Create a Financial Analysis Tool Kit

Nonprofits are subject to constantly increasing financial and operational challenges along the road to achieving their goals in our profit-based world. Treating your organization more like a business -- focusing on figures and financial analyses -- is becoming a necessity of survival.

Luckily, the same financial analysis tools that are used by businesses are available to your nonprofit -- tools that will help you get an accurate view of your organization’s strengths and weaknesses. Just because you are a nonprofit doesn’t mean you can’t learn a thing or two from the for-profit sector!

Three tools of the trade that will help you analyze your organization are common size financial statements, ratios and budgets.

Tool No. 1: Common Size Financial Statements
Common size financial statements express financial results in percentages rather than in absolute amounts by comparing revenue and expenses to total income. They are useful for determining the relative size of revenue to expenses and are also  valuable for spotting trends. 

This percentage data is unique to your organization. While there may be some benefit in comparing yourself with another organization, the most revealing statistics come from monitoring your own trends. 
For example, if your volume of activities increases every year, determining whether you are becoming more or less dependent on gifts and contributions is difficult. Percentage data will help you spot this trend immediately. Also, these percentages will reveal if certain expenses are growing disproportionately. 

Tool No. 2: Ratios
The next tool for the nonprofit analyst is the ratio. Proper selection and understanding of the many possible ratios is critical -- choosing a few that are revealing to your organization is better than choosing too many.

Ratios can be divided into two broad categories:
1. Ratios that address your financial position, and
2. Ratios that give insight into your operations. 

Financial Ratios 
Liquidity ratios (current assets/current liabilities). These tell how well you are able to pay expenses in the normal course of business. They include working capital, current and solvency ratio. Your liquidity ratio should be at least 1.25, and 2.0 gives much more breathing room. 

The debt to equity ratio (total debt/total net assets). Using this ratio to compare one organization with another is not always beneficial, but the trend from year to year for your organization will be revealing. 
Coverage ratio (net assets/expenses). This ratio will show to what extent your net worth can cover your expenses and how long you could operate if all revenue ceased coming in.

Operations Ratios
Program ratio (program expenses/total revenue). This shows how much of your total revenue is spent delivering your services.
Fund-raising ratio (fund-raising expenses/total fund-raising income). This ratio can vary depending on volunteer efforts.

Administrative ratio (administrative costs/total revenue). This discloses what percentage of total revenue administrative costs are. Add administrative to direct program cost to calculate the total cost of operating programs. This will confirm whether you have adequate funding to carry on programs. Once you have calculated administrative costs, you can calculate break-even for any program that receives funding on a fixed-per-unit or unit-of-service basis. 

Other Important Ratios
Salary ratio (salaries/total expenses). The trend here is most meaningful. Many organizations are experiencing increased technology costs relative to decreasing salary costs. However, salary continues to be the biggest cost for most nonprofits. 

Payroll overhead ratio (payroll tax and benefits/payroll). This analysis will help you determine the total cost of payroll. 

Occupancy cost per square foot ratio (total rent, utilities and expenses/square footage). Also particular to your organization, this ratio can tell you if your occupancy costs are too high.

Budget
The final tool that will provide tremendous benefit is a well-prepared budget. A well-prepared budget realistically considers the estimated level of operations and the total support and revenue for each program.

It will include a proper analysis of each of the cost relationships for the expenses of carrying on programs such as payroll cost per unit of service and payroll overhead ratio, among other things.

A budget will serve as a valuable tool in monitoring your actual results. It will deliver an early warning when finances are not on track and allow you to make necessary adjustments throughout the year. 

Get To Know Them
The good news about each of these tools is that they are readily available, thanks to technology. But remember, more isn’t better. Find the key ratios and analytic tools that give insight into your situation. Too much of a good thing will leave you confused rather than enlightened.