A nonprofit organization’s financial statements are key to assessing its financial condition. While financial statements play an important role, they may not be the best way to communicate performance to a nonprofit’s stakeholders. Ratios grab information from financial statements and can be presented as easy-to-process snapshots. This article reviews nine relevant ratios organizations should consider using.
Ratios assist in translating information from financial statements and can be presented as easy-to-process snapshots.
Why ratios matter
Although financial statements play an important role, they may not be the best way to communicate performance to your nonprofit’s stakeholders. Ratios assist in translating 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. They can be an invaluable tool for your leaders’ decision-making.
What ratios to use
Ratios can assist your organization in calculating its general financial health, comparing liquid assets to the ongoing cost of operations, determining efficient and effective ways to use resources, and assessing reliance on certain types of funding. Specifically, you should be reviewing:
1. 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.
2. Accounts payable (A/P) ratio = Accounts payable aged more than 90 days / Total accounts payable.A high A/P ratio can reflect cash flow problems and predict severe financial consequences, such as an eventual inability to pay bills on time.
3. 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 cash flow issues due to lack of expected revenue — grows.
4. Defensive interval (DI) = Cash plus marketable securities (excluding permanently restricted investments) plus current receivables / Average monthly expenses. The DI ratio measures the number of months’ expenses an organization can cover if no additional inflows of quick assets (cash, short-term investments and current receivables) occur. It’s particularly useful when contribution inflows are highly variable. A high or increasing value generally is better than a low value.
5. Liquid funds indicator = Net assets less restricted endowments, land and plant, property and equipment / Average monthly expenses. This indicator shows the number of months before a nonprofit will completely exhaust its liquid funds, assuming no additional revenue inflows. Because it excludes plant, property and equipment, it’s more conservative than the DI metric. But like the DI ratio, high or increasing values are positive indicators.
6. Fundraising efficiency = Contributed income / Fundraising expense. In recent years, many donors have focused on the amount nonprofits spend on fundraising compared with the amount raised. This ratio shows the average dollar amount raised for each dollar in fundraising spending. Be careful though — organizations may have a higher level of expenses when venturing into different fundraising campaigns, such as those for capital needs or endowments.
7. 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.
8. 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.
9. 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.
If the ratios show that your organization receives almost all of its support from government funding and individual donations, you may see those sources recede in a recession or depression, threatening your survival. If you haven’t already done so, you may need to diversify your income.
Reliability counts
Using these ratios can help nonprofits more effectively market their organizations to donors and steer away from potential financial crises. But remember: Ratios are only as reliable as the data you rely on to compute them. Your ratios won’t be helpful if the financial information you use isn’t accurate or complete. Also, if your organization has debt service covenants that require you to maintain specific financial ratios, include those in your regular financial reporting. Reach out to your Hood & Strong team for guidance.
