The working of a non-profit organization is similar to that of a for-profit organization, but their financials are different. The objectives of the two organizations differ, and so do their methods for earning revenue, raising funds, forecasting, budgeting, and spending. Hence, non-profit organizations use different ratios for financial planning and tracking.
How Money Flows into A Non-Profit Organization
A non-profit organization raises money through donations, grants, and income earned. The money they receive is used for a specific program and to support the organization’s operations. Donors who give money request accountability, seeking assurance that the funds and assets they have donated are being used for the cause they support.
Financial Ratios to Better Manage Non-Profit Organizations
You can divide the flow of money into three stages. You can use various financial ratios to track the organization’s finances at every stage, ensuring its smooth operation.
Determining the Need for Funding
The first stage of the funds flow is to determine how much money the organization needs, when it needs it, and for what purpose it needs the money. The purpose is important as many donations and grants non-profit organizations (NPOs) receive are for specific purposes, such as grants for cancer treatment, education of children, or care for pets. This money is called restricted funds.
1. Operating Reserve Ratio = Unrestricted Net Assets ÷ Average Monthly Expenses
The donations and grants are seasonal. Hence, NPOs keep some money in reserve to pay for the low-income days. An organization may maintain three to six months of reserves to ensure ample liquidity to run its operations, even if no donations are received.
The Operating Reserve Ratio can alert you to the number of months of reserves you have available. You can determine a benchmark that is comfortable for your operations. Suppose you keep a five-month reserve. A decrease in the ratio could alert you to divert surplus money to reserve or cut costs.
This ratio can also help with budget planning and determining the allocation of unrestricted assets.
2. Ratio of Unrestricted Revenue = (Unrestricted Revenue ÷ Total Revenue) x 100
An NPO must account for restricted and unrestricted revenue separately, as restricted revenue can only be used for its designated purpose. Even if the NPO has restricted money, it cannot use it for administrative, operating, or fundraising purposes. The management can determine the ratio of unrestricted revenue they need to run the NPO and target their campaigns to raise unrestricted donations.
Planning Fundraising Campaigns
The next stage of cash flow is fundraising. An NPO aims to raise the maximum amount of money by spending the minimum. Moreover, they want to draw money from diverse resources to reduce their dependency on a single source. NPOs can use three ratios to make fundraising campaigns effective and efficient.
3. Fundraising Efficiency = Total Fundraising Revenue ÷ Fundraising Expenses
The ratio tells you how much money you raised for every dollar spent. The higher the ratio, the more efficient the fundraising. Management can identify the efficiency of past campaigns and channel resources to the most effective ones.
4. Revenue Diversity Index = Source of Revenue ÷ Total Revenue
An NPO should have a diversified revenue stream. Suppose you get 80% from individual donations, with no single donor accounting for more than 30% of revenue. It will show you the diversity of your revenue and your dependence on each source.
The management can use the revenue diversity index to determine which source to target for the next fundraising campaign. They can also study the index to shortlist the most reliable sources and accordingly build a benchmark diversity index.
5. Donor Retention Rate = (Repeat Donors ÷ Total Donors from Prior Year) x 100
For a business, generating revenue from existing customers is always more cost-effective than acquiring new ones. Similarly, NPOs can focus on donor retention to make fundraising efficient. A dip in the donor retention rate could alert you to focus on donor engagement and retention.
Efficient Utilization of Funds
6. Program Efficiency Ratio = Program Expenses ÷ Total Expenses
7. Administrative Cost Ratio = Administrative Expenses ÷ Total Expenses
This is where the accounting of restricted and unrestricted funds matters. An NPO needs to balance the use of funds between the program (the cause they are working towards) and other expenses. Donors typically examine this ratio to determine how their funds are being utilized.
While program efficiency is higher than administrative cost, very high spending on the program (90-95%) could indicate that the NPO may not be investing in its infrastructure. At the same time, incurring excessive administrative costs could indicate that the NPO is undermining the program or that its operations are inefficient. Even though NPOs are not interested in profits, they have to be efficient in fund usage.
An NPO should determine the right balance between the two costs. This ratio can help forecast funds requirements and balance restricted and unrestricted funds.
8. Outcome Metrics
This metric is not a ratio, but a showcase of the cause the NPO is working for, and how much it has succeeded in that cause. Suppose an NPO distributes meals to the homeless; they can specify how many meals were distributed to each beneficiary. If an NPO helps strayed animals, it can specify how many animals they provide shelter to and the improvement in their health.
NPOs can use these numbers to communicate to donors how they made a difference and encourage them to donate more. It can help retain donors.
The above financial ratios are generic monitoring tools to get you started. Once you start using ratios, you can build specific ratios that better define your financial needs. You can tweak the benchmarks depending on the overall financial or macro situation.
Contact Ford Keast LLP in London, Ontario, to Help Non-Profit Organizations Track Financials
A financial consultant can help you prepare a dashboard to track your NPO’s financial performance, timely review the performance, and improvise. At Ford Keast LLP, our accountants and consultants offer a range of services, including financial reporting and analysis. To learn more about how Ford Keast LLP can provide you with the best accounting and consulting expertise, contact us online or call us at 519-679-9330.
