Best practices suggest that management and the Board of Directors regularly assess the financial performance of a nonprofit to understand its strength, areas of improvement and steps towards goals. Management and the Board are usually focused on serving their mission. In other words, the focus is often on ensuring that the organization is delivering the highest and best value to those it serves. Appropriate attention should also be dedicated to evaluating financial and operational performance to ensure the vitality of the organization. Many are surprised to learn that this doesn’t require a complex study but can be accomplished through some simple financial ratios. These are quick tests which can be performed using information in the financial statement. A summary of key ratios for nonprofits is below.
Key Nonprofit Ratios
- Defensive Interval – This ratio measures how many months the organization could function if it did not receive any additional funding. While it is unlikely such a scenario would occur, it provides insight into the organization’s ability to survive if the worst case happened. It is calculated by adding cash, marketable securities and receivables, and dividing it by average monthly expenses. A goal should be between three to six.
- Savings Indicator – This ratio measures the increased/decreased ability of an organization to add to it its net assets. A value that is greater than one indicates an increase in savings, while less than one means that savings have been expended. This is an effortless way to determine if an organization is consuming its assets to fund programs/operations. It is calculated by subtracting revenues from expenses and dividing the resulting number over total expenses.
- Fundraising Efficiency Ratio – This ratio is used to determine how much a nonprofit spends to raise $1. The higher the ratio, the less the organization is spending on fundraising. This is the desired outcome because it allows more money to be used for program development and administration. It is it calculated by dividing fundraising expenses by total contributions.
- Contributions & Grants Ratio – This ratio reveals the amount of the organization’s funding that is generated from contributions and grants. The information provided is used to analyze both long- and short-term scenarios and determine if they are in alignment with strategic funding goals. It is calculated by dividing the revenue from contributions and grants by total annual revenue.
- Government Grants Ratio – This ratio measures the amount of funding coming into the organization that originates from government sources. The information provided is used to analyze whether the funding is sufficient to meet the short- and long-term funding plans of the organization. It can also be used to determine if an organization should pursue additional government funding opportunities. It is calculated by dividing the revenue from government grants by total annual revenue.
- Program Service Expense Ratio – This ratio measures the relationship between funds spent for programming purposes to all expenses. This ratio is quite commonly used to assess nonprofits and the Better Business Bureau has set a standard of sixty five percent for this ratio. It is calculated by dividing the total program service expenses by the total annual expense. The higher the number, the greater the amount of revenue generated that is expended on programs.
Regularly assessing financial ratios and comparing to period ratios can help uncover essential trends that reflect the financial health of the organization. This will permit management and the Board to identify the needed changes to keep the organization financially stable. If you have questions about ratios, or would like assistance with an audit or tax issue, GBQ can help! For additional information please contact us at 614-221-1120 or info@gbq.com. We look forward to speaking with you soon.
