Financial ratios use data from your financial statements to provide indicators of financial performance, helping you to understand financial results and flagging trends or patterns. They can serve as useful early warning indicators of potentially serious financial problems, and should therefore be monitored on a regular basis.
When reviewing financial statements of our not-for-profit clients, there are three key financial ratios we often bring to management’s attention:
1. Current Ratio: Do I have enough money to pay bills as they come due?
This is the ratio of current assets to current liabilities. It is a measure of the organization’s ability to meet its short-term commitments. A ratio of less than 1:1 indicates the organization may have difficulty paying its bills in a timely manner, and may be facing cash flow issues.
2. Deferred Revenue Ratio: Am I spending money that was received up front and intended to pay for goods or services that have not yet been delivered?
It is the ratio of cash and investments to deferred revenue (also called unearned revenue). The amount of cash on hand should exceed the deferred revenue balance. If there is not at least as much cash as deferred revenue, then the organization has used funds that it has not yet actually earned. It has in effect borrowed from expected future revenues.
3. Operating Reserve Ratio: How long can I sustain operations without additional funding?
The ratio of expendable net assets to total expenses. It measures whether there are enough resources (operating reserves) to meet expenditures without having to borrow from lenders. Not for profits should have expendable net assets of at least 25% of annual expenditures.
Financial ratios are a valuable tool for any organization, providing insight into the financial health of an organization, and raising flags to signal when management action may be required. Different not-for-profits will have a need for different ratios, so we recommend discussing with your financial advisor which ones may be the most useful to report and monitor for your organization.
Find out more about financial ratios – call me and we can have a conversation. We can also talk about improving operating efficiency, reducing costs and strengthening your organization. Reach me at 613-727-1230 ext. 212 or firstname.lastname@example.org
Richard MacNeill, FCPA, FCMA, CMC, Dipl. T. is a partner at OTUS Group, a team of advisors to business, government and not-for-profit organizations.