There are increasing numbers of new players entering the field of philanthropy. These new players are joining many previous donors in demanding not simply greater operational accountability from those organizations to which they provide contributions, but a greater capacity to document the social and other impacts of their charitable giving. These new donors speak not only of “measurement” and “outcome funding,” but rather of “social return” and the ability to document the “added-value” of their philanthropic investments.
Perhaps more importantly, it is our contention that the true impact of the collective work taking place in the nonprofit sector is grossly under-valued by those both within and outside of the sector due to an absence of appropriate metrics by which value creation may be tracked, calculated and attributed to the philanthropic and public “investments” financing those impacts. In the for-profit sector, one speaks of Price/Earnings Ratios and Portfolio Fund Performance. Indeed, at the close of every day one knows exactly what financial returns have been generated by “the market.” By contrast, nonprofit organizations have no equivalent metrics by which to lay claim to the value created through their labor. This lack of transferable metrics underlies an array of issues confronting the sector, ranging from difficulties in fund-raising to an inability to provide personnel with adequate compensation.
As the sector continues to compete for limited charitable dollars it becomes increasingly important that we be able to understand not simply that a program is a “good cause,” but rather that its social returns argue for increasing our investments in their work. Therefore, we must understand the value creation generated by social enterprises and the documentation of that value creation through the application of SROI analysis.
A SROI analysis does the following:
- examines a social service activity over a given time frame (usually five to 10 years)
- calculates the amount of “investment” required to support that activity and analyzes the capital structure of the nonprofit that is in place to support that activity
- identifies the various cost savings, reductions in spending and related benefits that accrue as a result of that social service activity
- monetizes those cost savings and related benefits (that is to say, calculates the economic value of those costs in real dollar terms)
- discounts those savings back to the beginning of the investment timeframe (referred to as “Time Zero”) using a net present value and/or discounted cash flow analysis
- presents the socio-economic value created during the investment time frame, expressing that value in terms of net present value and Social Return on Investment rates and ratios
The image below illustrates the overall framework for the social return on investment calculation. The return may be measured as a ratio such that the present value of the net benefits is divided by the present value of the total costs or may be calculated based upon a return on investment calculation using an agreed upon a discount rate or range of rates.
The net benefits of an investment in a social enterprise are comprised of two “cash flows.” The first cash flow is generated from the operations of the social enterprise itself. The business cash flows are forecasted out 10 years and to perpetuity and are then discounted back to a present value figure. The second cash flow is a calculation of the total net savings to society, which is to say the economic value of the program’s social impacts. For our purposes, the term “society” refers specifically to those governmental entities upon which the social “cost” of poverty falls. Creating social and socio-economic value clearly is of benefit to individual program participants and communities and we also recognize that the immediate burden of poverty falls upon families and communities. However, the actual dollar expense of social and other programs accrues to the public sector which is supported by taxpayer dollars and, thus, society at large.
The net savings to society is made up of the additional tax dollars generated from the operations of the business and the reduction in unemployment costs, the new wages of the employees, and additional dollars the enterprises used associated with their social mission, less any grant and philanthropic investment dollars. Wages and the additional dollars used for the enterprises’ social mission, while costs to the enterprises, are considered benefits to the employees. This cash flow is forecasted out 10 years and to perpetuity and is then discounted back to a present value figure using a range of discount rates. The new tax dollars, net savings, and business cash flows are discounted using the appropriate discount rates and then summed to form the total benefits to society. This figure represents the performance of the organization — its socio-economic value.
The net present value of the benefits is divided by the total costs of the organization. The total “costs” represent the philanthropic dollars invested during a given year or other investment time frame. This final figure represents one of the performance measures of the organization—its SROI ratio. Another performance measure is the SROI rate, which is calculated by performing Internal Rate of Return (IRR) calculations based on the total Socio-Economic Value and total “costs.”