The financial health of nonprofit organizations is an important indicator of their success. Measuring financial health can help an entity understand how well the current business model is functioning. Analyzing financial health can measure current performance and serve as a great planning tool. Calculating key ratios and metrics to determine financial health can help organizations adapt and grow in the future.
For nonprofit organizations, analyzing financial health offers an additional benefit to its leaders and members. Successful nonprofits can balance the influence of the organization’s mission with the stability of the finances. There are many ways to measure financial health, including using financial ratios.
Understanding what the following five metrics and ratios mean for your organization and how to calculate them is a great first step in assessing the financial health of your nonprofit.
The current ratio addresses the organization’s ability to pay its bills. An average current ratio is one that is between 1 and 2. When the current ratio is equal to or greater than one it means that there is enough cash and current assets to cover current liabilities. This is an indication of short-term financial stability. A current ratio above 2 is an indicator of strong financial health.
- Current ratio = current assets / current liabilities
The current ratio is calculated by dividing the current assets by the current liabilities and measures the ability of the organization to cover obligations with cash, pledges receivable, and other current assets. The assets used in calculating the current ratio are assets that are already liquid or expected to be collected in the next twelve months, and the current liabilities are those that require payment within that same one-year period.
Calculating the revenue-to-date ratio can provide helpful information for nonprofits that are looking to extend their reach. It acts as a comparison tool to compare current performance to prior periods. A high revenue-to-date ratio can show that the organization is on track to meet growth expectations. A revenue-to-date ratio that is less than one can indicate that efforts to generate revenue need to be explored and improved. Revenue can come from donations, grants, and community events.
- Revenue-to-date ratio = current YTD revenue / revenue to date one year ago
This calculation can also be used to help budget and forecast cash needs. Being aware of decreasing revenues allows leaders to reevaluate expenses and react. If the revenue-to-date ratio is less than one, expenses may need to be cut until revenues are increased again.
Cash Reserves Metric
The cash reserves make up the money available to meet operating expenses independently of revenues. Calculating this ratio allows an organization to be aware of how many months the entity can survive, serve its mission, and meet obligations. It is ideal for nonprofit organizations to have 6 months of cash reserves, but reserves above 3 months indicate good financial health.
- Cash reserve metric = total cash / average monthly expenses
When figuring out the cash reserves metric, total cash includes unrestricted cash balances and liquid investments. Average monthly expenses can be calculated by taking annual expenses and dividing them by 12. The cash reserve ratio, or metric, is similar to the defensive interval ratio (DIR), which measures the ability to meet obligations in days.
- DIR = current assets / daily expenditures
Restricted Asset Ratio
The restricted asset ratio measures the percent of assets that are restricted. Restrictions are often put on the revenue received by nonprofits by the donor or agency contributing the funds. Understanding the ratio of unrestricted net assets helps nonprofit leaders analyze the net worth of the organization.
- % Restricted Asset = unrestricted net assets / total net assets
Ideally, nonprofit entities will see a restricted asset percentage that increases over time. It is a good business practice to calculate this ratio at least once per quarter. If the percentage is too low, that indicates to leaders that changes may need to be made in the collection efforts of revenues.
Program Expense Ratio
Program expenses make up a large part of a nonprofit organization’s liabilities. Funding projects and programs are imperative for a nonprofit to continue to fulfill its core mission. The percent of an entity’s expenses spent on its dominant programs validate the strength and intentions of the organization.
- Program expense ratio = program services expenses / total expenses
The program expense ratio is often reviewed by current and potential donors because it shows that the organization focuses most of its efforts on the core mission. Resources for donors often recommend that organizations maintain a ratio of 65% or higher. Some well-known directories like Charity Navigator, recommend that donors select organizations with a program expense ratio of at least 85%.
The financial health of a nonprofit organization can determine its success. Using the financial health metrics given above can help leaders manage an organization, but monitoring complicated metrics requires time and additional manpower. For many successful nonprofit leaders, working with an accounting services provider, like JFW Accounting Services, is the most efficient way to efficiently manage financial health.