Financial performance measurement is a strategy a not-for-profit (NFP) can use for evaluating operations, programs, services and financial stability. One of the key measurement tools is financial ratio analysis. It involves taking data from your NFP’s financial statements, using it to calculate ratios appropriate for your NFP, and then benchmarking those ratios against past performance, management objectives or other organizations.
Utilizing financial ratio analysis can help you assess your NFP’s overall financial condition and liquidity and flag patterns that might not be conducive to your NFP’s success.
If we look closer at liquidity, there are certain measures that can be used to ensure your NFP has a sufficient level of cash flow for continued programmatic operations and growth. There are three main financial ratios you may want to consider to measure your NFP’s liquidity:
1. Current ratio equals current assets divided by current liabilities. A 2-3 ratio generally indicates that the NFP has adequate liquid funds to pay its current obligations.
2. Quick ratio equals current assets (less any inventory amounts) divided by current liabilities. A ratio of 1 – 2 generally indicates an NFP has adequate liquid funds to pay its current obligations without selling inventory.
3. Organizational liquidity funds indicator equals expendable net assets divided by average monthly total expenses. Expendable net assets are calculated as net assets less restricted endowments, fixed assets and prepaid expenses. This indicator measures how many months the NFP has before it will consume its liquid assets, assuming that no additional revenue flows into the NFP. The higher the ratio, the better the liquidity.
These ratios are fairly easy to calculate for any NFP and you can then benchmark your organization by comparing it to other similar NFPs. Comparing your organization’s performance to benchmarks allows you to zero in on areas with the greatest potential for improvement. Using this information, you may be able to improve performance without making significant changes in your operations. Further, when comparing against similar NFPs, you might improve performance by simply adopting best practices used by your peers. You can obtain information on other nonprofits’ metrics from websites such as GuideStar and Charity Navigator.
Using monthly, quarterly or even yearly financial ratio analysis can help you understand your NFP’s liquidity and provide you with valuable insight into your organization’s financial future. You will be able to identify the strengths and weaknesses of your NFP and take appropriate actions to improve liquidity.
This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Fall 2015). Copyright © 2015 BDO USA, LLP. All rights reserved. www.bdo.com
