Financial statements play an important role in assessing your organization’s health. However, they aren’t necessarily the best way to communicate performance to stakeholders. Ratios, on the other hand, grab information from your financial statements and can be presented as easy-to-process snapshots, an effective tool in the COVID-19–related economic crisis.
Ratios help board members and other decision-makers keep an eye on your nonprofit’s 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 funding types.
Gauging financial health
Here are some ways to calculate your organization’s general financial health via ratios:
Current ratio = Current assets / Current liabilities.
The current ratio indicates the ability to satisfy short-term financial obligations — that is, debts due within the coming year. A current ratio of “1” or more generally demonstrates the ability to meet those obligations. 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.
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.
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.
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 = Net assets 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 plant, property and equipment, it’s more conservative than the DI. But like the DI, high or increasing values are positive indicators.
Using funds wisely
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 amount nonprofits spend on fundraising compared with the amount 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.
Overusing a single funding source
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 can see those sources recede in a recession or depression, threatening your survival. If you haven’t already done so, diversify your income now.
Avoid “garbage in, garbage out”
Ratios are only as reliable as the data used to compute them. Be sure to take steps to ensure that the financial information you use is accurate, complete, and calculated in a consistent manner. For comparison purposes, your CPA might be able to put you in touch with other nonprofits that use ratios.