Ratio Analysis Used to evaluate relationships among financial statement items Used to identify trends over time for one entity or to compare two or more entities at one point in time Three key types of ratios: Liquidity Profitability Solvency
Liquidity Ratios Measure the ability of the entity to repay its short-term debts and meet unexpected cash needs Current ratio – Measures the entity’s ability to pay its current obligations using current assets. Calculated by dividing current assets by current liabilities.
Liquidity Ratios Quick ratio – Quick assets are defined as cash, marketable securities and accounts receivable (very liquid assets). Calculated by dividing the quick assets by current liabilities. Rule of thumb for this ratio is 1:1. A downward trend in these ratios could indicate cash flow troubles.
Liquidity Ratios Receivables turnover – Measures the number of times in a year an entity collects its receivables. Calculated by dividing net credit sales by average net receivables. A downward trend it this ratio could indicate billing or collection problems with accounts receivable.
Liquidity Ratios Average collection period – Measures the number of days it takes to collect the average receivable balance. A good rule of thumb is the average collection period should not be significantly greater than the entity’s credit term period. Calculated by dividing 365 days by the receivables turnover. Lower is favorable.
Liquidity Ratios Defensive Interval Ratio – Measures the adequacy of the resources of the entity to support its mission. Calculated by dividing quick assets by average monthly expenses.
Profitability Ratios Profitability ratios measure an entity’s operating efficiency, including its ability to generate income and cash flow. Profit margin ratio – Measures the entity’s ability to turn its revenue into net income. Calculated by dividing net income by net sales.
Profitability Ratios Asset turnover ratio – Measures how efficiently an entity is using its assets. Calculated by dividing net sales by average total assets. Both these ratios need to be compared to industry statistics to be evaluated.
Profitability Ratios Return on assets ratio – Overall measure of profitability. Measures how much net income was generated for each $1 of assets the entity has. Calculated by dividing net income by average total assets or multiplying the profit margin ratio by the asset turnover ratio.
Solvency Ratio Measure long-term risk. Debt to total assets ratio – Measures the percentage of assets provided by creditors. Calculated by dividing total debt (liabilities) by total assets.
Nonprofit Specific Ratios Fundraising Efficiency – Measures the relative cost to produce voluntary contributions from the general public. Calculated by dividing total contributions by fundraising expense.
Nonprofit Specific Ratios Program Service Expense Ratio – Measures the efficiency in the funds spent on the nonprofit’s mission. Calculated by dividing total program service expense by total expenses.
Nonprofit Specific Ratios Supporting Service Expense Ratio – Measures the percentage of funds spent on supporting services (management & general and fundraising).
Nonprofit Specific Ratios Unrestricted Net Asset Ratio – Measures the amount of unrestricted, spendable net assets in relation to the nonprofits annual operating expenses.
Nonprofit Specific Ratios Net Temporarily Restricted Asset Ratio – Indicates if the nonprofit is borrowing from the future or from net assets intended for future periods. Calculated by dividing temporarily restricted net assets (plus deferred revenue) by cash and cash equivalents.
Benchmarking Benchmarking is the use of nonfinancial information and ratio analysis to identify trends over time in one entity or to compare to competitors at a point in time. Used to establish internal goals, pinpoint opportunities, identify strengths and weaknesses.
Benchmarking Before beginning with benchmarking each entity should answer the following questions: Why benchmark? Who is going to use the results? What are you going to measure?
Benchmarking Why benchmark? Save time by reviewing highlights Track progress toward goals Spot potential problems Identify patterns Provide meaningful information
Benchmarking Who is going to use the results? Knowing who is going to use the information is key to determining what to measure. Groups that may benefit from benchmarking are the Board of Directors, senior leadership, and program managers. Each of these groups will measure different metrics.
Benchmarking What to measure? Knowing what to measure and why is the key to effective benchmarking. Below are five areas to consider when selecting appropriate benchmarks. Mission related outcomes Strategic initiatives Drivers of success Risk factors Services and resources
Benchmarking Mission related outcomes A common nonprofit mission is to produce some sort of beneficial change in a defined population. These nonprofits measure success of the mission by defining and measuring the program’s outcomes. An example of an outcome would be “improved health of the un- insured population of a community”. Incremental improvements in health might be hard to measure, so the nonprofit would define the outcome in terms of outputs, activities or inputs.
Benchmarking Outputs are the direct products of program activities. Examples include: Number of patient visits Number of classes taught Number of counseling sessions conducted Number of participants served
Benchmarking Inputs are the resources that are dedicated to or consumed by the program. Examples include: Money Staff time Volunteer time Facilities
Benchmarking Activities are what the program does with inputs to fulfill the mission. Examples include: Feed homeless families Provide job training Educate public about signs of child abuse Mentor youth
Benchmarking Strategic Initiatives Strategic initiatives tie into the strategic plan’s major themes, directions or initiatives and should define the benchmarking metrics.
Benchmarking Drivers of Success Drivers of success are the key performance indicators, outcomes, goals or activities that are essential for fulfilling the mission. Risks Factors Risks factors negatively affect the success of the organization. They include regulatory noncompliance, potential litigation, and financial risk factors such as default on debt obligations.
Benchmarking Services and resources Service responsiveness is the degree to which existing services are responsive to existing needs. It can be gauged by trends in clients served, client satisfaction scores, retention rates. Service quality can be gauged by measures of repeat business, complaints or referrals.
Benchmarking Services and resources Resource acquisition measures how effective the organization is in getting necessary resources such as contributions or required staff. Resource management includes a broad range of financial indicators that manage financial efficiency and budget adherence.
Dashboards Dashboards are user-friendly tools for displaying performance measures (benchmarks) to the Board or management. The dashboard displays several key indicators that can demonstrate progress toward a goal or warning signs of a pending problem.
Dashboards Once an organization has determined what to benchmark, they can present the information in a dashboard format. Dashboard typically come in two formats: Scorecard format presents the key performance indicators and whether they are trending up or down. Graphical format presents the key performance indicators as graphs and charts.