Irrespective of the core mission of any organization, it is imperative that on a timely basis, it should review how well it has fulfilled its mission and how effectively resources are being utilized in the process. Even though the exact metric that is used by different nonprofits will not be the same, there are certain key measures that should be used to effectively measure overall performance, identify trends month over month and year over year, improve decision making and benchmark against similar organizations.
Ratios Used To Gauge The Financial Performance Of A Nonprofit Organization
This is a basic measure of financial fortitude. To get this ratio, you should simply divide your current assets (e.g., cash reserves and investments, real estate, vehicles and equipment) by your current liabilities (e.g., taxes and lease agreements). The result you will get represents the ability of the nonprofit to meet short-term obligations.
Generally speaking, a current ratio exceeding one indicates an ability to meet existing obligations.
2. Net Operating Ratio
This figure indicates how efficiently the organization is using its money to fund operations. In order to calculate the net operating ratio, you will have to deduct total expenses from total income and divide the result by total income. The higher the ratio of income to expenses, the more cost efficient the organization is.
You can compare the data you collected with those that you have collected from previous years to have a clearer picture of your nonprofits growth.
3. Fundraising Efficiency Ratio
Nonprofit organizations rely a lot on funds that they receive through events such as galas, golf outings and raffles, which involve significant planning, marketing, staffing and logistics costs. In order for the nonprofit to determine that they have made a gain or loss in the investments that they made in their fund raising efforts, you will have to divide the total amount spent on fundraising by the total amount raised.
A result of less than one means that the organization gained more than it spent. Conversely, if it is greater than one, the organization spent more than it gained. To gain further insight, consider dividing total contributions by unrestricted contributions, which can be used as the organization sees fit, including for general operating expenses.
4. Program Efficiency Ratio
This figure indicates how efficiently an organization is at using funds for its main purpose and is determined by dividing total program expenses (money spent directly on furthering the organization’s mission) by total expenses.
Basically, donors and board members would like to see a one-to-one ratio, but it’s unrealistic for all funds to be dedicated to programs without some administrative costs.
5. Operating Reliance Ratio
This ratio is used by nonprofits to find out how easy it will be for them to cater for their expenses while solely relying on their program revenues. To find a nonprofits operating reliance ratio, you should divide the program revenue by total expenses. The ideal result should be more than one which would allow the nonprofit to use additional funds to expand programs or grow other areas of the organization.
6. Operating Reserve Ratio
In order for a nonprofit to remain stable, it is expected that a certain amount of liquidity will be needed in order for the nonprofit to remain financially strong for periods when no additional operating revenue is available.
When comparing expendable net assets (i.e., savings and the total value of everything that could be used to raise cash if necessary) to total expenses, a ratio of 25% or greater (enough for at least three months of expenses) indicates that resources are sufficient and flexible enough to support the organization’s mission without having to borrow funds.
Business Model Indicators
The business model indicator seeks to find out how a nonprofit makes and spends its funds in relation to its mission. It is reflected on the Income Statement (aka The Statement of Activities in nonprofit accounting)
- Revenue reliability: instead of placing your main focus on the ratio of earned to contributed revenue, another take will be to evaluate revenue reliability. Revenue reliability refers to an organization’s track-record of bringing in recurring funds on an unrestricted operating basis year after year.
Reliable revenue does not necessarily mean that the funds will come from one source that provides a certain amount of money. However, it suggests an ongoing ability to earn or raise a level of income with a fair amount of certainty. While revenue reliability can be reflected in numbers via historical trends, it is more fully understood through a conversation with or among the organization’s leadership, and in the context of relevant market dynamics.
Nonprofits should avoid balancing budgets with nonrecurring revenues, one-time grants or contributions and other uncertain revenue sources.
One reliable source of recurring unrestricted revenue received each year should be contributions by an organization’s board members. Organizations should seek 100 percent board participation in giving. However, organizations should be careful not to set contribution minimums that board members should meet. In contrast, board members should contribute to the organization a gift that is meaningful to them and their own personal financial situation.
A nonprofit should start its annual budgeting process by identifying the recurring unrestricted revenues received each year. While recurring revenues may not always come from the same sources, the ability to reasonably predict a steady level of income helps the organization adequately budget for routine expenditures and demonstrates revenue reliability.
2. Consistent surpluses: a nonprofit that has a healthy financial performance should be characterized by reliable revenue that covers operating expenses and contributes to surpluses – all in the service of mission.
Nonprofit is a tax status, not a way of operating: Positive operating results (unrestricted revenue consistently exceeding expenses) are an indicator of strong financial management, and are necessary for organizational health and financial resilience. Simply aiming for breakeven results doesn’t allow for the breathing-room necessary when things don’t go according to plan.
Balance Sheet Indicators
This financial statement provides a picture of the assets that an organization owns and the liabilities and net assets and thus can be used to gauge the financial performance at that point in time.
- Appropriate liquidity: this very important measure of financial performance shows a nonprofit organization’s ability to withstand risk and respond to new opportunities that may come its way.
It is calculated by dividing the cash at hand by the average monthly expenses. Liquidity directly impacts an organization’s ability to respond to new opportunities and adapt to unforeseen budget constraints. It can be measured in terms of months of expenses that can be covered with available unrestricted cash on hand. Recent studies indicate that approximately 60 percent of organizations have less than three months of cash in reserve.
The right amount of liquidity for an organization depends on its unique factors such as fund volatility, facility needs, economic environment and cash management strategies. But as a general rule, organizations should strive to have, at a minimum, three to six months of unrestricted cash on hand.
2. Ability to manage debt: the measure of debt is a very important financial tool that can help organizations to manage the ebbs and flows of cash for operations, facility purchases and upgrades, and more. However, as liabilities bump up against an organization’s ability to pay off those obligations, they can become a real problem. Debt is an important indicator of how solvent an organization is.
By measuring an organization’s liabilities as a percent of total assets, one can get a clearer picture of how much an organization owes relative to what it owns. If this percentage is close to the 50 percent mark, it can raise questions about the ability of the nonprofit organization to manage debt, which could negatively impact the delivery of programs and services.
3. Ability to steward facilities: if owing properties is necessary to realize the mission of a nonprofit organization, then, it is up to the organization to maintain and replace these assets when needed. A best practice for organizations with substantial property and equipment is to create and sustain a reserve designated by the board of directors to fund facility improvements and replacements.
Other Financial Metrics to Measure Nonprofit performance
- Full-cost coverage: a lot of nonprofits develop budgets on the cash basis to help manage and understand the amount of cash coming in and going out of the organization each month. When the budgeting process is ongoing, it is of critical importance to understand the hidden costs of doing business and include those in the budget.
Nonprofit Organizations should set their revenue targets to be high so as to cover depreciation of fixed assets, payment of debt principal and, if possible, an amount for surplus funds. By budgeting to cover the depreciation expense of fixed assets, organizations are able to grow a surplus for asset replacement in the future. Covering the full cost of doing business will ensure an organization’s longer-term sustainability and help maintain a strong liquidity position as discussed above.
2. Cash flow from operations: The amount of cash flows from operations presented on the Statement of Cash Flows is many times a more accurate reflection of the results of unrestricted operations of a nonprofit than its net income. This figure removes the effects of restricted grants or contributions, depreciation expense and investment income. A positive cash flow from operations would indicate that an organization is effectively covering their costs of unrestricted operations and programming.
When evaluating these or any other financial metrics, make sure to review them not only for the current year but for a three to five-year history so trends or outliers can be identified.
3. Balance sheet: a balance sheet is also called a statement of financial position. It is based on this accounting formula: Assets = Liability + Owner’s Equity.
Assets represent the property, equipment, donations and charity inventory that will provide the organization with a future benefit.
Liabilities represent all obligations charities must pay, including lease payments, debts, and other account fees.
Owner’s equity refers to that portion of funds that belongs to the charity organization.
4. Income statement: this is also known as the statement of activity. The accounting formula used here is: Revenue - Expenses = Net income
Revenue is all cash inflows into the charity bank account.
Expenses are the cost associated with operating charity programs. Net income is the difference between the revenue and expenses.
5. Statement of cash flow: The statement of cash flow used by charity organizations is similar to that used by a for-profit business. It breaks down these three activities: Operating activities, investing activities, financing activities, Statement of functional expenses.
As an alternative to the income statement, accountants measure the nonprofit’s financial position using the Statement of Functional Expenses. This statement helps charity leaders to track spending. The statement breaks expenses into three categories: Program Expenses: goods and services distributed to fulfill the purpose of the organization. Administrative expenses: costs of business management, record keeping, budgeting, finance and other management and administrative activities.
In conclusion, it is the duty of nonprofit leaders to masterfully balance the art of managing funds while still adhering to their (the nonprofit organization) mission. With limited finance staff and multiple sources of financial information, it’s no wonder these leaders and their supporters often struggle to tell a clear, compelling financial story that makes sense of all the data.
You can use these indicators that have been discussed here to gauge the financial performance of your organization. If you work at a nonprofit, use these financial indicators to focus your staff and board on the big picture story. If you are a nonprofit supporter, consider streamlining your financial due diligence using these themes as your guide. Examining these key indicators of financial performance can help replace belief with fact – ensuring decisions are driven by data that will support mission execution today and for years to come.