Many factors play into a nonprofit’s financial status, but some categories are particularly indicative of underlying health and stability. Nonprofit leaders who recognize the importance of the factors below and act upon our suggestions to maximize them will be better positioned to withstand scrutiny from donors, board members and other interested parties and chart a course for sustained success.
Calculated as cash on hand divided by average monthly expenses, liquidity directly impacts an organization’s ability to respond to new opportunities and adapt to unforeseen budget constraints. It can be measured in terms of months of expenses that can be covered with available unrestricted cash on hand. Recent studies indicate that approximately 60 percent of organizations have less than three months of cash in reserve.
The right amount of liquidity for an organization depends on its unique factors such as fund volatility, facility needs, economic environment and cash management strategies. But as a general rule, organizations should strive to have, at a minimum, three to six months of unrestricted cash on hand.
#2 Program expenses as percentage of total expenses
Nonprofit watchdog agencies, such as GuideStar and Charity Navigator, pay particular attention to the percentage of program expenses incurred in relation to total expenses. According to Charity Navigator, seven out of 10 nonprofits listed on their site spend at least 75 percent of their expenses directly on their programs.
It is also important to monitor program expenses over an extended period of time. Growth in program expenses as a percentage of total expenses would indicate a growing and vibrant organization, whereas a consistent reduction in program expenses could indicate a shrinking nonprofit cutting back on program activities.
#3 Sources of unrestricted recurring dollars
A nonprofit should start its annual budgeting process by identifying the recurring unrestricted revenues received each year. While recurring revenues may not always come from the same sources, the ability to reasonably predict a steady level of income helps the organization adequately budget for routine expenditures and demonstrates revenue reliability. Nonprofits should avoid balancing budgets with nonrecurring revenues, one-time grants or contributions and other uncertain revenue sources.
One reliable source of recurring unrestricted revenue received each year should be contributions by an organization’s board members. Organizations should seek 100 percent board participation in giving. However, organization should be careful not to set contribution minimums that board members should meet. In contrast, board members should contribute to the organization a gift that is meaningful to them and their own personal financial situation.
#4 Liabilities as percentage of total assets
Measuring an organization’s liabilities as percent of total assets shows how much it owes relative to what it owns. While debt can be used to manage cash flows for things like operations, facility purchases and upgrades, it is important to manage debt appropriately. As a rule of thumb, organizations should strive to keep this ratio below 50 percent.
#5 Full-cost coverage
Many nonprofits develop budgets on the cash basis to help manage and understand the amount of cash coming in and going out of the organization each month. During the budgeting process, it is also important to understand the hidden costs of doing business and include those in the budget.
Organizations should set revenue targets high enough to cover depreciation of fixed assets, payment of debt principal and, if possible, an amount for surplus funds. By budgeting to cover the depreciation expense of fixed assets, organizations are able to grow a surplus for asset replacement in the future. Covering the full cost of doing business will ensure an organization’s longer-term sustainability and help maintain a strong liquidity position as discussed above.
#6 Fundraising expenses as percentage of total contributions
Many nonprofits rely heavily on grants and contributions from donors and support agencies. While raising these funds are vital to an organization’s survival, it is also important to understand and maintain a measurement of the cost of obtaining those revenue sources.
Calculating fundraising expenses as a percentage of total contributions allows nonprofits to see the cost of each dollar raised. While there is no right answer of the amount of money that should be spent to raise a dollar, a best practice is to keep administrative and fundraising costs under 20 percent of expenses. This translates into a fundraising cost of less than ten cents of every dollar raised.
#7 Cash flow from operations
The amount of cash flows from operations presented on the Statement of Cash Flows is many times a more accurate reflection of the results of unrestricted operations of a nonprofit than its net income. This figure removes the effects of restricted grants or contributions, depreciation expense and investment income. A positive cash flow from operations would indicate that an organization is effectively covering their costs of unrestricted operations and programming.
When evaluating these or any other financial metrics, make sure to review them not only for the current year but for a three to five-year history so trends or outliers can be identified. RKL has a deep bench of professionals with the industry expertise and financial acumen to help your organization assess its financial standing and position it for long-term sustainable success. To get started, contact Doug Berman, RKL’s Not-for-Profit Industry Group leader.