Nonprofit Financial Ratios As the funding environment continues to remain competitive, donors and stakeholders increasingly want nonprofits to demonstrate a strong understanding of financial management. Measuring financial performance through the use of ratios is a common practice in for-profit enterprises, but few nonprofits effectively use ratios as a financial management tool. While nonprofits fundamentally operate to fulfill their social mission and are usually less interested in their return on investment than the number of lives they have transformed, there are lessons that nonprofits can learn from for-profit analysis. This paper will present several common ratios that can be used to present a snapshot of an organization s financial health and can help a nonprofit measure itself against other similar organizations and demonstrate fiscal responsibility to donors and other stakeholders. Preparing to Analyze Financial Data As you prepare to analyze your financial data, always make sure that you are working with an accurate and complete financial picture. First, make sure that you establish the timeframe you are going to use and then use this consistently year after year. For instance, you may want to report financial trends and ratios on a monthly, quarterly or annual basis. If you measure data on a quarterly basis, ensure that any comparisons you make to prior years is also done on a quarterly basis. Second, to the extent that you are able, make sure that the financials are complete and include all receivables for the time period as well as prepaid expenses if you are using an accrual method of accounting. More information on cash vs. accrual accounting as well as the preparation of financial reports can be found in our April Topic of the Month, Cash vs. Accrual Accounting For Non-Profits: Which is Right for Your Organization?. 1 Fundraising Reliance An easy way to start analyzing your financial statements using ratios is to determine how diversified your funding base is or how reliant you are on one or two types of income. Ideally, you will want to have a mix of income, including: Donations from individuals. Grants from Foundations Government funding. Earned income that could be from program service fees, membership dues, or special events. Simply divide each identified income source by the total income to determine the percentage of income each source provides. 1 http://www.cathedralconsulting.com/files/topic CashVsAccrual April 2011.pdf Cathedral Consulting Group, LLC Page 1
Fundraising Reliance Formula Fundraising Reliance Formula = Income Source Total Income Too Low Under 15% Average 30% Too High Above 50% For example, if you are running an arts organization, you may have total income of $100,000, of which $50,000 comes from grants, $25,000 comes from paid tickets, and $25,000 comes from individual donations. This means that your funding base is 50% from grants, 25% from earned income (ticket sales) and 25% from individual donations. While each organization is different, you will ideally want a mix of at least four different income streams and no income stream should represent more than 75% of the total income. Example case to illustrate the Fundraising Reliance ratio: Calculating these ratios is also important to help you plan for a major reduction in income. For example, in the current economic environment, state, and local governments are cutting funding to social service agencies. If you are a nonprofit that relies heavily on government funding, you will want to determine how a sudden loss of this funding will impact your ability to continue programming at its current level. Self-sufficiency Ratio Related to the fund-raising reliance ratio, the self-sufficiency ratio measures the extent to which a nonprofit can cover its operating expenses through earned income. This ratio is primarily useful for organizations that have earned revenue through memberships, fees or tuition. For instance, if you are a museum, you will want to calculate the percentage of your revenue that comes from ticket sales, space rental, classes and any other earned income. Self - Sufficiency Formula Self - Sufficiency Formula = Total Earned Income Total Expenses Too Low Under 0.10 Average 0,40 Too High Depends on organization Since this is a sub-set of the fundraising reliance ratios, simply divide total earned income by total organizational expenses. Remember that earned income streams offer your organization flexibility and autonomy and can be easier to generate than government contracts or significant increases in individual donations. Example case to illustrate the Self-Sufficiency ratio: Cathedral Consulting Group, LLC Page 2
Fundraising Efficiency Charitable watchdog organizations like Guidestar and Charity Navigator typically rate nonprofits on their fundraising efficiency. This ratio determines how much it costs an organization to raise funds. To determine your fundraising efficiency ratio, divide all of your donated income by the total fundraising expenses. Ideally, it should cost you a lot less than $1 to raise $1, which means that the higher this ratio, the better. Fundraising Efficiency Formula Fundraising Efficiency Formula = Total Fundraising Expenses Total Fundraising Income Average $0,35 Too High $1.50 or higher CharityNavigator gives its highest ratings to organizations that raise $1 for less than $.10. Another similar organization, Charity Watch, indicates that an organization should spend no more than $.35 to raise $1. Example case to illustrate the Fundraising Efficiency ratio: Program Efficiency The other key ratio that is measured by organizations like Guidestar is the Program Efficiency ratio. This ratio is used to determine the percentage of funds that are invested directly in programming vs. funds that are spent for fundraising or administrative functions. To calculate this ratio, divide total program service expenses by the organization s total expenses. A general rule of thumb is that a nonprofit should have approximately 80% program expense, and 20% general and fundraising expenses. The average nonprofit on CharityNavigator achieves 67% program efficiency. Program Efficiency Formula = Program Efficiency Formula Program Service Expenses Total Organizational Expenses Too Low 70/30 or Under 70% Target 80/20 or 80% Cathedral Consulting Group, LLC Page 3
It is important to realize that not every organization can achieve this 80/20 ratio, and this ratio does vary widely depending on the size of the organization and its program services. Examples of organizations with lower program efficiency ratios would include organizations that provide a high-level of technical care to a small number of individuals or an entity that has a large campus or physical plant. However, if your ratio is significantly higher or lower than 80/20, it will be important for you to be able to explain to donors and other stakeholders why this is the case. Example case to illustrate the Program Efficiency ratio: Cost per Unit of Service Many donors want to know how their donation will really make a difference in your organization. One way to demonstrate this is to calculate your organization s cost per unit of service. If you can identify a unit of service a student, training course, fitness class divide the total expense of that program by the units of service. For example, if you run a summer camp, you would have multiple units of service, including campers, camp sessions, and any specific trainings related to the camp. If you divide these units of service by the expenses, you could conceivably have a list of costs per unit of service that would be: This data can then be used to construct an opportunities for involvement list that can be presented to donors. Other Operating Ratios From a management standpoint, there are a few more ratios that are helpful to measure. You can measure your organization s current ratio, which is an over-all measure of the financial health of your organization. It shows to what extent you can take care of your short-term liabilities with the cash and cash equivalents you own. From your balance sheet, divide current assets by current liabilities. The resulting ratio measures the extent to which you can meet short-term obligations, including short-term debt and current operating expenses. This ratio should be greater than 1. Cathedral Consulting Group, LLC Page 4
Current Ratio: Current Ratio Formula Too Low Under 1.0 Average 1,0 Too High Above 2.0 Current Assets Current Liabilities Example case to illustrate the Current Ratio: Finally, you can measure the Cash Expenses Per Day. This will provide you with a benchmark of how much money you actually need to run the organization every day. Calculate cash expenses by starting with total operating expenses. From there, subtract depreciation and amortization, and any unusual one-time expenses, such as a capital improvement or severance payment. Divide this total by 365 if you operate every day or 260 if you operate on a 5-day-aweek schedule. Once you calculate the Cash Expenses Per Day, you can calculate the Cash on Hand. This will tell you how many days the organization can operate as is without receiving additional revenue. Measuring this on a monthly basis can help predict the seasonality of a nonprofit s programs and revenue streams and can help you plan additional fundraising or earned income opportunities. This ratio is calculated by dividing operating cash by cash expenses per day. Conclusion Ratios can be used to help an organization better manage its finances and programs, prepare to adjust to changes in revenue or expenses, and better explain and present itself to donors and stakeholders. The list of ratios is nearly endless and can include measuring performance objectives such as costs or revenue per employee, total compensation per FTE and the proportion of assets to debt. As you begin to integrate the use of ratios in your fiscal management, remember to not lose sight of the individuals behind the numbers, including your staff, volunteers and donors. NOTE: Cathedral Consulting offers General Executive Counsel to help leaders in nonprofit Cathedral Consulting Group, LLC Page 5
organizations manage from their financial statements, stay on track and keep their organization strong and growing. This service involves a monthly meeting that addresses financials, operations, and fundraising concerns an affordable price. For more information, please visit http://www.cathedralconsulting.com/nonprofit-services Kimberly Reeve is a Managing Director, Liz Gonzalez is a Senior Associate, and Rachelle Bottenbley is an Associate and at Cathedral Consulting Group, LLC. For more information, please visit Cathedral Consulting Group LLC online at www.cathedralconsulting.com or contact us at info@cathedralconsulting.com. Cathedral Consulting Group, LLC Page 6