Not-for-profit organizations and social enterprises are realizing the value of financial efficiency measurement as an approach for evaluating operations, programs, services and financial stability. One effective measurement tactic is financial ratio analysis. Extracting data from your financial statements, to calculate ratios specific to your not-for-profit, and then bench-marking those ratios on past performance, management objectives or comparable organizations.
Financial ratio analysis assists to assess your not-for-profits overall financial condition and flag financial patterns, both those that might be harmful or successful.
Upon identifying your goals for financial ratio analysis, next step is to quantify your financial information. The following are metrics and ratios not-for-profit organization’s should use and the primary indicators of financial health from the lens of funders across sectors.
Viability ratio. Compares expendable net assets (including unrestricted and temporarily restricted net assets) to long-term debt: a not-for-profit’s relative liquidity or its ability to cover its debt. This is a basic indicator of financial strength and measures the availability of cash and other liquid assets to meet the non-for-profits financial obligations.
Current ratio. Indicates your organization’s capability to meet short-term financial obligations comparing your current assets to your current liabilities. Ideally, a not-for-profit should have a current ratio of at least 1.0, and preferably greater. A current ratio under 2.0 could indicate an inability to pay current financial obligations with a measure of safety.
Quick Ratio. Banks utilize the quick ratio comparison to gauge financial stability. It compares quick assets (current assets less inventory and prepaid expenses) to current liabilities. An organization’s quick ratio should not be less than 1.0.
Operating reserve. Addresses the question of whether resources are sufficient and flexible to support your mission so to avoid having to borrow externally. It compares expendable net assets to total expenses. It describes your organization’s ability to fund programs and other expenses from expendable net assets, should no additional operating revenue be available. Not-for-profit organizations should aim to have an operating reserve ratio of no less than 25 percent, or enough to cover at least three months of their annual expenses.
Change in net assets. Measures financial performance by addressing: “Did your not-for-profit live within its means during the year?” While an organization’s success isn’t completely assessed by whether it had a positive or negative change in net assets, consecutive deficits are cause for concern.
Operating margin. An important forecasting ratio because it illustrates organizational ability to produce a potential surplus, which could be available if needed in future years. This ratio is determined by subtracting expenditures from revenues and dividing that sum by your revenues.
Program efficiency. Compares total program expenses to total expenses. This information helps to demonstrate to potential funders how efficient your organization is in fulfilling its mission.
Operating reliance. Illustrates that your not-for-profit is able to pay for total expenses solely from program revenues, divide program revenues by total expenses.
Fundraising efficiency. Always be aware of what you’re generating from fundraising activities! This ratio identifies the amount of contributions that result from fundraising expenses by dividing the former by the latter.