Do you understand the financial reports that you receive each month with your board packet? Financial oversight is a major responsibility of all nonprofits board members, not just the treasurer. By the time you finish reading this article, you will have two quick tools to help you better use those financial reports. Just as for-profit businesses use ratios to evaluate their finances, nonprofits can use similar ratios to help better understand their financial reports. This article explains two key ratios that every board member needs to understand. Information for the ratios comes from the Statement of Financial Position (called the Balance Sheet in for-profit accounting). Board members should receive this report monthly.
The first ratio to determine is your Current Ratio which is a standard measure of liquidity calculated by dividing current assets by current liabilities. A current ratio of 1.5:1 is generally considered acceptable because this indicates more than sufficient funds are available to meet short-term cash needs. For example, if your current assets are $50,000 and your current liabilities are $25,000, then your current ratio is 2:1. This means you have the resources on hand to pay all your current debts and more. If your current assets are $25,000 and your current liabilities are $50,000 you have a ratio of 1:2 and would not be able to pay your current debts.
Board members can use the current ratio to look at the short-term situation (usually a period of a year or less). For example, if your current ratio indicates you have twice as much cash on hand as you need immediately, this may be the time to establish a reserve account or begin a new program or service you have delayed because of lack of resources. If your current ratio shows that you can’t pay your current debt, this may be the time to implement a new fundraising endeavor or find a way to reduce expenses.
The second key ratio is the Debt Ratio which measures the relationship of total liabilities to total assets of the nonprofit. This is an indicator of financial solvency and should definitely be less than 1.0. For example, if your total assets are $50,000 and your total liabilities are $40,000, you could pay all of your debts and still have $10,000 in the bank. In this case, your debt ratio would be.9. Higher ratios could indicate financial problems in the future. For example, if your total assets are $50,000 and your total liabilities are $60,000, then the debt ratio would be.83 – and you could not pay your total liabilities should the need arise
Board members can use the debt ratio to look at the long-term health of the nonprofit. A higher ratio here could indicate serious financial problems in the future as many nonprofits unfortunately discovered in the recent economic downturn. It may be acceptable to have a minor problem with a current ratio as long as there is a plan in place to rectify the situation. However, board members should not accept a debt ratio higher than 1.0 and ideally this ratio should be lower.
© 2010 Jane B. Ford