We spent our last two articles focusing on Form 990 requirements. Now we turn our attention to Form 990 and Financial Statements as it relates to potential funding. We are in a new era of giving where nonprofits are being judged and evaluated on multiple levels. One way nonprofits are evaluated is based on ratio analysis. Hence, in this article we will walk you through certain financial ratios that your funders may use to analyze the financial health of your organization. Keep in mind that financial ratio analysis is not the only useful means to analyze financial health. Moreover, a single ratio does not say much about your organization’s financial standing. However, some funders and charity evaluators use financial ratios as part of their due diligence review of nonprofit organizations. With that said, let’s discuss how financial ratios are used and calculated.
Financial ratios are used to obtain a more accurate interpretation of an organization’s financial health over time, especially when compared to similarly situated organizations or industry benchmarks. Financial ratios can be used to measure a nonprofit’s efficiency, growth rates, liquidity, cash reserves among other things. Financial ratios are also very powerful measurements for analyzing trends (how an organization changes from year to year). Significant shifts in a key area may cause concern for a potential funder that requires additional explanation or inquiry into the nonprofit’s financial operations. Also, most ratios are best used in two ways: 1) in comparing similar organizations and 2) in analyzing an organization over time. Ideally, you should track internally certain ratios so that your organization zeros in on areas ripe for improvement.
Ratios are calculated based on financial data generated from financial statements or your Form 990 report. Audited financial statements provide the most comprehensive data about your organization, which is one reason funders request this information. However, because many nonprofit organizations are not required to be audited some funders request Form 990. Form 990 also provides relevant financial data that can be used to perform a reasonable analysis of an organization’s financial history. To calculate a ratio, you take one total and divided it by another total. For instance, a Quick Ratio equals current assets minus inventory all over current liabilities (Quick Ratio= Current Assets – Inventory/Current Liabilities).
Here are a few ratios and how they can be used:
Largest Type of Income/Total Income
A potential funder who is interested in knowing the depth of your support base may use this ratio. In this instance, the potential funder is analyzing whether your organization is dependent on a few major sources of income. Overreliance on a few sources of income causes higher risks for your organization. Diversification of funding sources reduces overall risks for an organization, and makes an organization more attractive to potential funders.
Income Source/Total Expenses
This ratio examines the organization’s ability to sustain itself without certain funding sources such as government funding or grant assistance. For instance, a funder may examine an organization’s ability to be self-reliant by including on the top line only unrestricted donations, program services fees, and investment income. By analyzing the trend line, a funder can determine whether you are broadening your donor base and public appeal.
Program Expense Ratio
Program Service Expenses/Total Expenses
This ratio is used by various watch dog organizations to determine how much of a donor’s contribution is being used to support programs versus administrative or fundraising expense. This ratio is probably one of the most widely debated ratios of those listed here.
Current Assets/Current Liabilities
This ratio gives insight on an organization’s ability to satisfy its obligations.
Contributed Income/Fundraising Expense
This ratio measures how efficient your organization is in raising funds per dollar spent. Funders may be interested in knowing whether their contributions will be spent efficiently if they decide to fund your organization.
Personnel Expense Ratio
Personnel Expense/Total Expense
A potential funder who wants to know how labor-intensive your organization is compared to other similar organizations may use this ratio.
There are dozens of other ratios. Listed here are only a few. You are encouraged to give us a call at 1-888-206-0066 if you would like to speak to one of our consultants about the needs of your nonprofit organization. SP Consulting is a division of The Scott Practice, LLC, an Atlanta based law practice. This is not legal or any other type of professional advice and may not be relied upon as substitute. Readers seeking professional advice should contact a professional advisor.