SEE ALSO>>> Nonprofit Organizations
As much as you might prefer to concentrate on only your nonprofit’s mission, strong financial health is vital to pursuing those goals. Financial statements provide essential information on your fiscal footing. However, you can expand everyone’s understanding of your organization’s performance and sustainability by monitoring a variety of ratios.
Reasons to “ratio-nalize”
While financial statements will always play an important role, they aren’t necessarily the best way to communicate performance to stakeholders. Ratios grab information from your financial statements and can be presented as easy-to-process snapshots.
Ratios also help stakeholders keep an eye on overall financial condition, identify worrisome and promising trends, and make informed decisions. Among other things, they can provide a picture of your organization’s current financial standing, its adequacy and use of resources, and its reliance on certain types of funding. Ratios also are an invaluable tool for your leaders’ decision-making.
Here are some ways to calculate your organization’s general financial health:
Current ratio = Current assets / Current liabilities. The current ratio indicates the ability to satisfy short-term financial obligations (debts due within the coming year). A current ratio of “1” or more generally demonstrates the ability to meet those obligations.
Accounts receivable (A/R) ratio = Accounts receivable aged more than 90 days / Total accounts receivable. As the A/R ratio gets higher, the risk of collection or billing problems — and, in turn, cash flow issues due to lack of expected revenue — grows.
Accounts payable (A/P) ratio = Accounts payable aged more than 90 days / Total accounts payable. The A/P ratio can reflect cash flow or more severe financial problems. For example, the organization may be having trouble paying its bills on time.
Ability to cover costs
These ratios compare your nonprofit’s liquid assets to the ongoing cost of operations:
Defensive interval (DI) = Cash plus marketable securities (excluding permanently restricted investments) plus current receivables / Average monthly expenses. The DI measures the number of months’ expenses the organization can cover if no additional inflows of quick assets occur. It’s particularly useful when contribution inflows are highly variable. A high or increasing value generally is better than a low value.
Liquid funds indicator = Fund balance less restricted endowments, land and plant, property and equipment / Average monthly expenses. This indicator shows the number of months before the nonprofit will completely exhaust its liquid funds, assuming no additional revenue inflows. Because it excludes restricted endowments, it’s more conservative than the DI. But like the DI, high or increasing values are positive indicators.
Use of Funds
How efficiently and effectively do you use your resources? Consult these ratios:
Fundraising efficiency = Contributed income / Fundraising expense. In recent years, many donors have focused on the amounts nonprofits spend on fundraising compared with the amounts raised. This ratio shows the average dollar amount raised for each dollar in fundraising spending.
Program expense ratio = Program expense / Total expenses. The ratio evaluates a nonprofit’s mission efficiency by considering the extent of funding that goes to programs, as opposed to administrative or other expenses. Alternatively, stakeholders may scrutinize the administrative expense ratio, calculated by swapping out program expense for administrative expense.
Cost per unit of service = Program expense / Number of units of service. When nonprofits provide identifiable units of service (for example, meals served), this ratio assesses the financial efficiency of the program over time.
Overreliance on funding sources
Reliance ratios. Finally, reliance ratios can reveal an unhealthy dependence on one funding source. To determine your reliance on any specific funding type (for example, government grants and contracts, individual donations or earned income), divide the amount of that funding by total income.
Say the ratios show that your organization receives almost all of its support from government funding and individual donations. You could see those sources recede if a recession hits, threatening your survival. So, you’d be wise to find ways to diversify your income now.
In a time when charitable-giving incentives are shrinking, nonprofits need to pay more attention than ever to their financial performance. The ratios above can help you steer away from potential problems and market your organization effectively to donors.