When someone managing a nonprofit needs to understand their organization’s financial standing, it’s generally a best practice to start with their financial reports. But some organizations, unaware of the ways financial information can change over time, don’t fully understand the meaning behind their financial statements. They need to do more than just analyze the numbers; they also have to make sense of them.
Financial ratios are a standard tool for helping nonprofits learn more about their financial condition. 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.
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Which Key Financial Ratios Are Most Important For Nonprofit Organizations?
A nonprofit’s financial health depends on the ability to monitor and assess its financial performance. By tracking three key indicators, you can receive a real-time understanding of how your organization is doing and implement plans to improve it.
Current Ratio Analysis
Current ratios are financial ratios that measure the ability of an organization to pay its short-term financial obligations. They compare the number of current assets against the number of current liabilities. If an organization has more current assets than current liabilities, it has positive current ratios. The ratio is also sometimes called the working capital ratio.
The current ratio measures an organization’s ability to pay short-term obligations. It is calculated using the nonprofit’s current assets divided by its current liabilities. A current ratio of 1.0 or more is satisfactory. Current ratios between 0.5 and 1.0 indicate the nonprofit may have difficulty meeting its obligations.
Current assets can be liquidated into cash within a year so they can be used in the organization. Current assets include cash, marketable securities, inventory, and Accounts Receivable. Current liabilities refer to obligations that need to be paid within a year. Current liabilities include short-term debt, Accounts Payable, and tax liabilities.
The formula is expressed as:
Current Ratio = Current Assets / Current Liabilities
Operating Reserve Ratio Analysis
Running an organization is expensive. It takes a lot of money to maintain the facilities, cover the payroll, and pay the bills. That’s why organizations need to maintain an operating reserve in order to help cover unexpected expenses. The operating reserve is also known as a working capital reserve.
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.
The operating reserve ratio is calculated by dividing the current assets by the current liabilities. Sound familiar? The difference between the operating reserve ratio and the current ratio is that, in this case, the ORR is accounting for unrestricted assets, amortization, and depreciation.
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 add up all of the departments’ revenue for the year. Then take the total revenue figure and divide it by the total expense figure.
The formula is expressed as:
Operating Reserve Ratio = Operating Reserves / Total Operating Expenses
Alternatively, that could be expressed as:
Operating Reserve = (Net Assets Without Donor Restrictions — (Fixed Assets — Debt Related To Fixed Assets)) / (Annual Expenses — Depreciation And Amortization)
Program Efficiency Ratios
When it comes to running an organization, finding ways to cut costs is essential. Program efficiency ratios are a great way to measure how efficiently your programs are performing. These are ratios that take the total amount of services you’ve delivered during a specific time period divided by the expenses of that same time period.
The ratio compares total program expenses to total expenses in order to determine how much of the overall expense of the program was used for administration and how efficient the program was in spending its budget. You can calculate your Program Efficiency ratio easily by dividing the total program expenses by the total expenses.
The mission statement of a nonprofit organization is a great place to start when it comes to determining how efficient the organization is at fulfilling its mission and short-term financial obligations. To calculate efficiency, divide the total expenses by the total numbers served. If the number is greater than 1.0, it means the organization is not efficiently managing its resources. If the number is less than 1.0, it means the organization is efficient.
The formula can be expressed as:
Program Efficiency = Program Service Expenses / Total Expenses
Profit Margin Ratios
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.
Profit margin is the ratio of net income to total revenue that can be used to measure the financial health of your organization. It helps you understand whether your nonprofit is bringing in more revenue than it is spending on operations.
Organizations have different goals, and would therefore set different profit margins depending on their nature, size, and desired results. A positive ratio means you’re doing well—generating enough revenue to meet your expenses and seeing the bottom line grow. Generally speaking, the more profit you make, the better off you are.
The formula can be expressed as:
Change In Unrestricted Net Assets / Total Unrestricted Revenue And Charitable Support
Other Key Financial Ratios And Metrics
The viability ratio compares net assets to debt. This ratio indicates an organization’s ability to cover its debt. The ratio serves as a basic indicator of financial strength because it measures cash flow and other liquid assets to meet legal obligations.
Fundraising Efficiency Ratios
This ratio tells a nonprofit how much value it’s getting from each fundraising activity, relative to the cost of those activities. If the ratio is greater than 1.0, then for each $1 spent, the nonprofit receives at least $1 in contributions.
Quick ratios are a measure of an organization’s ability to meet short-term obligations. For financial stability, quick ratios should not be less than 1.0, and ideally, they should be greater than 1.0. They are calculated as follows:
(Cash + Short-Term Investments) / Current Liabilities
Aplos provides helpful resources, but it is not meant to be a substitute for professional services. Always consult a CPA or trusted professional when seeking tax or accounting advice.