It costs money to do what you do, and certain costs are necessary to be better at what you do. You need to attract and retain happy employees and board members, operate in a clean, safe facility, and have access to the technology and office equipment your employees need to do their jobs. You also have necessary management and general expenses, such as those for the office and investment management, as well as for your legal, accounting, insurance, and banking needs. It’s how you motivate donors to support your cause, and it’s what keeps your organization sustainable. The net margin ratio measures an organization’s ability to operate at a surplus.
- In general, nonprofits don’t keep as close an eye on their nonprofit financial ratios as they should.
- Current ratios are financial ratios that measure the ability of an organization to pay its short-term financial obligations.
- For purposes of illustration, the authors present a set of eight ratios that are likely to be useful to a variety of not-for-profit organizations.
- It measures the number of times a company collects its average accounts receivable over a given period.
University courses in not-for-profit accounting emphasize the recording of transactions and the preparation of financial statements, rather than the evaluation of financial and operational effectiveness. Board members without substantial accounting expertise are even less equipped to interpret not-for-profit financial reports. Talk to an accountant who can help you interpret these ratios and set key performance indicators to improve them for the future. Bob is a Partner at LGA and the Director of Quality Control in the Audit and Assurance group.
Often they are simply a number divided by another number to show the relation between the two. For example, many nonprofits found these reserves very important (or regretted not having them) when the COVID-19 pandemic hit in 2020. A lower score is better here, with the top-rated charities generally having ratios of less than 30%. An increasing leverage ratio could be a sign of financial trouble for an organization. The benchmark for this nonprofit ratio may look different for each organization, depending on how service-based the organization is.
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Efficiency ratios, also known as activity ratios, are used by analysts to measure the performance of a company’s short-term or current performance. All these ratios use numbers in a company’s current assets or current liabilities, quantifying the operations of the business. Many organizations have a policy of maintaining cash reserves equal to two or three months of expenses; higher values indicate a stronger liquidity position. Because not-for-profit organizations exist for purposes other than earning a return for equity investors, measures commonly used to evaluate commercial enterprises are not well suited for evaluating them. Furthermore, although they are commonly represented as a single class of organization, great variety exists in the mission and finances of not-for-profit organizations. While many not-for-profits rely heavily on contributions, others derive most of their revenues from the sale of services or membership dues.
Longitudinal analysis permits the identification of trends and highlights aberrations. During the past four years, the selected YMCA has consistently maintained a cash balance of approximately 2½ months of spending and an overall liquid net asset balance of approximately 3½ months. The higher this ratio, the more your organization has on hand to cover emergency situations. The minimum recommended ratio for this is 25%, which is equivalent to three months of your expenses.
Organizations with high ratios in this category should consider how they can diversify their revenue sources. The ratio serves as a basic indicator of financial strength because it measures cash flow and other liquid assets to meet legal obligations. To do this calculation, add up the total of all of the departments’ fundraising expenses for the year (including shared services, like accounting, marketing, and HR). Then take the total revenue figure and divide it by the total expense figure.
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Often, burn rate is used by for-profit organizations just getting their start, to measure how much they’re burning through capital before they start seeing positive returns on the business. Your nonprofit needs to save money on a regular basis to build your reserve fund in the case of emergencies (just like individuals). Therefore, it’s best and indicates better financial health if your savings indicator ratio is greater than one. Your program efficiency ratio allows your nonprofit to also measure the amount that you spend on programming vs your overall expenses budget.
The operating reserve ratio is a financial ratio that is used to measure the liquidity of an organization. It’s a metric that demonstrates how long the organization can continue running without any additional revenue coming in. It takes a lot of money to maintain the facilities, cover the payroll, and pay the bills.
Not-for-Profit Ratios
They need to do more than just analyze the numbers; they also have to make sense of them. These simple financial health indicators can help you better understand your organization’s current true financial position. They can also illuminate areas of strength as well as target areas for improvement. Having a clear pulse on the organization is a big step toward financial health and sustainability. Since a bank’s operating expenses are in the numerator and its revenue is in the denominator, a lower efficiency ratio means that a bank is operating better.
Cash Ratio: Cash/Current Liabilities
There are dozens of key financial ratios that can be calculated, but most nonprofit organizations just need to familiarize themselves with a few of them. In essence, financial analysts consider efficiency ratios to be an important measure of the current and short-term performance of an organization. These ratios can be compared with peers in the same industry and can identify businesses that are better managed relative to the others.
In this case, the YMCA held expenses constant over a three-year period (Year 2 to Year 4), and the deficit reported in Year 3 was attributable to a 20% decline in contributions that year. Because the savings indicator returned to positive in the subsequent year, the one-year deficit should not be of particular concern to the governing board. If this is the first time you’re reviewing your own nonprofit financial ratios, you can use the calculations you found here as a starting point for your organization. However, when you’re able to interpret these numbers and use them to strengthen your financial strategy, your nonprofit can become more financially healthy and leverage additional funds for faster growth. Your nonprofit’s burn rate measures the monthly negative cash flows at your nonprofit.
To address abuse, accounting rulemaking bodies provide standards for the allocation of joint costs. For purposes of illustration, the authors present a set of eight ratios that are likely to be useful to a variety of not-for-profit organizations. The ratios represent the three broad areas of liquidity, operations, and spending. Exhibit 1 describes the ratios, what they measure, and how they are calculated. It also computes average values for these ratios for over 200,000 not-for-profits, divided into five categories by entity size, using information available from the IRS website.
For more information regarding KPIs for your nonprofit organization, contact one of our specialists in Ohio and Indiana. The more efficiently a company is managed and operates, the more likely it is to generate maximum profitability for its owners and shareholders over the long term. You should consult with a licensed professional for advice https://simple-accounting.org/ concerning your specific situation. Knowing where you are financially as an organization is the first step toward financial sustainability. Having a clear, honest financial picture of the current state should be your baseline for measurement. As the popular saying often attributed to Peter Drucker goes, “What gets measured, gets managed.”
Financial ratios can help determine if a not-for-profit has sufficient resources and determine if it is using those resources efficiently to support its mission. Ratios are useful because they express underlying financial relationships as a single value, allowing comparisons across time and among entities of varying size. It is important for a nonprofit’s unrestricted program revenues (funds that can be spent at the discretion of the nonprofit) to cover its total expenses. However, the organization must still determine whether expenses can be covered by program revenues alone. This key performance indicator can be defined as the operating reliance ratio.
Warren Averett is a top accounting firm providing audit, tax, accounting and consulting services to companies across the Southeast. Our firm has expertise in industries including manufacturing, construction, real estate, financial services, healthcare, government, education and retail. The accounts receivable turnover ratio is used to show trends in the aging of an organization’s accounts receivable. In the nonprofit sector, making a profit is essentially about increasing expendable net assets without restrictions on donor contributions. Expendable net assets are investments or resources that have not been restricted by donors.
This estimation tells you how much a not-for-profit is generating from its fundraising activities. It allows you to see how many dollars it generates from one dollar of fundraising. Ideally, this should be greater than 1.0, meaning the expense of fundraising should at minimum cover its costs.