Whenever you go to a doctor’s office or hospital, one of the first things they do is check your vital signs (i.e., pulse, temperature and blood pressure). Numbers that are unusually high or low, or change over time, may indicate an underlying problem that needs to be addressed.
For not-for-profit organizations, key performance indicators (KPIs) and other financial metrics serve a similar purpose. Tracking these numbers can help you identify areas where improvement is needed and provide an early warning of declining financial health. In addition, donors and charity watchdog agencies use financial metrics to evaluate organizations’ performance and determine whether they are worthy of financial support.
The most relevant financial metrics for your organization depend on its specific mission and operations. But to give you an idea of how they work, let us take a look at some commonly used metrics in the not-for-profit world.
Related Read: Use of Templates to Monitor Financial Performance
Program Expense Ratio
This simple but powerful metric measures the percentage of an organization’s total expenses that go toward its core mission — in other words, the portion of expenses spent on programs and services as opposed to things like management salaries, fundraising costs, technology and overhead. Because this ratio indicates how efficiently an organization makes use of its funding, it is very important to prospective donors and watchdog agencies. For example, Charity Navigator generally bestows its highest ratings on organizations with a program ratio of 85%or more. Generally, the higher this ratio, the better, but a certain level of spending on administrative costs is essential. If an organization’s program expense ratio is too high, it may have trouble sustaining itself in the future. Keep in mind that a specific organization’s program expense ratio depends on several factors, such as its size, geographical footprint, activities and revenue sources.
Fundraising Efficiency Ratio
This ratio gauges an organization’s fundraising efficiency by measuring the amount it spends on fundraising to generate a dollar of revenue. The lower this ratio, the better. Charity Navigator generally gives its highest ratings on organizations that spend less than ten cents for each dollar that they raise.
Operating Reserve Ratio
Financial planners usually advise families to have cash reserves set aside in case of unplanned expenses or financial emergencies, and the same is true for not-for-profit organizations. The operating reserve ratio measures the sufficiency of an organization’s funds to sustain it in the event of an emergency. This ratio refers to unrestricted net assets available in case of an emergency, as a percentage of annual expenses (excluding depreciation and amortization). It can also be expressed as the number of months that the organization could continue its operations with no new revenue coming in. For instance, if your organization’s operating reserve ratio is 50%, then its reserves would fund operations for six months. Organizations should typically strive to have sufficient reserves to cover expenses for three to six months.
Net Margin Ratio
Sometimes referred to as the “nonprofit operating margin ratio,” this metric is the equivalent of profit margin in the for-profit business world. It is calculated as: (Total revenues – total expenses)/total revenues. Not-for-profit organizations, by definition, do not generate profits, but their ability to earn revenues that exceed their expenses can be an indicator of financial health. The “right” margin depends on an organization’s particular characteristics, but a declining or negative net margin ratio may signal poor financial management. If margins are excessively high, donors may conclude that the organization has “more money than it needs” and redirect their charitable dollars elsewhere.
Track Your Numbers
These are just a few examples of the dozens of KPIs and financial metrics that not-for-profit organizations can use to monitor their vital signs and gauge their financial health. If you need help in determining which metrics are most relevant to your organization and assistance in setting up processes for tracking and analyzing the numbers, get in touch to see how we can help.
For more information, contact Segdrick Byrd at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Not-For-Profit Group. To learn more about our outsourced accounting and CFO services for not -for-profit organizations, visit ORBA Cloud CFO Services and How to Map Metrics to Your Mission.