Due to the COVID pandemic, there have been declines in profits and tighter cash flows that have really put a strain on a lot of non-profit organizations. There are a lot of financial indicators to assess the organization’s financial health, but the following are some key ratios that can be used to help determine if the organization needs to make some proactive changes before it has to permanently close its doors:
The ratio measures the organization’s ability to pay short-term obligations or those due with one year.
The ratio is calculated by taking current assets (i.e. cash, accounts receivables, inventory, etc.) divided by current liabilities (accounts payable, accrued personnel, deferred revenue, debt coming due within the upcoming year). Once calculated, organizations should have at least a 1:0 ratio.
Before the organization panics if it is less than 1:0, consider the following:
- Comparing it to prior periods to determine where the organization was at prior to COVID. The organization might historically operate at a less than 1:0 ratio so there might not be an immediate financial concern.
- Refinancing debt to achieve lower interest rates and more affordable monthly payments.
The ratio measures how much of a reserve the organization has and how many months the organization could continue to operate.
The reserve is calculated as follows: Net assets without donor restrictions less net property and equipment plus debt related to that property equipment less designated net assets. The organization can adjust the reserve to include designated net assets since those net assets can be undesigned by the board at any time.
To convert the reserve into months, the organization would perform this multiple step calculation:
Step 1: Determine cash related expenses by taking total expenses for the year and subtracting in-kind and depreciation expenses.
Step 2: Take the annual cash related expenses divided by 12 to get an estimate of monthly expenses.
Step 3: Take the reserve amount calculated above divided by Step 2 to determine how many months the organization can operate on its reserve.
The organization will want to compare these calculations for both the reserve in dollars and in months to prior year calculations. The organization will want to maintain a positive reserve in dollars and avoid significant declines from year-to-year. In addition, it is best practice the reserve in months be between 3 and 6 months and not to exceed 24 months.
Management and General Expenses to Total Expenses
The ratio measures how much of total expenses are administrative.
The ratio is calculated by taking total management and general or administrative expenses divided by total expenses. Management and general expenses can come from your audited or reviewed financial statements on the Statement of Functional Expenses. Once calculated, the ratio should not exceed 20%.
This is a great ratio to see if you should be cutting down on some administrative expenses or if you are not spending enough on programing.
When calculating these ratios, you cannot just look at any one ratio. Assess these ratios together as well as other financial ratios will give you a whole picture of how the organization is doing. Since there is so much uncertainty in our futures, it is best to evaluate and monitor the organization’s financial health now before it is too late to make changes.
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