The COVID-19 pandemic has resulted in unprecedented disruption to the global economy creating significant financial pressures for many Associations. The association landscape as we know it has changed in many ways. Meetings and annual conferences have been postponed, pivoted to virtual, or have been eliminated entirely. Membership attrition rates in some cases are trending to historical highs, putting further strain on already scarce resources. Now more than ever, organizations are best served by deploying a full arsenal of financial tools. Below we identify the “five must-have ratios” associations should consider when assessing the financial health of their organization.
1. Operating Reserve Ratio
Probably the most well-known but often ignored ratio related to organizational security and liquidity, essentially this ratio indicates how long an organization can continue operations without any incoming revenue. It can be stated as a percentage or in number of months. The most common benchmark range for this ratio is a minimum of three to six months of reserves. This ratio evaluates the cushion for the unexpected should declines in revenue sources befall the organization. When an unexpected shortfall occurs, having cash reserves to tap into can help sustain the organization through tough times. There is a caveat here though, in that bigger may not always be better; too high of an operating reserve may indicate that the organization may be losing other opportunities to further its mission. The story of Goldilocks’ porridge is a good analogy; it should be “just right.”
2. Current Ratio
This ratio indicates the organization’s ability to meet short term obligations by comparing current assets to current liabilities. A ratio of at least one should be considered the minimum threshold with the goal of two or greater. A current ratio below one means that current liabilities are more than current assets, which may indicate liquidity problems.
3. Liquid Funds Indicator
This ratio is used to reflect how many months of operation the organization has in liquid assets. It compares the total net assets less restricted and fixed assets to the average monthly expenses. It is more conservative than the Defensive Interval below because it removes assets with restrictions.
4. Defensive Interval
Much like the Liquid Funds Indicator, this ratio calculates the days of average expenses the organization’s highly liquid current assets would cover.
5. Profit Margin Ratio
The old saying “non-profit is a tax status, not a business philosophy” is more relevant today than ever. Identifying whether the organization is earning or receiving more than it is spending on operations is critical to the ability to deliver benefits and services for members and the overall sustainability of the organization for the long term. The target profit margin would depend greatly on the organization’s size, goals, and benefits or services offered. When the profit margin is too high, it may indicate that dues are too high, discouraging membership. Conversely, when the profit margin is too low or even negative it may indicate the opposite. There may be times when an organization plans to have a negative margin, due to investing in new programs or offerings which have lead times before revenue outpaces expense. Planned negative margins are also seen when there may be a need to correct reserve balances. However, running consistent negative profit margins is a warning sign that the organization may be headed into financial trouble.
Ratios alone are not the “silver bullet” to predicting or evaluating an organization’s financial condition or health. Ratio analyses are great tools and can provide excellent insight to an organization’s fiscal health. They are part of a broader set of financial best practices and methodologies that include budgeting, forecasting and financial statement review and analysis. As in the story of Goldilocks, getting it “just right” is unique to each organization. Financial ratios in conjunction with sound and consistently applied financial best practices is the best chance to ensure your organization is fiscally sound.