Control expenses and improve efficiency by monitoring financial ratios
In general, not-for-profits should work with professional financial advisors to ensure they’re complying with the IRS’s rules for tax-exempt organizations and effectively managing budgets, endowments and other financial functions. At the same time, your executives and board members need to regularly monitor financial indicators.
Certain ratios can provide early warnings that, for example, your nonprofit is overspending on fundraising, inefficiently managing cash flow or could benefit from a larger operating reserves cushion. Keeping an eye on financial ratios can also tip you off to potential fraud in your organization. Here’s a short summary of four key ratios and what they can reveal.
Spending numbers
The first ratio is the percentage spent on program activities. It indicates how much of your total budget is used to provide direct services. To calculate this ratio, divide your total program service expenses by total expenses. A result higher than 65% is widely considered to be good, and 85% and above is usually excellent.
Percentage spent on fundraising is the second critical number. It represents how much you spend to raise a dollar and is a prime indicator of overall fiscal health. To calculate it, divide total fundraising expenses by contributions. The standard benchmark for fundraising and administrative expenses is 35%.
Current and reserve percentages
The current ratio represents your nonprofit’s ability to pay its bills, providing a snapshot of financial conditions at any given time. To calculate your current ratio, divide current assets by current liabilities. Typically, this ratio should be at least 1:1.
Then there’s the reserve ratio. This tells you whether your organization is capable of sustaining programs and services during temporary revenue and expense fluctuations. To calculate your nonprofit’s reserve ratio, divide expendable net assets (unrestricted and temporarily restricted net assets less net investment in property and equipment and less any nonexpendable components) by one day’s expenses (total annual expenses divided by 365). For most organizations, this number should be between 90 and 180 days. Base your target on the nature of your operations, your program commitments and the predictability of funding sources.
Other options
Depending on your niche and mission, there may be additional ratios your nonprofit should monitor. For example, a revenue diversification ratio can tell you how much of your funding depends on a single source (no one source should provide more than 30%). Similarly, a government reliance ratio can expose a dependence on potentially insecure grants. To learn more about these and other tools for effective nonprofit management, contact us.
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