%
level across the first two models. As shown in Table 3A and Table 3B, as an organiza-
tion’s revenue streams became more concentrated over time (1998-2003), we observe
declines in total revenues, total net assets, and unrestricted net assets over the 5-year
period. This suggests that revenue concentration is more effective at generating finan-
cial growth when deployed as a one-time strategy.
However, like the previously discussed results pertaining to the revenue concentra-
tion measure, the change in the most comprehensive revenue concentration measure
model (see Table 3C) shows a positive association with revenue growth (24%). In addi-
tion, the change in revenue concentration is associated with a smaller cut to the growth
in the total net assets. Overall, the findings on revenue concentration suggest that the
more comprehensive the measure of revenue concentration, the relatively more positive
the association between revenue concentration and capacity growth. This calls for fur-
ther inquiry into the measurement and sensitivity of revenue concentration indices.
Finally, recall that this analysis is limited to a 5-year growth rate due to data con-
straints. Although many nonprofits might consider 5 years as long term in their plan-
ning, some nonprofits might have a longer- (or shorter-) term horizon. To assess
whether our results hold over different time frames, we also extracted the NCCS core
data for the years 1998 to 2008. The limitations in the core data however hampered
this sensitivity test in a number of ways. First, we were limited to one measure of rev-
enue concentration—the Carroll and Stater (2009) measure (HHIC-S). Second, we
could not control for administrative expenses, and finally, we could not assess the
growth in unrestricted fund balances.
With these caveats in mind, in running robust regressions (available upon request),
our results remained qualitatively similar (in terms of direction and statistical signifi-
cance) to those reported in Table 3A for our revenue concentration measure. The results

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Chikoto and Neely 11

also remained similar when we consider the 5-year growth period from 2003 to 2008.
And finally, replicating these regressions over a 2-year period (2001 to 2003), utilizing
the digitized data, also yielded qualitatively similar results to those reported in Table 2.

Discussion and Conclusions

The nonprofit literature exhibits overwhelming endorsement of revenue diversifica-
tion as a key strategy for achieving financial stability and reducing a nonprofit’s vul-
nerability to financial shocks (e.g., Chang & Tuckman, 1994; Frumklin & Keating,
2002; Greenlee & Bukovnsky, 1998; Greenlee & Trussel, 2000; Greenlee & Tuckman,
2006; Tuckman & Chang, 1991). However, shifting the focus to financial capacity
building, this research provides robust empirical evidence in support of the hypothesis
(see Faulk, 2010; Foster & Fine, 2007) that the inverse of revenue diversification—
revenue concentration—has some utility in advancing an organizations’ financial
capacity, apart from minimizing administrative burdens associated with revenue
diversification (Frumkin & Keating, 2002).
Overall, there are four noteworthy observations across all three of our models. First,
revenue concentration is positively associated with a growth in nonprofits’ financial
capacity, particularly when capacity is measured as total revenues. Conditioned on the
number of funding streams measured, certain caveats apply. For instance, one key pat-
tern that stands out is that the number of funding streams an organization has, and
therefore included in the measurement of the revenue concentration indices, appears to
influence the degree to which this variable effectively contributes toward growing one’s
restricted and unrestricted net assets over time. Specifically, the more comprehensive
the revenue concentration index, the larger the size of the coefficients gets. This pattern
raises questions about the sensitivity of the revenue concentration indices and their
measurement implications, on the direction and magnitude of their effects on the depen-
dent variable as well as other variables. Overall, the more comprehensive the revenue
concentration index is, the more likely it is to positively influence financial capacity
growth across all measures. Such a finding warrants further investigation.
Second, when financial capacity is measured in terms of net assets, we find mixed
results. A plausible explanation for the mixed effects of revenue concentration on the
growth of nonprofits’ restricted and unrestricted fund balances may have to do with
the meaning and symbolic value of retained earnings, as types of rainy-day funds.
The public administration and public budgeting literature has tended to view fund
balances as a type of rainy-day fund (e.g., Douglas & Gaddie, 1996; Knight &
Levinson, 1999; Pollock & Suyderhoud, 1986; Wagner & Elder, 2007). Viewed in
this light, it makes sense that revenue concentration would negatively affect nonprof-
its’ net fund balances. As is consistent with prior research (e.g., Carroll & Stater,
2009; Jegers, 1997; Kingma, 1993; White, 1983), being less concentrated increases
organizational financial stability.
Third, though not surprising with fundraising, our results are divergent from the
prevalent debate on achieving organizational efficiency by minimizing expenditures

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12 Nonprofit and Voluntary Sector Quarterly XX(X)

on administration and executive compensation. Whereas past research (e.g., Tuckman

& Chang, 1991) hailed the availability of the option to shed off administrative sup-
port as a sign of financial health, our results suggest that nonprofit organizations may
not be able to grow their financial capacity without making some investment in
administrative capacity.
And finally, others contend that in order to attract and retain the best and the bright-
est, nonprofits need to offer competitive executive salaries (e.g., Pallotta, 2008) when
trying to build their financial capacity. Our findings show that nonprofits can certainly
do without making huge resource allocations toward executive salaries. Large expen-
ditures or investments toward this line item negatively affect nonprofits’ potential for
financial growth, especially if organizations want to enlarge their total revenues and,
to some degree, grow their unrestricted net assets over time. This result is not surpris-
ing since it has been documented that organizations with a lot of slack or unrestricted
funding tend to pay their executive staff more (Bowman, Keating, & Hager, 2006).
Naturally, this can hinder an organization’s ability to retain more net assets over time.
However, this result in no way implies that professional executives do not add value to
their organizations in other qualitative ways, such as strengthening relationships with
communities, articulating the strategic vision in meaningful and practical ways, and
advancing their organizations’ missions, among other innovative contributions. And to
Pallotta’s point, the challenge remains of devising compensation levels that enable
nonprofits to attract and retain talented leaders.
Overall, for those nonprofits trying to build their financial capacity, directors and
managers should find these results informative as they consider their resource allo-
cations decisions. It is also equally important that nonprofit directors and managers
recognize the two-dimensional nature of financial health—as distinguished between
financial capacity (having more resources to further the organizational mission) and
financial stability (being able to weather any fluctuations in revenue streams in
order to continue to exist). Such an understanding will enlighten their judgment
about which revenue-generating strategies are appropriate for which of these
purposes.
Also equally important is the consideration that a nonprofit’s revenue-generating
strategy, even for financial growth purposes, may be influenced by other contextual
factors such as organizational mission and services. The application of Young’s (2006)
benefits-based theory of nonprofit finance by Fischer et al. (2010) alerts us to the fact
that a nonprofit organization’s revenue mix can be fueled in part by its mission or the
nature of the services it provides, thus minimizing its desire to concentrate its revenue
along a single funding stream.
Inferring from Young’s (2006) benefits-based theory, therefore, it can be con-
cluded that an organization’s ‘natural’ revenue mix—the revenue streams that ema-
nate as a result of the nature of the benefits conferred—and the revenue concentration
strategy addressed here do not necessarily have to be at odds. Nonprofits’ understand-
ing of the benefits their services confer, and hence, why they are able to attract par-
ticular funding sources, may serve as an important precursor. That is, having achieved

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Chikoto and Neely 13

a revenue mix that is congruent with its mission and the services it provides, a non-
profit can then adopt a revenue concentration strategy from this mix, for financial
capacity–building purposes.
However, if the desire is to enhance one’s financial stability, then a revenue diver-
sification strategy may be implemented instead. In some respects, this ties in with
Foster and Fine’s (2007) second hypothesis, first concentrating one’s resources (e.g.,
relying on government funding) and then diversifying within the limited funding
sources (e.g., by obtaining funding from different levels of government), a strategy
that is predicted to reduce the transactions costs associated with managing and account-
ing for multiple funding sources. With more nuanced data, future research should
investigate into this type of “within-source” diversification.

Appendices
Table 3A. Robust Regression Results—Determinants of Growth in Nonprofit Financial
Capacity
(1) (2) (3)

Log of 5-year
Log of 5-year total Log of 5-year fund unrestricted fund
  revenue growth balance growth balance growth

Revenue concentration (1998; 0.24b –0.43b –0.16b

HHIC-S)  (0.03) (0.03) (0.04)
Change in revenue –0.08b –0.71b –0.51b
concentration_C-S (0.03) (0.03) (0.04)
(1998-2003) 
Log of total revenue (1998) –0.31b — —
  (0.00)  
Log of fund balance (1998) — –0.48b —
  (0.00)  
Log on unrestricted fund — — –0.42b
balance (1998)  (0.00)
Administrative expenses ratio 0.09b 0.06b 0.06a
(1998)  (0.02) (0.03) (0.03)
Fundraising expenses ratio 0.22b 0.55b 0.76b
(1998)  (0.05) (0.06) (0.08)
Compensation expense ratio –0.06a –0.03 –0.10
(1998)  (0.03) (0.05) (0.07)
State Yes Yes Yes
Sector Yes Yes Yes
Observations 113,860 115,774 49,506
R2 12% 30% 25%

Note: Standard errors are in parentheses.

a
Significant at 10%.
b
Significant at 5%.
c
Significant at 1%.

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14 Nonprofit and Voluntary Sector Quarterly XX(X)

Table 3B. Robust Regression Results—Determinants of Growth in Nonprofit Financial

Capacity
(1) (2) (3)

Log of 5-year total Log of 5-year fund Log of 5-year unrestricted

  revenue growth balance growth fund balance growth

Revenue concentration (1998; 0.27b –0.17b 0.17b

HHIYan)  (0.03) (0.03) (0.04)
Change in revenue –0.24b –0.66b –0.17b
concentration_Yan (1998-2003)  (0.03) (0.03) (0.04)
Log of total revenue (1998)  –0.30b — —
(0.00)  
Log of fund balance (1998)  — –0.46b —
(0.00)  
Log on unrestricted fund — — –0.41b
balance (1998)  (0.00)
Administrative expenses ratio 0.13b 0.07b 0.07a
(1998)  (0.02) (0.03) (0.03)
Fundraising expenses ratio 0.30b 0.60b 0.79b
(1998)  (0.05) (0.06) (0.08)
Compensation expense ratio –0.05a –0.01 –0.09
(1998)  (0.02) (0.05) (0.07)
State Yes Yes Yes
Sector Yes Yes Yes
Observations 105,253 107,450 49,590
R2 12% 29% 25%

Note: Standard errors are in parentheses.

a
Significant at 10%.
b
Significant at 5%.
c
Significant at 1%..

Table 3C. Robust Regression Results—Determinants of Growth in Nonprofit Financial

Capacity
(1) (2) (3)

Log of 5-year total Log of 5-year fund Log of 5-year unrestricted

  revenue growth balance growth fund balance growth

Revenue concentration (1998; 0.51b 0.17b 0.37b

HHIComp)  (0.02) (0.03) (0.04)
Change in revenue 0.24b –0.40b 0.03
concentration_Comp (1998-2003)  (0.02) (0.03) (0.04)
Log of total revenue (1998) –0.31b — —
  (0.00)  

(continued)

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Chikoto and Neely 15

Table 3C. (continued)

(1) (2) (3)

Log of 5-year total Log of 5-year fund Log of 5-year unrestricted

  revenue growth balance growth fund balance growth

Log of fund balance (1998) — –0.45b —

  (0.00)  
Log on unrestricted fund balance — — –0.41b
(1998)  (0.00)
Administrative expenses ratio 0.16b 0.08b 0.10b
(1998)  (0.02) (0.03) (0.03)
Fundraising expenses ratio (1998) 0.37b 0.61b 0.83b
  (0.05) (0.06) (0.08)
Compensation expense ratio –0.06a –0.00 –0.07
(1998)  (0.02) (0.05) (0.07)
State Yes Yes Yes
Sector Yes Yes Yes
Observations 105,276 107,470 49,590
R2 12% 29% 25%

Note: Standard errors are in parentheses.

a
Significant at 10%.
b
Significant at 5%.
c
Significant at 1%.

Acknowledgments

We gratefully acknowledge the feedback received at the 2011 ARNOVA conference, as well as
comments from Dr. Deborah A. Carroll (UGA), and Dr. Robert Purtell (University at Albany).
In addition, we acknowledge the National Center for Charitable Statistics, which provided the
data used for this project.

Declaration of Conflicting Interests

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

Funding
The authors received no financial support for the research, authorship, and/or publication of this
article.

Notes
1. We started with the entire digitized dataset of Form 990s from 1998-2003. The data set of
1,388,480 observations encompasses the population of nonprofits filing a Form 990 during
the sample period. We then deleted negative or missing values for revenues and expenses,
dropping the total observations to 1,357,387. We then kept just one observation for each

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16 Nonprofit and Voluntary Sector Quarterly XX(X)

organization, further dropping the total observations to 248,493. This strategy was neces-
sary because our dependent variables of interest are 5-year growth rates. We further deleted
negative values of individual revenue items, which brought the total observations down to
236,202. Finally, we deleted observations with negative fund balances, and/or negative com-
pensation, leaving us with 200,976 total observations. It should be noted that the above dele-
tions were executed to ensure a more reliable data set. In addition, not only can organizations
not have negative revenues, retaining negative entries would have affected the calculation of
the Herfindahl–Hirschman Index (HHI) and of the log of the dependent variables.
2. Interestingly, Bourgeois (1981) pointed out that organizational slack plays three key roles
in an organization: as spare resources offering a cushion—when confronted with “a surge
of activity” (p. 30); “as a resource that allows for adjustments to shifts in the external envi-
ronment,” that is, “as an agent of top management initiating . . . strategic changes”; and
executing those changes (p. 31). Viewed in this light, nonprofit financial capacity—as a
type of organizational slack—also promotes organizational stability.
3. We employ ordinary least squares (OLS) in lieu of firm fixed effects due to the data con-
straint that require a 5-year lag to measure growth in capacity. The digitized data set has 6
years of data that allow only one observation for each nonprofit. Employing a less compre-
hensive data set (i.e., core or statistics of income [SOI]) would limit the scope of our analy-
sis in a number of ways (e.g., we would not have been able to capture unrestricted net assets
or many revenue streams, and it would have also reduced the sample size considerably, etc.).
4. The traditional HHI calculates the absolute measure of concentration, without consider-
ing “the relative position of a nonprofit’s revenue structure to its maximal diversification
scenario” (Yan et al., 2009, p. 57).
5. Modifying the traditional HHI calculation, we adopted Carroll and Stater’s (2009) method
by calculating an absolute measure of concentration equal to the sum of the squared portion
of total revenue from donative income, earned income, and investment income. All nega-
tive values were set equal to zero before the HHIC-S index was calculated.
6. Modifying the traditional HHI calculation, we adopted Yan et al.’s (2009; HHIYan) method
by calculating an absolute measure of concentration equal to the sum of the squared por-
tion of total revenue from government grants, donations, program revenue, and investment
income. Consistent with Hager (2001), all negative values were set equal to zero before the
HHIYan index was calculated.
7. Modifying the traditional HHI calculation, we calculate an absolute measure of concentra-
tion equal to the sum of the squared portion of total revenue from direct public support,
indirect public support, government grants, program revenue, membership dues, interest
and savings, dividends, other investment income, net rental income, net gain on sale, net
income from special events, net profit from selling inventory, and other revenue. All nega-
tive values were set equal to zero before HHIComp index was calculated.

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Bios
Grace L. Chikoto is an assistant professor at the University of Wisconsin–Milwaukee. Her
research specializes in the implications of funding on nonprofit organizations, state–INGO rela-
tions, and nonprofit disaster management.

Daniel Gordon Neely is an assistant professor at the University of Wisconsin–Milwaukee. His

research specializes in the role of financial information in governmental and nonprofit
organizations.

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