Let’s face it, every month you review the same financial statements, which are most commonly: the statement of financial position, the statement of activities, and possibly the cash flow statement. Do you take the next step and dig deeper into these financial statements by calculating the key financial ratios that are important to your organization? If not, you are not alone, and it is not as challenging to do as you may think. I want to discuss three key financial ratios that every nonprofit organization should track and how they can be benchmarked against similar organizations.
What ratios should I look at?
There are hundreds of ratios that you could identify as being relevant to your organization. I’ve narrowed it down to three that I believe every organization can benefit from by tracking, and they are simple to calculate.
Current ratio = (current assets/current liabilities)
The current ratio indicates your organization’s ability to meet short-term financial obligations by comparing your current assets to your current liabilities. Current assets are typically defined as cash and other assets that are expected to be converted to cash within one year. Current liabilities are usually defined as the organization’s debt or obligations that are due within one year. In simpler terms, current assets are used to pay your current liabilities. Ideally, you would want to have a current ratio of at least 1.0, which would indicate that your current assets equal your current liabilities.
Operating reserve = (net assets without restrictions – (fixed assets – debt related to fixed assets)/annual expenses – depreciation and amortization
The operating reserve ratio indicates how long an organization can continue its operations without any revenue coming in to fund the operations. This calculation will give you a feel for the overall health of the organization and can be very helpful should a large portion of your revenue come from just a few sources.
Program efficiency = (program service expenses/total expenses)
The program efficiency ratio compares total program expenses to total expenses. By performing this calculation, you can see how efficient your organization is in fulfilling its mission.
Now that we have calculated these ratios, how do we know what results we should be striving for? Well, one benefit of being in the nonprofit sector is that every nonprofit’s 990 is made publicly available. So, it’s very simple to look up similar organization’s financial information, prepare the same calculations as mentioned above, and see where you stack up. I recommend finding three to five organizations that are similar in size and mission and compare your results against theirs.
Using ratio analysis and performing benchmarking analysis can only help you plan for the future by providing you with valuable insight into your organization’s financial health. The calculations are simple, and the information is already available, it’s just a matter of doing the math and evaluating the results. If you would like help in implementing ratio analysis and benchmarking for your organization, don’t hesitate to contact the professionals at TDT CPAs and Advisors, P.C. We are here to help!
Dan Montgomery, CPA, and Manager at TDT, discusses 3 key financial ratios that every nonprofit organization should know. With more than twelve years of experience, Dan specializes in audits of nonprofits, governmental entities, and employee benefit plans. Dan is a member of the American Institute of Certified Public Accountants and the Iowa Society of CPAs and serves nonprofit clients across all nine TDT office locations.